UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-Q
(Mark one)
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended NOVEMBER 30, 2000
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
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COMMISSION FILE NUMBER 000-26565
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LIBERATE TECHNOLOGIES
(Exact name of registrant as specified in its charter)
DELAWARE 94-3245315
(State or Other Jurisdiction (I.R.S. Employer
of Incorporation) Identification No.)
2 CIRCLE STAR WAY, SAN CARLOS, CALIFORNIA 94070-6200
(Address of principal executive office) (Zip Code)
(650) 701-4000
(Registrant's telephone number, including area code)
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 [ ]
103,746,783 shares of the Registrant's common stock were outstanding
as of December 31, 2000.
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LIBERATE TECHNOLOGIES
FORM 10-Q
FOR THE QUARTER ENDED NOVEMBER 30, 2000
TABLE OF CONTENTS
PAGE
----
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets at November 30, 2000 and
May 31, 2000..................................................................... 1
Condensed Consolidated Statements of Operations and Comprehensive Loss
for the Three Months and Six Months Ended November 30, 2000 and 1999............. 2
Condensed Consolidated Statements of Cash Flows for the Six Months Ended
November 30, 2000 and 1999....................................................... 3
Notes to Condensed Consolidated Financial Statements................................. 4
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations.............................................. 8
Item 3. Quantitative and Qualitative Disclosure About Market Risk............................ 29
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.................................................................... 29
Item 2. Changes in Securities and Use of Proceeds............................................ 29
Item 3. Defaults in Securities............................................................... 30
Item 4. Submission of Matters to a Vote of Security Holders.................................. 30
Item 5. Other Information.................................................................... 30
Item 6. Exhibits and Reports on Form 8-K..................................................... 31
Signature..................................................................................... 32
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
LIBERATE TECHNOLOGIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands)
Unaudited
NOVEMBER 30, MAY 31,
2000 2000
-------------- --------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents.......................................... $ 140,642 $ 132,962
Short-term investments............................................. 236,556 176,053
Accounts receivable, net .......................................... 6,380 3,058
Receivable from affiliate, net..................................... 403 543
Note receivable.................................................... 2,000 --
Prepaid expenses and other current assets.......................... 7,050 6,054
-------------- --------------
Total current assets............................................. 393,031 318,670
Property and equipment, net........................................... 14,976 12,759
Restricted cash....................................................... 8,788 8,788
Long-term investments................................................. 119,523 121,607
Warrants.............................................................. 94,685 106,127
Purchased intangibles, net............................................ 543,437 177,482
Other assets.......................................................... 510 754
-------------- --------------
Total assets................................................... $1,174,950 $ 746,187
============== ==============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable................................................... $ 2,136 $ 1,759
Accrued payroll and related expenses............................... 3,787 4,303
Accrued liabilities................................................ 12,509 10,290
Current portion of capital leases.................................. 636 607
Deferred revenues.................................................. 58,875 69,132
-------------- --------------
Total current liabilities...................................... 77,943 86,091
Capital lease obligations, net of current portion..................... 752 1,019
Long-term liabilities................................................. 1,267 910
-------------- --------------
Total liabilities.............................................. 79,962 88,020
-------------- --------------
COMMITMENTS AND CONTINGENCIES (NOTE 5)
STOCKHOLDERS' EQUITY:
Common stock....................................................... 1,035 909
Contributed and paid-in capital.................................... 1,395,790 803,400
Warrants........................................................... 88,908 89,770
Deferred stock compensation........................................ (4,243) (5,583)
Stockholder notes receivable....................................... -- (8)
Accumulated other comprehensive income............................. 554 162
Accumulated deficit................................................ (387,056) (230,483)
-------------- --------------
Total stockholders' equity .................................... 1,094,988 658,167
-------------- --------------
Total liabilities and stockholders' equity..................... $1,174,950 $ 746,187
============== ==============
The accompanying notes are an integral part of these condensed
consolidated financial statements.
1
LIBERATE TECHNOLOGIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE LOSS
(in thousands, except per share data)
Unaudited
THREE MONTHS ENDED SIX MONTHS ENDED
NOVEMBER 30, NOVEMBER 30,
-------------------------- ---------------------------
2000 1999 2000 1999
------------ ------------ ------------ ------------
REVENUES:
License and royalty................................ $ 5,726 $ 2,000 $ 10,302 $ 3,482
Service............................................ 6,002 4,074 10,830 7,880
------------ ------------ ------------ ------------
Total revenues................................... 11,728 6,074 21,132 11,362
------------ ------------ ------------ ------------
COST OF REVENUES:
License and royalty................................ 650 586 1,261 1,108
Service............................................ 6,100 5,131 11,433 10,693
------------ ------------ ------------ ------------
Total cost of revenues........................... 6,750 5,717 12,694 11,801
------------ ------------ ------------ ------------
Gross margin..................................... 4,978 357 8,438 (439)
------------ ------------ ------------ ------------
OPERATING EXPENSES:
Research and development........................... 11,416 6,300 23,510 11,642
Sales and marketing................................ 5,717 3,702 10,741 6,918
General and administrative......................... 2,637 1,756 5,219 3,180
Amortization of purchased intangibles.............. 55,288 1,521 105,549 3,042
Amortization of warrants........................... 5,721 710 11,767 1,069
Amortization of deferred stock compensation........ 476 525 975 1,029
Acquired in-process research and development....... -- -- 22,425 --
------------ ------------ ------------ ------------
Total operating expenses......................... 81,255 14,514 180,186 26,880
------------ ------------ ------------ ------------
Loss from operations............................. (76,277) (14,157) (171,748) (27,319)
Interest income, net.................................. 8,292 1,903 15,948 2,898
Other income (expense), net........................... (369) (262) (569) (560)
------------ ------------ ------------ ------------
Loss before income tax provision................. (68,354) (12,516) (156,369) (24,981)
Income tax provision.................................. -- 8 204 49
------------ ------------ ------------ ------------
Net loss......................................... $ (68,354) $ (12,524) $(156,573) $ (25,030)
Foreign currency translation adjustment............... 214 (38) 392 (53)
------------ ------------ ------------ ------------
Comprehensive loss............................... $ (68,140) $ (12,562) $(156,181) $ (25,083)
============ ============ ============ ============
Basic and diluted net loss per share.................. $ (0.66) $ (0.15) $ (1.55) $ (0.46)
============ ============ ============ ============
Shares used in computing basic and diluted net loss
per share........................................... 103,047 83,204 100,744 54,780
============ ============ ============ ============
The accompanying notes are an integral part of these condensed
consolidated financial statements.
2
LIBERATE TECHNOLOGIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
Unaudited
SIX MONTHS ENDED
NOVEMBER 30,
--------------------------------
2000 1999
--------------- --------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss................................................................ $ (156,573) $ (25,030)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization......................................... 107,934 3,868
Amortization of warrants.............................................. 11,767 1,069
Provision for doubtful accounts....................................... -- 202
Write-off of acquired in-process research and development............. 22,425 --
Loss on disposal of property and equipment............................ -- 600
Non-cash compensation expense......................................... 974 1,029
Changes in operating assets and liabilities:
Increase in accounts receivable..................................... (3,322) (1,787)
(Increase) decrease in receivable from affiliate, net............... 140 (271)
Increase in prepaid expenses and other current assets............... (1,341) (1,150)
(Increase) decrease in other assets................................. 281 (397)
Increase in restricted cash......................................... -- (8,788)
Increase (decrease) in accounts payable............................. 377 (327)
Increase (decrease) in accrued liabilities.......................... (6,206) 855
Increase (decrease) in accrued payroll and related expenses......... (516) 391
Decrease in deferred revenues....................................... (10,257) (4,239)
Increase in other long-term liabilities............................. 357 --
------------- ---------------
Net cash used in operating activities............................ (33,960) (33,975)
------------- ---------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment..................................... (3,678) (4,474)
Purchase of investments................................................. (58,419) (65,078)
Issuance of note receivable............................................. (2,000) --
Cash acquired in MoreCom acquisition.................................... 1,500 --
------------- ---------------
Net cash used in investing activities............................ (62,597) (69,552)
------------- ---------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from initial public offering, net.............................. -- 97,970
Proceeds from private placement, net.................................... 100,000 12,125
Proceeds from exercise of stock options................................. 4,182 838
Principal payments on capital lease obligations......................... (337) (63)
------------- ---------------
Net cash provided by financing activities........................ 103,845 110,870
------------- ---------------
Effect of exchange rate changes on cash.................................... 392 (53)
------------- ---------------
Net increase in cash and cash equivalents.................................. 7,680 7,290
Cash and cash equivalents, beginning of period............................. 132,962 33,657
------------- ---------------
Cash and cash equivalents, end of period................................... $ 140,642 $ 40,947
============= ===============
The accompanying notes are an integral part of these condensed
consolidated financial statements.
3
LIBERATE TECHNOLOGIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Unaudited
NOTE 1. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements
include the accounts of Liberate Technologies ("Liberate" or "the Company") and
its wholly owned subsidiaries. All intercompany accounts and transactions have
been eliminated. These financial statements have been prepared by Liberate,
without audit, and reflect all adjustments, which in the opinion of management
are necessary to present fairly the financial position and the results of
operations for the interim periods. These financial statements have been
prepared in accordance with the rules and regulations of the Securities and
Exchange Commission. However, they omit certain information and footnote
disclosures necessary to conform to generally accepted accounting principles.
These statements should be read in conjunction with the audited consolidated
financial statements and notes to consolidated financial statements included in
Liberate's Form 10-K and subsequent reports on Form 10-Q filed with the
Securities and Exchange Commission since August 25, 2000. The results of
operations for such periods do not necessarily indicate the results expected for
the full fiscal year or for any future period.
RECENT ACCOUNTING PRONOUNCEMENTS. In March 2000, the Financial
Accounting Standards Board's (FASB) Emerging Issue Task Force ("EITF") reached a
consensus on EITF 00-2, "Accounting for Web Site Development Costs." EITF 00-2
discusses how an entity should account for costs incurred to develop a web site.
The Company does not believe that the adoption of EITF 00-2 will have a material
effect on its financial position or results of operations.
In June 1998, the FASB issued Statement of Financial Accounting
Standard (SFAS) No. 133, Accounting For Derivative Instruments And Hedging
Activities. SFAS No. 133 establishes accounting and reporting standards for
derivative financial instruments and hedging activities related to those
instruments, as well as other hedging activities. The Company is currently
evaluating the effect SFAS No. 133 will have on its financial position, results
of operations and cash flows. The Company will be required to adopt SFAS No. 133
in fiscal 2002.
NOTE 2. OFFERINGS OF COMMON STOCK
COMMON STOCK. In July 2000, Cisco Systems, Inc. purchased 3,963,780
shares of the Company's common stock at approximately $25.23 per share,
resulting in aggregate cash proceeds to the Company of approximately $100.0
million.
During the six months ended November 30, 2000, Liberate issued
1,035,917 shares of common stock to employees, external consultants and other
service providers upon the exercise of stock options and an additional 201,075
shares of common stock to certain customers upon the exercise of warrants.
WARRANTS. In fiscal year 1999, the Company entered into letter
agreements with several network operators whereby it agreed to issue warrants to
purchase up to an aggregate of 4,599,992 shares of common stock that are
exercisable if those network operators satisfy certain milestones. The value of
the warrants is estimated using the Black-Scholes model as of the earlier of the
grant date or the date that it becomes probable that the warrants will be
earned. Pursuant to the requirements of Emerging Issues Task Force No. 96-18,
the warrants will continue to be revalued in situations where they are granted
prior to the establishment of a performance commitment. The value of the
warrants is recorded primarily as a non-current asset on the accompanying
condensed consolidated balance sheet and will be amortized over the estimated
economic life of the arrangements with the network operators.
As of November 30, 2000, warrants to purchase up to 2,336,660 shares of
the Company's common stock were earned by these network operators. The fair
market value of these warrants at the time they were earned was $117.2 million.
Amortization of warrants was approximately $5.7 million and $710,000 for the
three months ended November 30, 2000 and 1999, respectively. This increase was
primarily due to amortization related to additional warrants earned since
November 30, 1999.
4
If the remaining warrants are earned or the Company decides to issue
additional warrants to new customers, the Company will be required to record
significant non-cash accounting expenses or offsets to revenue related to any
such warrants. As a result, the Company could incur net losses or increased net
losses for a given period and this could seriously harm the operating results
and stock price of the Company.
NOTE 3. SEGMENT INFORMATION
The Company operates solely in one segment--providing software and
services to a broad range of information appliances, such as cable and
satellite set-top boxes. As of November 30, 2000, the Company's long-term
assets were located primarily in the United States. The Company's revenues by
geographic area are as follows:
THREE MONTHS ENDED SIX MONTHS ENDED
NOVEMBER 30, NOVEMBER 30,
-------------------------- --------------------------
2000 1999 2000 1999
------------ ------------ ------------ ------------
(in thousands)
England............................. $ 5,139 $1,207 $ 8,436 $ 2,167
United States....................... 3,212 3,122 7,190 5,904
Japan............................... 1,085 1,015 1,602 1,812
Canada.............................. 974 293 1,409 346
Other............................... 1,318 437 2,495 1,133
------------ ------------ ------------ ------------
Total revenues...................... $11,728 $6,074 $21,132 $11,362
============ ============ ============ ============
International revenues consist of sales to customers incorporated in
foreign countries. International revenues were 73% and 49% of total revenues for
each of the three months ended November 30, 2000 and 1999. For each of the six
months ended November 30, 2000 and 1999, international revenues were 66% and 48%
of total revenues.
For the three months ended November 30, 2000, two customers each
provided for 10% or more of the Company's total revenues--Cable & Wireless
(recently acquired by NTL) and Telewest. For the six months ended November
30, 2000, three customers each provided for 10% or more of the Company's
total revenues--Cable & Wireless, Telewest and America Online. For both the
three months and six months ended November 30, 1999, two customers each
provided for 10% or more of the Company's total revenues--Wind River and
Cable & Wireless.
NOTE 4. CALCULATION OF NET LOSS PER SHARE
Shares used in computing basic and diluted net loss per share are based
on the weighted average shares outstanding in each period. The effect of
outstanding stock options and warrants are excluded from the calculation of
diluted net loss per share, as their inclusion would be antidilutive. Previously
issued preferred stock, which converted to common stock, is weighted from the
time the shares were converted. At May 31, 2000, options to purchase 13,298,048
shares of common stock and warrants to purchase 2,103,328 shares of common stock
were outstanding and were excluded from the calculation of net loss per share.
At November 30, 2000, options to purchase 16,320,080 shares of common stock and
warrants to purchase 1,853,328 shares of common stock were outstanding and were
excluded from the calculation of net loss per share.
NOTE 5. COMMITMENTS AND CONTINGENCIES
COMMITMENTS. In June 2000, the Company acquired MoreCom, Inc. At the
closing of the acquisition, the Company assumed MoreCom's obligations under an
office lease for approximately 16,000 square feet of office space in Horsham,
Pennsylvania. Future minimum lease payments as of November 30, 2000 are
approximately $257,000.
5
In October 2000, the Company entered into a facility lease for
approximately 10,000 square feet in Murray City, Utah. Future minimum lease
payments as of November 30, 2000 are approximately $754,000. In November 2000,
the Company terminated its Salt Lake City, Utah facility lease.
In October 2000, the Company committed to a 68-month lease, for
approximately 4,700 square feet of office space, in London, England. The lease
commenced in November 2000 with occupancy expected in January 2001. Upon
occupancy, the Company will terminate its existing month-to-month London,
England facility lease with Oracle Corporation. Future minimum lease payments
related to the new lease are expected to be approximately $1.2 million,
excluding potential rent increases and the effect of foreign currency exchange
rates.
In November 2000, the Company entered into a convertible term loan
facility to advance up to $7.0 million to Two Way TV Ltd. at an interest rate of
15% per annum. If the loan is not converted, it will be repaid, depending upon
the occurrence of certain events, within 11 to 18 months. In addition, for every
$1.00 borrowed, the Company will earn 0.94 of a Two Way TV warrant at an
exercise price of approximately (pound)0.001 per warrant. As of November 30,
2000, $2.0 million had been advanced to Two Way TV.
SUBLEASES. In July 2000, the Company signed an agreement with a third
party to sublease furniture and office equipment and approximately 25,000 square
feet in the Company's headquarters building located in San Carlos, California.
The sublease is for 13 months and commenced in July 2000. As of November 30,
2000 future minimum sublease income under this agreement is approximately $1.6
million.
In October 2000, by mutual agreement with the landlord, the Company
terminated its Sunnyvale, California facility lease. Therefore, the Company's
sublease of this facility was also terminated.
LITIGATION. As part of the Company's acquisition of the Virtual Modem
software product and related assets and technology of SourceSuite, LLC, the
Company acquired certain patents that were the subject of a patent infringement
lawsuit. This lawsuit was initially brought by Interactive Channel Technologies,
Inc. and SMI Holdings, Inc., affiliated companies of SourceSuite, against
Worldgate Communications, Inc. in May 1998. The patent infringement claims have
been assigned to the Company as a result of the merger with SourceSuite. In June
1998, Worldgate filed a counterclaim against the plaintiffs and Source Media,
Inc., a shareholder of SourceSuite, alleging among others, violations of the
Lanham Act and Delaware's Uniform Deceptive Trade Practices Act, common law
unfair competition, tortious interference with existing and prospective business
relationships and misappropriation of confidential information and trade
secrets. Following discovery and briefing of the patent claim construction
issues, the parties have entered into settlement negotiations covering both the
Company's patent infringement claims against Worldgate and Worldgate's
cross-complaint against Interactive Channel, SMI Holdings and Source Media. The
Company currently believes that this matter and its related actions are likely
to be settled for an immaterial amount.
NOTE 6. OTHER
ACQUISITION OF MORECOM. In June 2000, the Company acquired MoreCom. In
connection with the acquisition, the Company issued an aggregate of 7,310,830
shares of common stock in exchange for all of the outstanding stock of MoreCom
and assumed all of MoreCom's stock options. The acquisition was accounted for as
a purchase. The fair market value of the equity securities issued in the
acquisition was approximately $459.0 million.
The value assigned to acquired in-process research and development was
determined by identifying research projects in areas for which technological
feasibility has not been established. The value was determined by estimating the
costs to develop the acquired in-process technology into commercially viable
products, estimating the resulting net cash flows from such projects, and
discounting the net cash flows back to their present values. The discount rate
includes a factor that takes into account the uncertainty surrounding the
successful development of the acquired in-process technology. Failure to
successfully develop these projects could seriously harm future revenue and
profitability of the Company. Additionally, the value of the other purchased
intangible assets may be reduced.
6
In connection with the acquisition, net assets acquired were as
follows:
(in thousands)
Purchased intangibles, including in-process technology.............. $471,202
Property, plant and equipment and other non-current assets.......... 842
Cash, receivables and other current assets.......................... 1,500
Current liabilities assumed......................................... (550)
-----------------
Net assets acquired................................................. $472,994
=================
The following table presents the unaudited pro forma results assuming
that the Company had merged with MoreCom at the beginning of fiscal year 2000.
Net income has been adjusted to exclude the write-off of acquired in-process
research and development of $22.4 million and includes amortization of purchased
intangibles of approximately $39.3 million for each of the quarters ended
November 30, 1999 and 2000. This information may not necessarily be indicative
of the future combined results of operations of the Company.
THREE MONTHS ENDED SIX MONTHS ENDED
NOVEMBER 30, NOVEMBER 30,
-------------------------- --------------------------
2000 1999 2000 1999
------------ ------------ ------------ ------------
(in thousands, except per share data)
Revenues....................................... $ 11,728 $ 6,074 $ 21,132 $ 11,362
Net loss....................................... $(68,354) $(52,765) $(166,704) $(105,494)
Basic net loss per share....................... $ (0.66) $ (0.63) $ (1.65) $ (1.93)
Also in connection with the acquisition, the Company expensed
approximately $22.4 million of acquired in-process research and development,
which in the opinion of the Company's management has not reached technological
feasibility and has no alternative future use. The Company also recorded
goodwill and other intangibles of approximately $471.5 million to be amortized
over an estimated economic life of three years.
LONG-TERM INVESTMENT. In August 2000, the Company made a strategic
investment of approximately $3.0 million in Everypath, Inc. in exchange for
179,425 shares of Series C preferred stock of Everypath.
NOTE 7. SUBSEQUENT EVENTS
In December 2000, the Company advanced an additional $2.5 million to
Two Way TV, under the convertible term loan agreement with Two Way TV of $7.0
million.
In December 2000, the Company entered into an amendment to a voting
rights agreement, which subject to Oracle's contribution of its beneficially
owned shares of Liberate to a blind voting trust, releases Oracle from its
obligations to vote those shares for a Board of Directors candidate designated
by Comcast Cable Communications, Inc., Cox Communications, Inc. and MediaOne
Interactive Services, Inc. (recently acquired by AT&T), and agrees that Liberate
management will nominate and otherwise support the election of such a designated
candidate.
In January 2001, the Company entered into extended loans in exchange
for promissory notes from Coleman Sisson, its President and Chief Operating
Officer and David Limp, its Executive Vice President and Chief Strategy
Officer. Each loan is in the amount of $500,000 at 5.9% compounded annually
and is due and payable two years from issuance. Also in January 2001, the
Company entered into employee retention agreements with Mr. Sisson, Mr. Limp
and Donald Fitzpatrick, its Executive Vice President of Sales and Services.
Each retention agreement provides approximately $820,000 to the employee over
the next two years of continued service.
7
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
This document contains forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933, as amended, and Section 23E of the
Securities Act of 1934, as amended. These statements relate to future events or
our future financial performance. Any statements contained in this document that
are not statements of historical fact may be deemed to be forward-looking
statements. In some cases, you can identify forward-looking statements by
terminology such as "may," "will," "should," "expect," "plan," "anticipate,"
"intend," "believe," "estimate," "predict," "potential" or "continue," or
similar words. These statements are only predictions. Actual events or results
may differ materially.
Although we believe that the expectations reflected in the
forward-looking statements are reasonable, we cannot guarantee future results,
levels of activity, performance or achievements. Moreover, neither we nor any
other person assumes responsibility for the accuracy and completeness of the
forward-looking statements. We are under no obligation to update any of the
forward-looking statements after the filing of this Form 10-Q to conform such
statements to actual results or to changes in our expectations.
The following discussion should be read in conjunction with our
financial statements, related notes and the other financial information
appearing elsewhere in this Form 10-Q. Readers are also urged to carefully
review and consider the various disclosures made by us that attempt to advise
interested parties of the factors that affect our business, including without
limitation, the disclosures made under the caption "Risk Factors," and the
factors and risks discussed in our Form 10-K and subsequent reports on Form 10-Q
filed since August 25, 2000.
OVERVIEW
Liberate Technologies ("Liberate," "we" or "us") is a leading provider
of a comprehensive software platform for delivering content, services and
applications to a broad range of information appliances, such as cable and
satellite set-top boxes. We began operations in December 1995 as a division of
Oracle developing server and client software for the consumer, corporate and
educational markets. In April 1996, we were incorporated as a Delaware
corporation. We began shipping our initial products and generating revenues in
the last quarter of fiscal 1997. Our fiscal year runs from June 1 to May 31,
with each fiscal year ending on May 31 of the corresponding calendar year.
We generate revenues by licensing our server and client products and
providing related services to network operators, primarily providers of
television services, and information appliance manufacturers, primarily set-top
box manufacturers. In addition, service revenues are generated from consulting,
training and maintenance provided in connection with client and server licenses.
License revenues consist principally of fees earned from the licensing
of our software, as well as royalty fees earned upon the shipment or activation
of products that incorporate our software. We typically recognize revenues from
up-front software license fees upon final delivery of the licensed product, when
collection is probable and when the fair market value and the fee for each
element of the transaction is fixed and determinable. In addition to up-front
license fees, network operators typically pay server royalty fees on a per
subscriber basis. We typically recognize revenue on these server subscriber fees
when a network operator reports to us that a user of an information appliance
has activated the operator's service. We also license our client software to
either network operators or information appliance manufacturers, who typically
pay us client royalties on a per unit basis. We typically recognize revenue when
they report to us that an information appliance owner has activated the
operators' service or an information appliance manufacturer has shipped the
device.
Service revenues consist of consulting, engineering, training and
maintenance services. Maintenance services include both updates and technical
support. We generally recognize consulting, engineering and training revenues as
services are performed. We recognize maintenance revenue, which typically ranges
from 17% to 25% of annual license fees and activation royalties, ratably over
the term of the agreement. In instances where software license agreements
include a combination of consulting services, training and maintenance, these
separate elements are unbundled from the arrangement based on each element's
relative fair value. For the six months ended November 30, 2000, total service
revenues were $10.8 million,
8
representing 51% of our total revenues. We expect service revenues to continue
to account for a significant portion of total revenues until customers begin
deploying services and information appliances incorporating our software on a
large scale.
Deferred revenues consist primarily of payments received from customers
for prepaid license and royalty fees and prepaid services for undelivered
product and services. Deferred revenues decreased from $69.1 million at May 31,
2000 to $58.9 million at November 30, 2000. The majority of this decrease
represents recognition of revenues related to both customer deployments and
performance of services. We expect this downward trend to continue in future
quarters as our customers begin to deploy. Deferred revenues can fluctuate
significantly. These fluctuations are the result of several factors, including
when a contract is signed, when services are performed, when deployments occur
and when prepayments, if any, are made.
A significant event in our history was the acquisition of Navio
Communications in August 1997. Navio was a development stage company involved in
designing Internet application and server software for the consumer market. In
connection with the acquisition, we changed our strategic direction and
restructured our operations. Prior to the acquisition, we focused on selling
software to original equipment manufacturers of network computer products for
corporate customers. Following the acquisition, we focused our development and
marketing efforts on fewer products targeted primarily at the consumer
information appliance market and aggressively pursued sales to a limited number
of large network operators and information appliance manufacturers. As a result
of this strategic shift, we significantly reduced our sales and engineering
operations for corporate products and increased investment in the development of
client and server software for the consumer market.
To more closely align our product offerings with this strategic shift
in direction, we entered into an agreement with Sun Microsystems, Inc. in May
1999 to transfer our corporate network computer technology to Sun while
retaining the right to ship, support and maintain these products for existing
customers using this technology. In addition, we have agreed not to compete in
the market for corporate network computers and, specifically, network computers
intended to displace personal computers or terminals, until May 2002. However,
outside of this market, we intend to continue developing new products based on
network computer technology. Sales of our corporate network computer products
and related services accounted for approximately $675,000 and $1.0 million of
our total revenues for the quarters ended November 30, 2000 and 1999,
respectively.
We have also agreed with Sun to co-develop television set-top box
technology. We will distribute the co-developed technology pursuant to a
non-exclusive license with Sun. In addition, under this license, we have agreed
to incorporate Sun's Personal Java technology, television interface software and
Jini technology in our software products and to pay Sun a royalty. Sun has also
agreed to promote us as one of its preferred channel partners within the TV
devices market. We believe this relationship will result in joint worldwide
efforts with Sun to co-market and co-sell the jointly-developed technology.
In fiscal 1999, we entered into letter agreements with several network
operators whereby we agreed to issue warrants to purchase up to an aggregate of
4,599,992 shares of common stock that are exercisable if those network operators
satisfy certain milestones. The value of the warrants is estimated using the
Black-Scholes model as of the earlier of the grant date or the date that it
becomes probable that the warrants will be earned. Pursuant to the requirements
of Emerging Issues Task Force No. 96-18, the warrants will continue to be
revalued in situations where they are granted prior to the establishment of a
performance commitment. The value of the warrants is recorded primarily as a
non-current asset on the accompanying consolidated balance sheet and will be
amortized over the estimated economic life of the arrangements with the network
operators. As of November 30, 2000, warrants to purchase up to 2,336,660 shares
of our common stock were earned by these network operators. The fair market
value of these warrants at the time they were earned was $117.2 million. As of
November 30, 2000, accumulated amortization for the warrants was $22.6 million.
If the remaining warrants are earned or we decide to issue additional warrants
to new customers, we will be required to record significant non-cash accounting
expenses or offsets to revenue related to any such warrants. As a result, we
could incur net losses or increased net losses for a given period and this could
seriously harm our operating results and stock price.
9
To date, we have completed three acquisitions. They are as follows:
- Navio in August 1997 (as mentioned above)
- Virtual Modem assets of SourceSuite in March 2000 (see below)
- MoreCom in June 2000 (see below)
In March 2000, we acquired the VirtualModem assets of SourceSuite in
exchange for 1,772,000 shares of our common stock. The acquisition was accounted
for as a purchase. The fair market value of the equity securities issued in the
acquisition was approximately $190.5 million.
In June 2000, we acquired MoreCom. In connection with the acquisition,
we issued an aggregate of 7,310,830 shares of common stock in exchange for all
of the outstanding stock of MoreCom and assumed all of MoreCom's stock options.
The acquisition was accounted for as a purchase. The fair market value of the
equity securities issued in the acquisition was approximately $459.0 million.
Also in connection with the MoreCom acquisition, we expensed
approximately $22.4 million of acquired in-process research and development,
which in the opinion of our management, had not reached technological
feasibility and had no alternative future use. We also recorded goodwill and
other intangibles of approximately $471.5 million to be amortized over an
economic useful life of three years.
In July 2000, Cisco Systems purchased 3,963,780 shares of our common
stock at approximately $25.23 per share, resulting in aggregate cash proceeds to
us of approximately $100.0 million.
Since inception, we have incurred net losses of $387.1 million. These
losses include write-offs totaling $82.5 million of acquired in-process research
and development related to our acquisitions, $121.1 million of research and
development expenditures, $138.3 million of amortization of purchased
intangibles, $22.6 million of amortization of warrants and $3.5 million of
amortization of deferred compensation. We anticipate incurring significant
operating losses for the foreseeable future as we:
- continue to invest in research and development and professional and
engineering services to support new devices for our software
platform and large-scale deployments by our network operator
customers
- record non-cash expenses related to the acquired in-process
research and development and amortization of purchased intangibles
associated with our acquisitions, amortization of deferred
compensation and amortization of warrant expense associated with
the issuance of warrants
10
RESULTS OF OPERATIONS
THREE MONTHS ENDED NOVEMBER 30, 1999 AND NOVEMBER 30, 2000
REVENUES
Total revenues increased 93%, from $6.1 million for the three months
ended November 30, 1999 to $11.7 million for the three months ended November 30,
2000.
LICENSE AND ROYALTY. License and royalty revenues increased 186%, from
$2.0 million for the three months ended November 30, 1999 to $5.7 million for
the three months ended November 30, 2000. The increase was primarily due to
increased deployments to our customers' subscribers. We expect that license and
royalty revenue growth may be modest in the next few fiscal quarters as many of
our recent network operator wins continue to be in the design, implementation
and trial phases.
SERVICE. Service revenues increased 47%, from $4.1 million for the
three months ended November 30, 1999 to $6.0 million for the three months ended
November 30, 2000. The increase was primarily due to the continued growth in our
customer base, which resulted in an increase in the integration and
implementation services provided to those customers. We expect service revenues
to increase in absolute dollar amounts to the extent existing and new customers
install and initiate deployment of our products.
COST OF REVENUES
Total cost of revenues increased 18%, from $5.7 million for the three
months ended November 30, 1999 to $6.8 million for the three months ended
November 30, 2000. We anticipate that total cost of revenues will increase in
absolute dollar amounts in future periods as we continue to provide services to
support customer implementations and the possible introduction of third-party
license costs from increased deployments.
LICENSE AND ROYALTY. Cost of license and royalty revenues increased
11%, from $586,000 for the three months ended November 30, 1999 to $650,000 for
the three months ended November 30, 2000. These amounts represented 29% and 11%
of license and royalty revenues in the respective periods. The absolute dollar
amounts of cost of license and royalty revenues have remained relatively flat.
However, we expect the cost of license and royalty revenues, as a percentage of
license and royalty revenues, to fluctuate in future periods. Certain previously
capitalized third-party costs that have been fully amortized may have the effect
of decreasing license and royalty costs as a percentage of related revenues in
the near term. However, introduction of new third-party technology would serve
to offset the effect of the fully amortized costs or increase license and
royalty cost as a percentage of related revenues.
SERVICE. Cost of service revenues increased 19%, from $5.1 million for
the three months ended November 30, 1999 to $6.1 million for the three months
ended November 30, 2000. These amounts represented 126% and 102% of service
revenues in the respective periods. The increase in absolute dollar amounts was
primarily due to additional professional services expenses incurred to implement
and integrate our products, slightly offset by a reduction in custom development
work. We expect cost of service revenues to increase in absolute dollar amounts
to the extent existing and new customers install and initiate deployment of our
products. We also expect the cost of service revenues, as a percentage of
service revenues, to fluctuate in future periods. These costs may increase in
the near term due to continued expansion of services as existing and new
customers install and deploy our products and we continue to provide and support
limited trial installations of our products at discounted prices to network
operators in order to continue to increase our market share.
OPERATING EXPENSES
RESEARCH AND DEVELOPMENT. Research and development expenses consist
primarily of salary and other related costs for personnel and external
consultants as well as costs related to outsourced development projects to
support product development. Research and development expenses increased 81%,
from $6.3 million for the three months ended November 30, 1999 to $11.4
million for the three months ended
11
November 30, 2000. These amounts represented 104% and 97% of total revenues
over the respective periods. The increase in both absolute dollar amounts and
as a percentage of total revenues was primarily due to increases in staffing
and employee-related expenses, mainly due to the SourceSuite and MoreCom
acquisitions. We expect research and development expenses to increase in
absolute dollar amounts in future periods as we continue to pursue our
strategic objectives.
SALES AND MARKETING. Sales and marketing expenses consist primarily of
salaries and other related costs for sales and marketing personnel, sales
commissions, travel, public relations, marketing materials and trade shows.
Sales and marketing expenses increased 54%, from $3.7 million for the three
months ended November 30, 1999 to $5.7 million for the three months ended
November 30, 2000. These amounts represented 61% and 49% of total revenues over
the respective periods. The increase in absolute dollar amounts was primarily
due to increased staffing and employee-related expenses, larger presence at
trade shows and higher commissions. We believe sales and marketing expenses will
increase in absolute dollar amounts in future periods as we expand our direct
sales and marketing efforts both domestically and internationally.
GENERAL AND ADMINISTRATIVE. General and administrative expenses consist
primarily of salaries and other related costs for corporate development,
finance, human resources and legal employees, as well as outside legal and other
professional services. General and administrative expenses increased 50%, from
$1.8 million for the three months ended November 30, 1999 to $2.6 million for
the three months ended November 30, 2000. These amounts represented 29% and 22%
of total revenues over the respective periods. The increase in absolute dollar
amounts was primarily due to increased staffing and the establishment of the
infrastructure necessary to support our continuing expansion and our increased
obligations as a public company. We expect that these expenses will continue to
grow in absolute dollars in future quarters.
AMORTIZATION OF PURCHASED INTANGIBLES. Purchased intangibles represent
the purchase price of Navio, SourceSuite and MoreCom in excess of identified
tangible assets and are amortized over three years. In August 1997, we recorded
approximately $18.3 million of purchased intangibles, related to the Navio
acquisition. In March 2000, we recorded approximately $192.0 million of
purchased intangibles related to the SourceSuite acquisition. In June 2000, we
recorded approximately $471.5 million of purchased intangibles related to the
MoreCom acquisition. We recorded approximately $1.5 million of amortization
expense for the three months ended November 30, 1999 and approximately $55.3
million for the three months ended November 30, 2000.
AMORTIZATION OF WARRANTS. As of November 30, 2000, warrants to purchase
up to 2,336,660 shares of common stock were earned by network operators. The
fair market value of these warrants at the time they were earned was $117.2
million. Amortization of warrants was approximately $710,000 and $5.7 million
for the three months ended November 30, 1999 and 2000, respectively. This
increase was primarily due to amortization related to additional warrants earned
since November 30, 1999. We expect warrant amortization to continue to increase
as additional warrants are earned. If the remaining warrants are earned or we
decide to issue additional warrants to new customers, we will be required to
record significant non-cash accounting expenses or offsets to revenue related to
any such warrants. As a result, we could incur net losses or increased net
losses for a given period and this could seriously harm our operating results
and stock price.
AMORTIZATION OF DEFERRED STOCK COMPENSATION. Deferred stock
compensation represents the difference between the estimated fair value of our
common stock for accounting purposes and the option exercise price of such
options at the grant date. In fiscal 1999, we began recording deferred stock
compensation for stock options granted to employees and others. These amounts
are amortized on a straight-line basis over the 48-month vesting period of such
options. Amortization of deferred stock compensation was approximately $525,000
for the three months ended November 30, 1999 compared to amortization of
deferred stock compensation of $476,000 for the three months ended November 30,
2000. We anticipate that deferred stock compensation expense will decrease
modestly over the next three years, based on the effect of employee terminations
and the completion of the vesting of stock option grants.
12
INTEREST INCOME, NET
Net interest income consists of interest earned on our cash, cash
equivalents and short-term and long-term investments, partially offset by
interest expense related to capital leases. Net interest income was $1.9 million
for the three months ended November 30, 1999 compared to $8.3 million for the
three months ended November 30, 2000. The increase was due to interest income on
proceeds from our secondary offering in February 2000 and the purchase of our
common stock by Cisco Systems in July 2000.
OTHER INCOME (EXPENSE), NET
Other income (expense), net is comprised primarily of bank charges,
losses on disposals of fixed assets and foreign exchange gains and losses. Other
income (expense), net over the two periods remained relatively flat.
INCOME TAX PROVISION
Income tax provision is comprised primarily of foreign withholding tax
expense. Income tax provision amounts over the two periods remained relatively
flat.
13
SIX MONTHS ENDED NOVEMBER 30, 1999 AND NOVEMBER 30, 2000
REVENUES
Total revenues increased 86%, from $11.4 million for the six months
ended November 30, 1999 to $21.1 million for the six months ended November 30,
2000.
LICENSE AND ROYALTY. License and royalty revenues increased 196%, from
$3.5 million for the six months ended November 30, 1999 to $10.3 million for the
six months ended November 30, 2000. The increase was primarily due to increased
deployments to our customers' subscribers.
SERVICE. Service revenues increased 37%, from $7.9 million for the six
months ended November 30, 1999 to $10.8 million for the six months ended
November 30, 2000. The increase was primarily due to the continued growth in our
customer base, which resulted in an increase in the integration and
implementation services provided to those customers.
COST OF REVENUES
Total cost of revenues increased 8%, from $11.8 million for the six
months ended November 30, 1999 to $12.7 million for the six months ended
November 30, 2000.
LICENSE AND ROYALTY. Cost of license and royalty revenues increased
14%, from $1.1 million for the six months ended November 30, 1999 to $1.3 for
the six months ended November 30, 2000. These amounts represented 32% and 12% of
license and royalty revenues in the respective periods. The absolute dollar
amounts of cost of license and royalty revenues have remained relatively flat.
SERVICE. Cost of service revenues increased 7%, from $10.7 million for
the six months ended November 30, 1999 to $11.4 million for the six months ended
November 30, 2000. These amounts represented 136% and 106% of service revenues
in the respective periods. The increase in absolute dollar amounts was primarily
due to additional professional services expenses incurred to implement and
integrate our products, slightly offset by a reduction in custom development
work.
OPERATING EXPENSES
RESEARCH AND DEVELOPMENT. Research and development expenses consist
primarily of salary and other related costs for personnel and external
consultants as well as costs related to outsourced development projects to
support product development. Research and development expenses increased 102%,
from $11.6 million for the six months ended November 30, 1999 to $23.5 million
for the six months ended November 30, 2000. These amounts represented 102% and
111% of total revenues over the respective periods. The increase in both
absolute dollar amounts and as a percentage of total revenues was primarily due
to increases in staffing and employee-related expenses, mainly due to the
SourceSuite and MoreCom acquisitions, and by less custom development projects.
SALES AND MARKETING. Sales and marketing expenses consist primarily of
salaries and other related costs for sales and marketing personnel, sales
commissions, travel, public relations, marketing materials and trade shows.
Sales and marketing expenses increased 55%, from $6.9 million for the six months
ended November 30, 1999 to $10.7 million for the six months ended November 30,
2000. These amounts represented 61% and 51% of total revenues over the
respective periods. The increase in absolute dollar amounts was primarily due to
increased staffing and employee-related expenses, including international
growth, as well as increased trade show presence.
GENERAL AND ADMINISTRATIVE. General and administrative expenses consist
primarily of salaries and other related costs for corporate development,
finance, human resources and legal employees, as well as outside legal and other
professional services. General and administrative expenses increased 64%, from
$3.2 million for the six months ended November 30, 1999 to $5.2 million for the
six months ended November 30, 2000. These amounts represented 28% and 25% of
total revenues over the respective periods. The increase in absolute dollar
amounts was primarily due to increased staffing and related
14
expenses, the establishment of the infrastructure necessary to support our
continuing expansion and our increased obligations as a public company.
AMORTIZATION OF PURCHASED INTANGIBLES. Purchased intangibles represent
the purchase price of Navio, SourceSuite and MoreCom in excess of identified
tangible assets and are amortized over three years. In August 1997, we recorded
approximately $18.3 million of purchased intangibles, related to the Navio
acquisition. In March 2000, we recorded approximately $192.0 million of
purchased intangibles related to the SourceSuite acquisition. In June 2000, we
recorded approximately $471.5 million of purchased intangibles related to the
MoreCom acquisition. We recorded approximately $3.0 million of amortization
expense for the six months ended November 30, 1999 and approximately $105.5
million for the six months ended November 30, 2000.
AMORTIZATION OF WARRANTS. As of November 30, 2000, warrants to purchase
up to 2,336,660 shares of common stock were earned by network operators. The
fair market value of these warrants at the time they were earned was $117.2
million. Amortization of warrants was approximately $1.1 million and $11.8
million for the six months ended November 30, 1999 and 2000, respectively. This
increase was primarily due to amortization related to additional warrants earned
since November 30, 1999.
AMORTIZATION OF DEFERRED STOCK COMPENSATION. Deferred stock
compensation represents the difference between the estimated fair value of our
common stock for accounting purposes and the option exercise price of such
options at the grant date. In fiscal 1999, we began recording deferred stock
compensation for stock options granted to employees and others. These amounts
are amortized on a straight-line basis over the 48-month vesting period of such
options. Amortization of deferred stock compensation was approximately $1.0
million for each of the six months ended November 30, 1999 and 2000.
INTEREST INCOME, NET
Net interest income consists of interest earned on our cash, cash
equivalents and short-term and long-term investments, partially offset by
interest expense related to capital leases. Net interest income was $2.9 million
for the six months ended November 30, 1999 compared to $15.9 million for the six
months ended November 30, 2000. The increase was due to interest income on
proceeds from our secondary offering in February 2000 and the purchase of our
common stock by Cisco Systems in July 2000.
OTHER INCOME (EXPENSE), NET
Other income (expense), net is comprised primarily of bank charges,
losses on disposals of fixed assets and foreign exchange gains and losses. Other
income (expense), net over the two periods remained relatively flat.
INCOME TAX PROVISION
Income tax provision is comprised primarily of foreign withholding tax
expense. Income tax provision amounts over the two periods remained relatively
flat.
15
LIQUIDITY AND CAPITAL RESOURCES
Our principal source of liquidity was cash, cash equivalents and
short-term investments, which were approximately $377.2 million as of November
30, 2000. Additionally, we had approximately $119.5 million in long-term
investments.
Cash used in operating activities was approximately $34.0 million for
each of the six months ended November 30, 2000 and 1999. Cash used in operating
activities remained relatively flat over the two periods although there were
significant changes in the components. The increase in net loss and decrease in
deferred revenues was offset by an increase in depreciation as well as the
write-off of acquired in-process research and development related to the MoreCom
acquisition for the six months ended November 30, 2000.
Net cash used in investing activities was approximately $62.6 million
and $69.6 million for the six months ended November 30, 2000 and 1999,
respectively, a decrease of approximately $7.0 million from year to year. This
decrease was primarily due to our investment activity offset slightly by the
convertible term loan to Two Way TV for the six months ended November 30, 2000.
Net cash provided by financing activities was approximately $103.8
million and $110.9 million for the six months ended November 30, 2000 and 1999,
respectively, a decrease of approximately $7.0 million from year to year. This
decrease was primarily due to the fact that our net proceeds from our initial
public offering and a private placement of our stock for the six months ended
November 30, 1999 were greater than the net proceeds received by us from the
sale of our common stock to Cisco Systems and an increase in the exercise of
stock options during the six months ended November 30, 2000.
At November 30, 2000, we had approximately $140.6 million in cash and
cash equivalents and did not have any material commitments for capital
expenditures, other than a capital lease. At November 30, 2000, we also had
approximately $236.6 million in short-term investments and $8.8 million in
restricted cash.
Under a development agreement entered into with General Instrument
Corporation (recently acquired by Motorola, Inc.) in April 1999, we are
committed to pay $10.0 million in development fees for certain services to be
provided by General Instrument. These fees are being paid out over a three-year
period, of which $1.1 million and $677,000 was paid for the three months ended
November 30, 2000 and 1999, respectively.
During the first quarter of fiscal 2000, we signed an amendment to our
Technology License and Distribution Agreement with Sun Microsystems. This
amendment called for us to pay certain minimum royalties and support fees in
exchange for the right to certain Sun technology and to maintain the status as
the preferred vendor of Sun. We will pay Sun minimum guaranteed royalties and
support fees of approximately $3.8 million through December 31, 2004. To date,
no significant royalty payments have been made. Support payments are due
annually; however, no payments have been made for the quarter ended November 30,
2000.
In November 2000, we entered into a convertible term loan facility
to advance up to $7.0 million to Two Way TV at an interest rate of 15% per
annum. Two Way TV borrowed $2.0 million in November 2000, and an additional
$2.5 million in December 2000. We expect Two Way TV to draw down the
remaining balance of $2.5 million in January 2001. If the loan is not
converted, it is to be repaid within 11 to 18 months, depending upon the
occurrence of certain events.
In January 2001, we extended loans in exchange for promissory notes
from Coleman Sisson, our President and Chief Operating Officer and David Limp,
our Executive Vice President and Chief Strategy Officer. Each loan is in the
amount of $500,000 at 5.9% compounded annually and is due and payable two years
from issuance. Also in January 2001, the Company entered into employee retention
agreements with Mr. Sisson, Mr. Limp and Donald Fitzpatrick, our Executive Vice
President of Sales and Services. Each retention agreement provides approximately
$820,000 to the employee over the next two years of continued service.
16
We believe that the net proceeds from our various offerings, together
with cash and cash equivalents generated from operations, will be sufficient to
meet our working capital requirements for at least the next 12 months. If our
cash balances and cash generated from operations is insufficient to satisfy our
liquidity requirements, we may seek to raise such additional funds through
public or private equity or debt financings. If additional funds are raised
through the issuance of debt securities, these securities could have certain
rights, preferences, and privileges senior to holders of common stock, and the
terms of such debt could impose restrictions on our operations. The sale of
additional equity or debt securities could result in additional dilution to our
stockholders. Additional financing may not be available at all and, if
available, such financing may not be obtainable on terms favorable to us. If we
are unable to obtain this additional financing, we may be required to reduce the
scope of our planned product development and marketing efforts, which could
seriously harm our business.
17
RISK FACTORS
WE HAVE A LIMITED OPERATING HISTORY THAT MAKES AN EVALUATION OF OUR BUSINESS
DIFFICULT
We were incorporated in April 1996 and began shipping our initial
products to customers in the last quarter of fiscal 1997. Our limited operating
history makes evaluation of our business and prospects difficult. Companies in
an early stage of development frequently encounter heightened risks and
unexpected expenses and difficulties. For us, these risks include:
- The limited number of network operators, such as providers of
television services, who have deployed products and services
incorporating our technology
- The limited number of information appliance manufacturers, such as
set-top box manufacturers, who have incorporated our technology into
their products
- Delays in deployment of high speed networks and Internet-enhanced
services and applications by our network operator customers
- Our unproven long-term business model, which depends on generating the
majority of our revenues from royalty fees paid by network operators
and information appliance manufacturers
These risks and difficulties apply particularly to us because our market, the
information appliance software market, is new and rapidly evolving.
WE HAVE A HISTORY OF LOSSES AND EXPECT TO INCUR LOSSES IN THE FUTURE
We incurred net losses of approximately $3.3 million in fiscal 1996,
$19.0 million in fiscal 1997, $94.4 million in fiscal 1998, $33.1 million in
fiscal 1999, $80.8 million in fiscal 2000 and $156.6 million for the six months
ended November 30, 2000. Our net losses of $94.4 million in fiscal 1998 included
a $58.1 million charge for the Navio acquisition related to acquired in-process
research and development. Our net losses of $80.8 million in fiscal 2000
included a $1.9 million charge for the SourceSuite acquisition related to
acquired in-process research and development, amortization of purchased
intangibles of $22.1 million and warrant amortization of $10.8 million. Our net
losses of $156.6 million for the six months ended November 30, 2000 included a
$22.4 million charge for the MoreCom acquisition related to the acquired
in-process research and development, amortization of purchased intangibles of
$105.5 million and warrant amortization of $11.8 million. As of November 30,
2000, we had an accumulated deficit of approximately $387.1 million.
Since our inception, we have not had a profitable quarter and may never
achieve or sustain profitability. Although our revenues increased for each of
the last three fiscal years, we may not be able to sustain our historical
revenue growth rates. We also expect to continue to incur increasing our cost of
revenues, and our research and development, sales and marketing and general and
administrative expenses. If we are to achieve profitability given our planned
expenditure levels, we will need to generate and sustain substantially increased
license and royalty revenues; however, we are unlikely to be able to do so in
the near future. As a result, we may incur significant and increasing losses and
negative cash flows in the near future. In addition, from the beginning of
fiscal 1997 through November 30, 2000, approximately 61% of our revenues have
been derived from services provided by us and not from license and royalty fees
paid by network operators and information appliance manufacturers in conjunction
with the deployment of products and services incorporating our software
products. If we are unable to derive a greater proportion of our revenues from
these license and royalty fees, our losses will likely continue indefinitely.
18
OUR QUARTERLY REVENUES AND OPERATING RESULTS ARE VOLATILE AND MAY CAUSE OUR
STOCK PRICE TO FLUCTUATE
Our quarterly operating results have varied in the past and are likely
to vary significantly from quarter to quarter. As a result, we believe that
period to period comparisons of our operating results are not a good indication
of our future performance. Moreover, we expect to derive substantially all of
our revenues for the near term from license fees and related professional and
support services. Over the longer term, to the extent deployments increase, we
expect to derive an increasing portion of our revenues from royalties paid by
network operators and information appliance manufacturers. If deployments do not
increase or this transition otherwise does not occur, we are unlikely to be able
to generate or sustain substantially increased revenue, and our operating
results will be seriously harmed.
In the short term, we expect our quarterly revenues to depend
significantly on a small number of relatively large orders for our products and
services, which generally have a long sales cycle. As a result, our quarterly
operating results may fluctuate significantly if we are unable to complete one
or more substantial sales in any given quarter. In some cases, we recognize
revenues from services on a percentage of completion basis. Our ability to
recognize these revenues may be delayed if we are unable to meet service
milestones on a timely basis. Moreover, because our expenses are relatively
fixed in the near term, any shortfall from anticipated revenues could result in
greater short-term losses.
Although we have limited historical financial data, in the past we
have experienced seasonal decreases in revenue growth in our quarter ending
August 31. These seasonal trends may continue to affect our quarter to
quarter revenues.
THE MARKET FOR INFORMATION APPLIANCES IS NEW AND MAY NOT DEVELOP AS WE
ANTICIPATE
Because the market for information appliances such as set-top boxes is
newly emerging, the potential size of the market opportunity and the timing of
its development are uncertain. As a result, our profit potential is unproven. We
depend upon the commercialization and broad acceptance by consumers and
businesses of information appliances such as cable and satellite set-top boxes.
Other types of information appliances may include game consoles and personal
digital assistants. Broad acceptance of information appliances, particularly
television set-top boxes, will depend on many factors. These factors include:
- The willingness of large numbers of consumers to use devices other than
personal computers to access the Internet
- The development of content and applications for information appliances
of interest to significant numbers of consumers
- The emergence of industry standards that facilitate the distribution of
content over the Internet to these devices
If the market for information appliances, and set-top boxes in particular, does
not develop or develops more slowly than we anticipate, our revenues will not
grow as fast as anticipated, if at all.
OUR SUCCESS DEPENDS ON NETWORK OPERATORS INTRODUCING, MARKETING AND PROMOTING
PRODUCTS AND SERVICES FOR INFORMATION APPLIANCES BASED ON OUR TECHNOLOGY
Our success depends on large network operators introducing, marketing
and promoting products and services based on our technology. There are, however,
only a limited number of large network operators worldwide. Moreover, only a
limited number of network operators have introduced or are in the process of
deploying products and services incorporating our technology and services for
information appliances. In addition, none of our network operator customers is
contractually obligated to introduce, market or promote products and services
incorporating our technology, nor are any of them contractually required to
achieve any specific introduction schedule. Accordingly, even if a network
operator initiates a customer trial of products incorporating our technology,
that operator is under no obligation to continue its
19
relationship with us or to launch a full-scale deployment of these products.
Further, our agreements with network operators are generally not exclusive, so
network operators with whom we have agreements may enter into similar license
agreements with one or more of our competitors.
Moreover, because the large-scale deployment of products and services
incorporating our technology by network operators is complex, time consuming and
expensive, each deployment of these products and services requires our
expertise. This customization process requires a lengthy and significant
commitment of resources by our customers and us. This commitment of resources
may slow deployment, which could, in turn, delay market acceptance of these
products and services. Unless network operators introduce, market and promote
products and services incorporating our technology in a successful and timely
manner, our software platform will not achieve widespread acceptance,
information appliance manufacturers will not use our software in their products
and our revenues will not grow as fast as anticipated, if at all.
IF INFORMATION APPLIANCE MANUFACTURERS DO NOT MANUFACTURE PRODUCTS THAT
INCORPORATE OR OPERATE WITH OUR TECHNOLOGY, OR IF THESE PRODUCTS DO NOT ACHIEVE
ACCEPTANCE, WE MAY NOT BE ABLE TO SUSTAIN OR GROW OUR BUSINESS
We do not typically manufacture hardware components that incorporate
our technology. Rather, we license software technology to information appliance
manufacturers and work with them to ensure that our products operate together.
Accordingly, our success will depend, in part, upon our ability to convince a
number of information appliance manufacturers to manufacture products that
incorporate or operate with our technology and the successful introduction and
commercial acceptance of these products. Our efforts also significantly depend
on network operators deploying services using our server software.
While we have entered into a number of agreements with information
appliance manufacturers, none of these manufacturers is contractually obligated
to introduce or market information appliances incorporating our technology, nor
is any of them contractually required to achieve any specific production
schedule. Moreover, our agreements with information appliance manufacturers are
generally not exclusive, so information appliance manufacturers with whom we
have agreements may enter into similar license agreements with one or more of
our competitors. Our failure to convince information appliance manufacturers to
incorporate our software platform into their products or modify their products
to operate with our software, or the failure of these products to achieve broad
acceptance with consumers and businesses, will result in revenues that do not
grow as fast as expected, if at all.
COMPETITION FROM BIGGER, BETTER CAPITALIZED COMPETITORS COULD RESULT IN PRICE
REDUCTIONS, REDUCED GROSS MARGINS AND LOSS OF MARKET SHARE
Competition in the information appliance software market is intense.
Our principal competitors on the client software side include Microsoft, OpenTV
(which recently acquired another former competitor, Spyglass), Canal +
Technologies and PowerTV. On the server side, our primary competitor is
Microsoft. We expect additional competition from other established and emerging
companies. We expect competition to persist and intensify as the information
appliance market develops and competitors focus on additional product and
service offerings. Increased competition could result in price reductions, fewer
customer orders, reduced gross margins, longer sales cycles, reduced revenues
and loss of market share.
Many of our existing and potential competitors, particularly Microsoft,
have longer operating histories, a larger customer base, greater name
recognition and significantly greater financial, technical, sales and marketing
and other resources than we do. This may place us at a disadvantage in
responding to our competitors' pricing strategies, technological advances,
advertising campaigns, strategic partnerships and other initiatives. In
addition, many of our competitors have well-established relationships with our
current and potential customers. Moreover, some of our competitors, particularly
Microsoft, have significant financial resources, which have enabled them in the
past and may enable them in the future to make large strategic investments in
our current and potential customers. Such investments may let them strengthen
existing relationships or quickly establish new relationships with our current
or potential customers. For example, as a result of an investment in AT&T,
Microsoft obtained a nonexclusive licensing agreement under which AT&T will
purchase up to 7.5 million licenses of Microsoft software for television set-top
boxes. Investments such as this may discourage our potential or current
customers who
20
receive these investments from deploying our information appliance software,
regardless of their views of the relative merits of our products and services.
ORACLE'S OWNERSHIP OF OUR STOCK AND OTHER RELATIONSHIPS WITH US COULD LIMIT THE
ABILITY OF OTHER STOCKHOLDERS TO INFLUENCE THE OUTCOME OF DIRECTOR ELECTIONS AND
OTHER TRANSACTIONS SUBMITTED FOR A VOTE OF OUR STOCKHOLDERS
Based on 103,496,005 shares outstanding on November 30, 2000, Oracle
beneficially owns 35,139,843 shares, approximately 34% of our outstanding common
stock. No Oracle designee currently serves on our Board of Directors. While
Oracle may be contributing those shares to a blind voting trust committed to
vote them in proportion to all other voted shares, if Oracle fails to make such
a contribution, Oracle may exert significant influence over us, including
influencing the election of directors; significant corporate transactions, such
as acquisitions; efforts to block an unsolicited tender offer; and other matters
that require shareholder approval. This concentration of ownership could also
delay or prevent a third party from acquiring control over us at a premium above
the then-current market price of our common stock.
WE HAVE RELIED AND EXPECT TO CONTINUE TO RELY ON A LIMITED NUMBER OF CUSTOMERS
FOR A SIGNIFICANT PORTION OF OUR REVENUES
We currently derive, and we expect to continue to derive, a significant
portion of our revenues from a limited number of customers. For the six months
ended November 30, 2000, our four largest customers accounted for approximately
54% of our revenues, with Cable & Wireless (recently acquired by NTL) accounting
for 21% of our total revenues, Telewest accounting for 17% of our total revenues
and AOL accounting for 11% of our total revenues. For the six months ended
November 30, 1999, our five largest customers accounted for approximately 54% of
our total revenues, with Wind River Systems accounting for 18% of our total
revenues and Cable & Wireless accounting for 14% of our total revenues. We
expect that we will continue to depend upon a limited number of customers for a
significant portion of our revenues in future periods, although the customers
may vary from period to period. As a result, if we fail to successfully sell our
products and services to one or more customers in any particular period, or a
large customer purchases fewer of our products or services, defers or cancels
orders, or terminates its relationship with us, our revenues could decline
significantly.
OUR LENGTHY SALES CYCLE AND POTENTIAL VARIATION IN THE TIMING OF REVENUE
RECOGNITION MAY CAUSE FLUCTUATIONS IN OUR OPERATING RESULTS, WHICH COULD CAUSE
OUR STOCK PRICE TO DECLINE
We believe that the purchase of our products and services involves a
significant commitment of capital and other resources by a customer. In many
cases, our customers' decision to use our products and services requires them to
change their established business practices and conduct their business in new
ways. As a result, we may need to educate our potential customers on the use and
benefits of our products and services. In addition, our customers generally must
consider a wide range of other issues before committing to purchase and
incorporate our technology into their offerings. As a result of these and other
factors, including the approval at a number of levels of management within a
customer's organization, our sales cycle averages from six to twelve months and
may sometimes be significantly longer. Because of the length of our sales cycle,
we have a limited ability to forecast the timing and amount of specific sales.
In addition, we base our quarterly revenue projections, in part, upon
our expectation that specific sales will occur in a particular quarter. In the
past, our sales have occurred in quarters other than those anticipated by us.
Moreover, because we recognize certain revenues based on our receipt of royalty
reports, delays in network operators' deployment schedules or our receipt of
those reports could adversely affect our revenues for any given quarter. If our
expectations, and thus our revenue projections, are not accurate for a
particular quarter, our actual operating results for that quarter could fall
below the expectations of financial analysts and investors resulting in a
potential decline in our stock price.
21
DEMAND FOR OUR PRODUCTS AND SERVICES WILL DECLINE SIGNIFICANTLY IF OUR SOFTWARE
CANNOT SUPPORT AND MANAGE A SUBSTANTIAL NUMBER OF USERS
Despite frequent testing of our software's scalability in a laboratory
environment, the ability of our software platform to support and manage a
substantial number of users in an actual deployment is uncertain. If our
software platform does not efficiently scale to support and manage a substantial
number of users while maintaining a high level of performance, demand for our
products and services and our ability to sell additional products to our
existing customers will be significantly reduced.
INTERNATIONAL REVENUES ACCOUNT FOR A SIGNIFICANT PORTION OF OUR REVENUES;
ACCORDINGLY, IF WE ARE UNABLE TO EXPAND OUR INTERNATIONAL OPERATIONS IN A TIMELY
MANNER, OUR FINANCIAL RESULTS WILL BE HARMED
International revenues accounted for approximately 66% of our total
revenues for the six months ended November 30, 2000 and approximately 48% for
the six months ended November 30, 1999. We anticipate that a significant portion
of our revenues for the foreseeable future will be derived from sources outside
the United States, especially as we increase our sales and marketing activities
with respect to international licensing of our technology. Accordingly, our
success will depend, in part, upon international economic conditions and upon
our ability to manage international sales and marketing operations. To
successfully expand international sales, we must establish additional foreign
operations, hire additional personnel and increase our foreign direct and
indirect sales forces. This expansion will require significant management
attention and resources, which could divert attention from other aspects of our
business. To the extent we are unable to expand our international operations in
a timely manner, our growth in international sales, if any, will be limited.
Moreover, substantially all of our revenues and costs to date have been
denominated in U.S. dollars. However, expanded international operations may
result in increased foreign currency payables. Although we may from time to time
undertake foreign exchange hedging transactions to cover a portion of our
foreign currency transaction exposure, we do not currently attempt to cover
potential foreign currency exposure. Accordingly, any fluctuation in the value
of foreign currency could seriously harm our business.
WE MAY HAVE TO CEASE OR DELAY PRODUCT SHIPMENTS IF WE ARE UNABLE TO OBTAIN KEY
TECHNOLOGY FROM THIRD PARTIES
We rely on technology licensed from third parties, including
applications that are integrated with internally developed software and used in
our products. Most notably, we license certain technologies from Sun
Microsystems, Wind River Systems, BitStream, RealNetworks and RSA. These
third-party technology licenses may not continue to be available to us on
commercially reasonable terms, or at all, and we may not be able to obtain
licenses for other existing or future technologies that we desire to integrate
into our products. If we cannot maintain existing third-party technology
licenses or enter into licenses for other existing or future technologies needed
for our products we would be required to cease or delay product shipments while
we seek to develop or license alternative technologies.
WE DO NOT CURRENTLY HAVE LIABILITY INSURANCE TO PROTECT AGAINST THIRD-PARTY
INTELLECTUAL PROPERTY INFRINGEMENT CLAIMS THAT COULD BE EXPENSIVE TO DEFEND
We expect that, like other software product developers, we will
increasingly be subject to infringement claims as the number of products and
competitors developing information appliance software grows and the
functionality of products in different industry segments overlaps. From time to
time, we hire or retain employees or external consultants who have worked for
independent software vendors or other companies developing products similar to
those offered by us. These prior employers may claim that our products are based
on their products and that we have misappropriated their intellectual property.
22
We cannot guarantee that:
- An infringement claim will not be asserted against us in the future
- The assertion of such a claim will not result in litigation
- We would prevail in such litigation
- We would be able to obtain a license for the use of any infringed
intellectual property from a third party on commercially reasonable
terms, or at all
We currently do not have liability insurance to protect against the
risk that licensed third-party technology infringes the intellectual property of
others. Any claims relating to our intellectual property, regardless of their
merit, could seriously harm our ability to develop and market our products and
manage our day to day operations because they could:
- Be time consuming and costly to defend
- Divert management's attention and resources
- Cause product shipment delays
- Require us to redesign our products
- Require us to enter into royalty or licensing agreements
OUR LIMITED ABILITY TO PROTECT OUR INTELLECTUAL PROPERTY AND PROPRIETARY RIGHTS
MAY HARM OUR COMPETITIVENESS
Our ability to compete and continue to provide technological innovation
is substantially dependent upon internally developed technology. We rely
primarily on a combination of patents, trademark laws, copyright laws, trade
secrets, confidentiality procedures and contractual provisions to protect our
proprietary technology. While we have numerous patent applications pending,
patents may not issue from these or any future applications. In addition, our
existing and future patents may not survive a legal challenge to their validity
or provide significant protection for us.
The steps we have taken to protect our proprietary rights may not be
adequate to prevent misappropriation of our proprietary information. Further, we
may not be able to detect unauthorized use of, or take appropriate steps to
enforce, our intellectual property rights. Our competitors may also
independently develop similar technology. In addition, the laws of many
countries do not protect our proprietary rights to as great an extent as do the
laws of the United States. Any failure by us to meaningfully protect our
intellectual property could result in competitors offering products that
incorporate our most technologically advanced features, which could seriously
reduce demand for our products and services.
WE COULD SUFFER LOSSES AND NEGATIVE PUBLICITY IF OUR TECHNOLOGY CAUSES OUR
NETWORK OPERATOR CUSTOMERS' SYSTEMS TO FAIL
Our technology is integrated into the products and services of our
network operator customers. Accordingly, a defect, error or performance problem
with our technology could cause our customers' telecommunication, cable and
satellite television or Internet service systems to fail for a period of time.
23
Any such failure will cause severe customer service and public relations
problems for our customers. As a result, any failure of our network operator
customers' systems caused by our technology could result in:
- Delayed or lost revenue due to adverse customer reaction
- Negative publicity regarding us and our products and services
- Claims for substantial damages against us, regardless of our
responsibility for such failure
Any claim could be expensive and require the expenditure of a significant amount
of resources regardless of whether we prevail. We currently do not have
liability insurance to protect against this risk.
WHILE OUR SUCCESS DEPENDS ON OUR ABILITY TO KEEP PACE WITH THE LATEST
TECHNOLOGICAL CHANGES, WE HAVE EXPERIENCED AND MAY IN THE FUTURE EXPERIENCE
DELAYS IN COMPLETING DEVELOPMENT AND INTRODUCTION OF NEW SOFTWARE PRODUCTS
The market for information appliance software is characterized by
evolving industry standards, rapid technological change and frequent new product
introductions and enhancements. Our technology enables network operators to
deliver content and applications to information appliances over the Internet.
Accordingly, our success will depend in large part upon our ability to adhere to
and adapt our products to evolving Internet protocols and standards. Therefore,
we will need to develop and introduce new products that meet changing customer
requirements and emerging industry standards on a timely basis. In the past, we
have experienced delays in completing the development and introduction of new
software products. We may encounter such delays in the development and
introduction of future products as well. In addition, we may:
- Fail to design our current or future products to meet customer
requirements
- Fail to develop and market products and services that respond to
technological changes or evolving industry standards in a timely or
cost effective manner
- Encounter products, capabilities or technologies developed by others
that render our products and services obsolete or noncompetitive or
that shorten the life cycles of our existing products and services
FAILURE TO MANAGE OUR GROWTH MAY SERIOUSLY HARM OUR ABILITY TO DELIVER PRODUCTS
IN A TIMELY MANNER, FULFILL EXISTING CUSTOMER COMMITMENTS AND ATTRACT AND RETAIN
NEW CUSTOMERS
Our rapid growth has placed, and is expected to continue to place, a
significant strain on our managerial, operational and financial resources,
especially as more network operators and information appliance manufacturers
incorporate our software into their products and services. This potential for
rapid growth is particularly significant in light of the large customer bases of
network operators and information appliance manufacturers and the frequent need
to tailor our products and services to our customers' unique needs. To the
extent we add several customers simultaneously or add customers whose product
needs require extensive customization, we may need to significantly expand our
operations. Moreover, we expect to significantly expand our domestic and
international operations by, among other things, expanding the number of
employees in professional services, research and development and sales and
marketing.
This additional growth will place a significant strain on our limited
personnel, financial and other resources. Our future success will depend, in
part, upon the ability of our senior management to manage growth effectively.
This will require us to implement additional management information systems, to
further develop our operating, administrative, financial and accounting systems
and controls, to hire additional personnel, to develop additional levels of
management within the corporation, to locate additional office space in the
United States and abroad and to maintain close coordination among our research
and development, sales and marketing, services and support and administrative
organizations. Failure to meet any of these requirements would seriously harm
our ability to deliver products in a timely fashion, fulfill existing customer
commitments and attract and retain new customers.
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THE LOSS OF ANY OF OUR KEY PERSONNEL WOULD HARM OUR COMPETITIVENESS
We believe that our success will depend on the continued employment
of our senior management team and key technical personnel, particularly
Mitchell E. Kertzman, our Chief Executive Officer, Coleman Sisson, our
President and Chief Operating Officer, David Limp, our Executive Vice
President and Chief Strategy Officer and Donald Fitzpatrick, our Executive
Vice President of Sales and Services. If one or more members of our senior
management team or key technical personnel were unable or unwilling to
continue in their present positions, these individuals would be very
difficult to replace and our ability to manage day to day operations, develop
and deliver new technologies, attract and retain customers, attract and
retain other employees and generate revenues, could be seriously harmed.
OUR PLANNED EXPANSION OF OUR INDIRECT DISTRIBUTION CHANNELS WILL BE EXPENSIVE
AND MAY NOT SUCCEED
To date, we have sold our products and services principally through our
direct sales force. In the future, we intend to expand the number and reach of
our indirect channel partners, primarily overseas, through distribution
agreements. The development of these indirect channels will require the
investment of significant company resources, which could seriously harm our
business if our efforts do not generate significant revenues. Moreover, we may
not be able to attract indirect channel partners able to effectively market our
products and services. The failure to do so could seriously hinder the growth of
our business.
IN ORDER TO REMAIN COMPETITIVE IN OUR MARKET, WE MAY NEED TO MAKE ACQUISITIONS
WHICH COULD BE DIFFICULT TO INTEGRATE, DISRUPT OUR BUSINESS AND DILUTE
STOCKHOLDER VALUE
We may acquire other businesses in the future in order to remain
competitive or to acquire new technologies. As a result of future acquisitions,
we may need to integrate product lines, technologies, widely dispersed
operations and distinct corporate cultures. In addition, the product lines or
technologies of future acquisitions may need to be altered or redesigned in
order to be made compatible with our software products or the software
architecture of our customers. These integration efforts may not succeed or may
distract our management from operating our existing business. Our failure to
successfully manage future acquisitions could seriously harm our operating
results. In addition, our stockholders would be diluted if we finance
acquisitions by incurring convertible debt or issuing equity securities.
WE MAY BE UNABLE TO SUCCESSFULLY INTEGRATE ACQUISITIONS INTO OUR BUSINESS OR
ACHIEVE THE EXPECTED BENEFITS OF THE ACQUISITIONS
Our acquisitions of SourceSuite and MoreCom will continue to require
integrating our business with their businesses, including integrating product
lines, technologies, widely-dispersed operations and distinct corporate
cultures. We may not be able to successfully assimilate the personnel,
operations and customers of these acquired companies into our business.
Additionally, we may fail to achieve the anticipated synergies from these
acquisitions, including product development and other operational synergies. The
integration process may further strain our existing financial and managerial
controls and reporting systems and procedures. This may result in the diversion
of management and financial resources from our core business objectives. In
addition, we are not experienced in managing significant facilities or
operations in geographically distant areas. Further, we may not be able to
retain various individuals who provide services to these acquired companies that
we have hired in connection with these acquisitions. Our failure to successfully
manage these acquired companies could seriously harm our operating results.
WE MAY NOT BE SUCCESSFUL IN MAKING STRATEGIC INVESTMENTS
We have established the Liberate Corporate Venture Fund. Both through
that fund and otherwise, we have made and plan to continue to make strategic
investments in other companies. In most instances these investments are in the
form of equity securities of private companies for which there is no public
market. These companies may be expected to incur substantial losses and may
never become publicly traded companies. Even if they do, an active trading
market for their securities may never develop and we
25
may never realize any return on these investments. Further, if these companies
are not successful, we could incur charges related to write-downs or write-offs
of these types of assets. Losses or charges resulting from these investments
could harm our operating results.
WE MAY INCUR NET LOSSES OR INCREASED NET LOSSES IF WE ARE REQUIRED TO RECORD A
SIGNIFICANT ACCOUNTING EXPENSE RELATED TO THE ISSUANCE OF WARRANTS
In fiscal year 1999, we entered into letter agreements with several
network operators whereby we agreed to issue warrants to purchase up to an
aggregate of 4,599,992 shares of common stock which are exercisable if those
network operators satisfy certain milestones. The value of the warrants is
estimated using the Black-Scholes model as of the earlier of the grant date or
the date that it becomes probable that the warrants will be earned. Pursuant to
the requirements of Emerging Issues Task Force No. 96-18, the warrants will
continue to be revalued in situations where they are granted prior to the
establishment of a performance commitment. The value of the warrants is recorded
primarily as a non-current asset on the accompanying condensed consolidated
balance sheets and will be amortized over the estimated economic life of the
arrangements with the network operators.
As of November 30, 2000, warrants to purchase up to 2,336,660 shares of
our common stock were earned by these network operators. The fair market value
of these warrants at the time they were earned was $117.2 million. As of
November 30, 2000, accumulated amortization for the warrants was $22.6 million.
If the remaining warrants are earned or we decide to issue additional
warrants to new customers, we will be required to record significant non-cash
accounting expenses or offsets to revenue related to any such warrants. As a
result, we could incur net losses or increased net losses for a given period and
this could seriously harm our operating results and stock price.
DEMAND FOR OUR PRODUCTS AND SERVICES WILL NOT INCREASE IF THE INTERNET DOES NOT
CONTINUE TO GROW AND IMPROVE
Acceptance of our software depends substantially upon the widespread
adoption of the Internet for commerce, communications and entertainment. As is
typical in the case of an emerging industry characterized by rapidly changing
technology, evolving industry standards and frequent new product and service
introductions, demand for and acceptance of recently introduced Internet
products and services are subject to a high level of uncertainty. In addition,
critical issues concerning the commercial use of the Internet remain unresolved
and may affect the growth of Internet use, especially in the consumer markets we
target. The adoption of the Internet for commerce, communications and access to
content and applications, particularly by those that have historically relied
upon alternative means of commerce, communications and access to content and
applications, generally requires understanding and acceptance of a new way of
conducting business and exchanging information. Moreover, widespread application
of the Internet outside of the United States will require reductions in the cost
of Internet access to prices affordable to the average consumer.
To the extent that the Internet continues to experience an increase in
users, an increase in frequency of use or an increase in the amount of data
transmitted by users, we cannot guarantee that the Internet infrastructure will
be able to support the demands placed upon it. In addition, the Internet could
lose its viability as a commercial medium due to delays in development or
adoption of new standards or protocols required to handle increased levels of
Internet activity, or due to increased government regulation. Changes in, or
insufficient availability of, telecommunications or similar services to support
the Internet could also result in slower response times and could adversely
impact use of the Internet generally. If use of the Internet does not continue
to grow or grows more slowly than expected, or if the Internet infrastructure,
standards, protocols or complementary products, services or facilities do not
effectively support any growth that may occur, demand for our products and
services will decline significantly.
26
NEW OR CHANGED GOVERNMENT REGULATION COULD CAUSE DEMAND FOR OUR PRODUCTS AND
SERVICES TO DECLINE SIGNIFICANTLY
We are subject not only to regulations applicable to businesses
generally, but also laws and regulations directly applicable to the Internet.
Although there are currently few such laws and regulations, state, federal and
foreign governments may adopt a number of these laws and regulations governing
any of the following issues:
- User privacy
- Copyrights
- Consumer protection
- Taxation of e-commerce
- The online distribution of specific material or content
- The characteristics and quality of online products and services
We do not engage in e-commerce, nor do we distribute content over the
Internet. However, one or more states or the federal government could enact
regulations aimed at companies, like us, which provide software that facilitates
e-commerce and the distribution of content over the Internet. The likelihood of
such regulation being enacted will increase as the Internet becomes more
pervasive and extends to more people's daily lives. Any such legislation or
regulation could dampen the growth of the Internet and decrease its acceptance
as a communications and commercial medium. If such a reduction in growth occurs,
demand for our products and services will decline significantly.
Moreover, the market for television, and particularly cable and
satellite television, is extensively regulated by a large number of national,
state and local government agencies, including the Federal Communications
Commission. New or altered laws or regulations that change the competitive
landscape, limit the market for interactive television or affect the pricing of
interactive television could seriously harm our business prospects.
WE EXPECT OUR OPERATIONS TO CONTINUE TO PRODUCE NEGATIVE CASH FLOW;
CONSEQUENTLY, IF WE CANNOT RAISE ADDITIONAL CAPITAL, WE MAY NOT BE ABLE TO FUND
OUR CONTINUED OPERATIONS
Since our inception, cash used in our operations has substantially
exceeded cash received from our operations, and we expect this trend to continue
for the foreseeable future. We believe that our existing cash balances will be
sufficient to meet our working capital and capital expenditure needs for at
least the next 12 months. After that, we may need to raise additional funds, and
we cannot be certain that we will be able to obtain additional financing on
favorable terms, or at all. If we need additional capital and cannot raise it on
acceptable terms, we may not be able to, among other things:
- Develop or enhance our products and services
- Acquire complementary technologies, products or businesses
- Open new offices, in the United States or internationally
- Hire, train and retain employees
- Respond to competitive pressures or unanticipated requirements
27
PROVISIONS OF OUR CORPORATE DOCUMENTS AND DELAWARE LAW COULD DETER TAKEOVERS AND
PREVENT YOU FROM RECEIVING A PREMIUM FOR YOUR SHARES
Certain provisions of our certificate of incorporation and bylaws may
discourage, delay or prevent a change in control of our company that a
stockholder may consider favorable. These include provisions that:
- Authorize the issuance of "blank check" preferred stock that could be
issued by our Board of Directors to increase the number of outstanding
shares and thwart a takeover attempt
- Require super-majority voting to effect certain amendments to our
certificate of incorporation and bylaws
- Limit who may call special meetings of stockholders
- Prohibit stockholder action by written consent, which requires all
actions to be taken at a meeting of the stockholders
- Establish advance notice requirements for nominations of candidates for
election to the Board of Directors or for proposing matters that can be
acted upon by stockholders at stockholder meetings
In addition, Section 203 of the Delaware General Corporation Law and
provisions in our stock incentive plans may discourage, delay or prevent a
change in control of our company.
WE ARE AT RISK OF SECURITIES CLASS ACTION LITIGATION DUE TO OUR STOCK PRICE
VOLATILITY
In the past, securities class action litigation has often been
brought against a company following periods of volatility in the market price
of its securities. This risk is especially acute for us because technology
companies have experienced greater than average stock price volatility in
recent years and, as a result, have been subject to, on average, a greater
number of securities class action claims than companies in other industries.
Due to the volatility of our stock price, we may in the future be the target
of similar litigation. Securities litigation could result in substantial
costs and divert management's attention and resources.
OUR STOCK PRICE COULD DECLINE BY SHARES BECOMING AVAILABLE FOR SALE IN THE
FUTURE
Shares of our common stock that are restricted, either by law or
otherwise, will become available for resale in the future. This includes the
eligibility for sale on July 19, 2001 of 3,963,780 shares held by Cisco Systems,
upon the satisfaction of the Rule 144 holding period. Resales of such shares
could adversely affect the market price of our common stock and could impair our
ability to raise capital through the sale of additional equity securities.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
INTEREST RATE RISK
As of November 30, 2000, our investment portfolio includes $429.2
million of U.S. government obligations, commercial paper and other corporate
securities which are subject to no interest rate risk when held to maturity but
may increase or decrease in value if interest rates change prior to maturity. We
do not use derivative financial instruments in our investment portfolio. We
place our investments with high credit quality issuers and, by policy, limit the
amount of credit exposure to any one issuer. As stated in our policy, we are
averse to principal loss and seek to preserve our invested funds by limiting the
fault risk, market risk and reinvestment risk. We currently maintain sufficient
cash and cash equivalent balances to typically hold our investments to maturity.
An immediate 10% change in interest rates would be immaterial to our financial
condition or results of operations.
FOREIGN CURRENCY/EXCHANGE RATE RISK
We transact business in various foreign currencies and are accordingly
subject to exposure from adverse movements in foreign currency exchange rates.
To date, the effect of changes in foreign currency exchange rates on revenues
and operating expenses have not been material. Substantially all of our revenues
are earned in U.S. dollars. Operating expenses incurred by our foreign
subsidiaries are denominated primarily in European currencies. We currently do
not use financial instruments to hedge these operating expenses. We continue to
assess the need to use financial instruments to hedge currency exposures.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
As part of our acquisition of the Virtual Modem software product and
related assets and technology of SourceSuite, we acquired certain patents that
were the subject of a patent infringement lawsuit. This lawsuit was initially
brought by Interactive Channel Technologies and SMI Holdings, affiliated
companies of SourceSuite, against Worldgate Communications in May 1998. The
patent infringement claims have been assigned to us as a result of our merger
with SourceSuite. In June 1998, Worldgate filed a counterclaim against the
plaintiffs and Source Media, a shareholder of SourceSuite, alleging among
others, violations of the Lanham Act and Delaware's Uniform Deceptive Trade
Practices Act, common law unfair competition, tortious interference with
existing and prospective business relationships and misappropriation of
confidential information and trade secrets. Following discovery and briefing of
the patent claim construction issues, the parties have entered into settlement
negotiations covering both our patent infringement claims against Worldgate and
Worldgate's cross-complaint against Interactive Channel, SMI Holdings and Source
Media. We currently believe that this matter and its related actions are likely
to be settled for an immaterial amount.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
(c) CHANGES IN SECURITIES
On July 19, 2000, we agreed to issue 3,963,780 shares of common stock
to Cisco Systems, resulting in aggregate cash proceeds of approximately $100.0
million. The issuance of these shares was deemed to be exempt from registration
under the Securities Act of 1933 in reliance on Section 4(2) of the Securities
Act of 1933, as amended.
On June 22, 2000, we issued an aggregate of 7,310,830 shares of common
stock in exchange for all of the outstanding stock of MoreCom and assumed all of
MoreCom's stock options. The issuance of these shares was deemed to be exempt
from registration under the Securities Act of 1933 in reliance on Section
3(a)(10) of the Securities Act of 1933, as amended. The terms and conditions of
such issuance were
29
approved after a hearing upon the fairness of such terms and conditions by a
government authority expressly authorized by law to grant such approval.
(d) USE OF PROCEEDS
On July 19, 2000 we agreed to issue 3,963,780 shares of common stock to
Cisco Systems at approximately $25.23 per share. Aggregate cash proceeds from
this transaction were approximately $100.0 million. The net proceeds have been
applied to working capital and were predominantly held in cash, cash equivalents
and short-term investments at November 30, 2000.
ITEM 3. DEFAULTS IN SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
We held our Annual Meeting of Stockholders in San Carlos, California on
October 24, 2000. Of the 102,806,363 shares outstanding as of the record date,
83,568,271 shares were present or represented by proxy and the following actions
were voted upon:
- To elect six members of the Board of Directors to serve until the next
Annual Meeting or until their successors have been duly elected and
qualified:
FOR WITHHELD
--------------- ----------------
Mitchell E. Kertzman 79,560,949 4,007,322
David J. Roux 79,549,689 4,018,582
Charles N. Corfield 79,546,795 4,021,476
Bradley P. Dusto 79,578,332 3,989,939
Dr. David C. Nagel 79,577,948 3,990,323
Barry M. Schuler 79,578,078 3,990,193
- To ratify the appointment of Arthur Andersen, LLP as our independent
public accountants for the fiscal year ending May 31, 2001:
FOR AGAINST ABSTAIN
--------------- -------------- --------------
79,546,449 21,617 4,000,205
ITEM 5. OTHER INFORMATION
None
30
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS
EXHIBIT
NO. EXHIBIT
------- -------
2.3 Plan and Agreement of Reorganization with MoreCom, Inc., dated March 27, 2000. (Incorporated by
reference to similarly numbered exhibit to the Form 8-K filed by the Registrant on July 7,
2000).
2.4 Amendment No. 1 to Plan and Agreement of Reorganization with MoreCom, Inc. (Incorporated by
reference to similarly numbered exhibit to the Form 8-K filed by the Registrant on July 7,
2000).
3.1 Amended and Restated Bylaws of Liberate. (Incorporated by reference to Exhibit 3.4 to the
Registration Statement on Form S-1 filed by the Registrant (Reg. No. 333-78781).)
3.2 Sixth Amended and Restated Certificate of Incorporation of Liberate. (Incorporated by reference
to Exhibit 3.5 to the Registration Statement on Form S-1 filed by the Registrant (Reg. No.
333-78781).)
4.1 Specimen Certificate of Liberate's common stock. (Incorporated by reference to similarly
numbered exhibit to the Registration Statement on Form S-1 filed by the Registrant (Reg. No.
333-78781).)
9.2 Amendment to Voting Agreement, dated December 11, 2000.
10.45 Employment Retention Agreement between Liberate and Coleman Sisson, dated January 8, 2001.
10.46 Employment Retention Agreement between Liberate and David Limp, dated January 9, 2001.
10.47 Employment Retention Agreement between Liberate and Donald Fitzpatrick, dated January 3, 2001.
10.48 Promissory Note, dated January 8, 2001, for loan extended to Coleman Sisson.
10.49 Promissory Note, dated January 3, 2001, for loan extended to David Limp.
27.1 Financial Data Schedule.
(b) REPORTS ON FORM 8-K
None
31
SIGNATURE
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
undersigned, thereunto duly authorized.
Liberate Technologies
Date: January 12, 2001 by: /s/ Nancy J. Hilker
----------------------
Nancy J. Hilker,
Vice President and
Chief Financial Officer
(duly authorized officer and
principal financial officer)
32