UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------------------------------
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 FEBRUARY 28, 2001
OR
[] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from___________ to__________
COMMISSION FILE NUMBER 000-26565
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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 [ ]
104,371,186 shares of the Registrant's common stock were outstanding as of
March 31, 2001.
--------------------------------------------------------------------------------
LIBERATE TECHNOLOGIES
FORM 10-Q
FOR THE QUARTER ENDED FEBRUARY 28, 2001
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION PAGE
----
Item 1. Financial Statements
Condensed Consolidated Balance Sheets at May 31, 2000 and
February 28, 2001................................................................ 1
Condensed Consolidated Statements of Operations and Comprehensive Loss
for the Three Months and Nine Months Ended February 29, 2000
and February 28, 2001............................................................ 2
Condensed Consolidated Statements of Cash Flows for the Nine Months Ended
February 29, 2000 and February 28, 2001.......................................... 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............................ 27
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.................................................................... 27
Item 2. Changes in Securities and Use of Proceeds............................................ 28
Item 3. Defaults in Securities............................................................... 28
Item 4. Submission of Matters to a Vote of Security Holders.................................. 28
Item 5. Other Information.................................................................... 28
Item 6. Exhibits and Reports on Form 8-K..................................................... 29
Signature..................................................................................... 30
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
LIBERATE TECHNOLOGIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands)
Unaudited
MAY 31, FEBRUARY 28,
2000 2001
------------- -------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents.......................................... $ 132,962 $ 148,765
Short-term investments............................................. 176,053 164,593
Accounts receivable, net .......................................... 3,058 11,740
Receivable from affiliate, net..................................... 543 403
Note receivable.................................................... 204 7,000
Prepaid expenses and other current assets.......................... 5,850 8,029
----------- -------------
Total current assets............................................. 318,670 340,530
Property and equipment, net........................................... 12,759 16,956
Restricted cash....................................................... 8,788 8,788
Long-term investments................................................. 121,607 162,852
Warrants.............................................................. 106,127 88,964
Purchased intangibles, net............................................ 177,482 488,148
Other assets.......................................................... 754 1,426
------------- -------------
Total assets................................................... $ 746,187 $ 1,107,664
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable................................................... $ 1,759 $ 2,464
Accrued payroll and related expenses............................... 4,303 4,865
Accrued liabilities................................................ 10,290 13,495
Current portion of capital leases.................................. 607 654
Deferred revenues.................................................. 69,132 57,612
------------- -------------
Total current liabilities...................................... 86,091 79,090
Capital lease obligations, net of current portion..................... 1,019 573
Long-term liabilities................................................. 910 1,445
------------- -------------
Total liabilities.............................................. 88,020 81,108
------------- -------------
COMMITMENTS AND CONTINGENCIES (NOTE 5)
STOCKHOLDERS' EQUITY:
Common stock....................................................... 909 1,042
Contributed and paid-in capital.................................... 803,400 1,426,249
Warrants........................................................... 89,770 59,897
Deferred stock compensation........................................ (5,583) (3,691)
Stockholder notes receivable....................................... (8) --
Accumulated other comprehensive income............................. 162 506
Accumulated deficit................................................ (230,483) (457,447)
------------- -------------
Total stockholders' equity .................................... 658,167 1,026,556
------------- -------------
Total liabilities and stockholders' equity..................... $ 746,187 $ 1,107,664
============== =============
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 NINE MONTHS ENDED
------------------------------- ------------------------------
FEBRUARY 29, FEBRUARY 28, FEBRUARY 29, FEBRUARY 28,
2000 2001 2000 2001
-------------- -------------- -------------- --------------
REVENUES:
License and royalty............................... $ 3,043 $ 8,608 $ 6,525 $ 18,910
Service........................................... 4,488 5,831 12,368 16,661
-------------- -------------- -------------- --------------
Total revenues.................................. 7,531 14,439 18,893 35,571
-------------- -------------- -------------- --------------
COST OF REVENUES:
License and royalty............................... 510 499 1,618 1,760
Service........................................... 4,576 7,703 15,269 19,136
-------------- -------------- -------------- --------------
Total cost of revenues.......................... 5,086 8,202 16,887 20,896
-------------- -------------- -------------- --------------
Gross margin.................................... 2,445 6,237 2,006 14,675
-------------- -------------- -------------- --------------
OPERATING EXPENSES:
Research and development.......................... 9,633 14,758 21,275 38,268
Sales and marketing............................... 5,200 5,816 12,118 16,557
General and administrative........................ 2,370 2,932 5,550 8,151
Amortization of purchased intangibles............. 1,521 55,289 4,563 160,838
Amortization of warrants.......................... 4,023 5,721 5,092 17,488
Amortization of deferred stock compensation....... 518 464 1,547 1,439
Acquired in-process research and development...... -- -- -- 22,425
-------------- -------------- -------------- --------------
Total operating expenses........................ 23,265 84,980 50,145 265,166
-------------- -------------- -------------- --------------
Loss from operations............................ (20,820) (78,743) (48,139) (250,491)
Interest income, net................................. 2,218 7,898 5,116 23,846
Other income (expense), net.......................... (123) 454 (683) (115)
-------------- -------------- -------------- --------------
Loss before income tax provision................ (18,725) (70,391) (43,706) (226,760)
Income tax provision................................. 12 -- 61 204
-------------- -------------- -------------- --------------
Net loss........................................ $ (18,737) $ (70,391) $ (43,767) $ (226,964)
Foreign currency translation adjustment.............. (12) (48) 4 344
-------------- -------------- -------------- --------------
Comprehensive loss.............................. $ (18,749) $ (70,439) $ (43,763) $ (226,620)
============== ============== ============== ==============
Basic and diluted net loss per share................. $ (0.22) $ (0.68) $ (0.68) $ (2.23)
============== ============== ============== ==============
Shares used in computing basic and diluted net loss
per share.......................................... 84,147 103,887 64,530 101,780
============== ============== ============== ==============
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
NINE MONTHS ENDED
-------------------------------
FEBRUARY 29, FEBRUARY 28,
2000 2001
------------- -------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss..................................................................... $ (43,767) $(226,964)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization.............................................. 5,952 164,645
Amortization of warrants................................................... 5,092 17,488
Provision for doubtful accounts............................................ 266 152
Write-off of acquired in-process research and development.................. -- 22,425
Loss on disposal of property and equipment................................. 600 329
Non-cash compensation expense.............................................. 1,547 1,439
Changes in operating assets and liabilities:
Increase in accounts receivable.......................................... (1,956) (8,834)
(Increase) decrease in receivable from affiliate, net.................... (562) 140
Increase in prepaid expenses and other current assets.................... (2,054) (2,300)
Increase in other assets................................................. (260) (655)
Increase in restricted cash.............................................. (8,788) --
Increase in accounts payable............................................. 1,277 705
Increase (decrease) in accrued liabilities............................... 3,704 (5,218)
Increase in accrued payroll and related expenses......................... 466 562
Increase (decrease) in deferred revenues................................. 9,766 (11,520)
Increase in other long-term liabilities.................................. -- 533
------------ -----------
Net cash used in operating activities.................................. (28,717) (47,073)
------------ -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment.......................................... (8,189) (7,409)
Purchase of investments...................................................... (74,723) (26,785)
Issuance of note receivable.................................................. -- (7,000)
Investment in Everypath...................................................... -- (3,000)
Cash acquired in MoreCom acquisition......................................... -- 1,500
------------ -----------
Net cash used in investing activities................................. (82,912) (42,694)
------------ -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from secondary public offering, net................................. 297,219 --
Proceeds from initial public offering, net................................... 97,970 --
Proceeds from private placement, net......................................... 12,500 100,000
Proceeds from exercise of stock options...................................... 3,237 5,724
Principal payments on capital lease obligations.............................. (155) (498)
Payments of notes payable.................................................... (52) --
------------ -----------
Net cash provided by financing activities.............................. 410,719 105,226
------------ -----------
Effect of exchange rate changes on cash......................................... (12) 344
------------ -----------
Net increase in cash and cash equivalents....................................... 299,078 15,803
Cash and cash equivalents, beginning of period.................................. 33,657 132,962
------------ -----------
Cash and cash equivalents, end of period....................................... $ 332,735 $ 148,765
============ ===========
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 that 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 expects that the adoption of SFAS
No. 133 will have no material impact on its financial position, results of
operations or 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 nine months ended February 28, 2001, Liberate issued 1,634,989
shares of common stock to employees, external consultants and other service
providers upon the exercise of stock options and an additional 332,552 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 is being amortized over the estimated economic life of the
arrangements with the network operators.
As of February 28, 2001, 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 $4.0 million and $5.7 million for the
three months ended February 29, 2000 and February 28, 2001, respectively. This
increase was primarily due to amortization related to additional warrants earned
since February 29, 2000.
4
If the remaining warrants are earned, the Company may be required to
record significant non-cash accounting expenses. 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, primarily cable and
satellite set-top boxes. As of February 28, 2001, 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 NINE MONTHS ENDED
--------------------------------- --------------------------------
FEBRUARY 29, FEBRUARY 28, FEBRUARY 29, FEBRUARY 28,
2000 2001 2000 2001
--------------- ---------------- --------------- ----------------
(in thousands)
England............................. $ 2,524 $ 7,189 $ 4,691 $ 15,625
United States....................... 3,222 4,119 9,126 11,308
Canada.............................. 703 1,115 1,049 2,524
Japan............................... 538 263 2,350 1,865
Other............................... 544 1,753 1,677 4,249
--------------- ---------------- --------------- ---------------
Total revenues...................... $ 7,531 $ 14,439 $ 18,893 $ 35,571
=============== ================ =============== ===============
International revenues consist of sales to customers incorporated in
foreign countries. International revenues were 57% and 71% of total revenues for
the three months ended February 29, 2000 and February 28, 2001, respectively.
For the nine months ended February 29, 2000 and February 28, 2001, international
revenues were 52% and 68% of total revenues, respectively.
The percentage of sales to significant customers is as follows:
THREE MONTHS ENDED NINE MONTHS ENDED
--------------------------------- --------------------------------
FEBRUARY 29, FEBRUARY 28, FEBRUARY 29, FEBRUARY 28,
2000 2001 2000 2001
--------------- ---------------- --------------- ----------------
Customer A........................... 26% 21% 18% 21%
Customer B........................... 14% * 17% *
Customer C........................... 10% * * *
Customer D........................... * 28% * 21%
__________________
* Less than 10%
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. As of 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. As of February 28, 2001, options to purchase 16,205,141 shares of
common stock and warrants to purchase 1,619,996 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 February 28, 2001 are
approximately $198,000.
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 February 28, 2001 are approximately $707,000. 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, and occupancy took place in January 2001. Upon
occupancy, the Company terminated its month-to-month London, England facility
lease with Oracle Corporation. Future minimum lease payments related to the new
lease are expected to be approximately $1.4 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. 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 February 28, 2001, a total of $7.0 million has been advanced to
Two Way TV and the Company has earned 6,580,000 Two Way TV warrants.
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.
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 February 28,
2001, future minimum sublease income under this agreement is approximately
$825,000.
In January and February 2001, two subtenants, each leasing approximately
26,000 square feet in the Company's headquarter building, notified the Company
that they would not be able to meet their sublease obligations after February
and April 2001, respectively. As a result, monthly rent expense will increase
approximately $71,000 per subtenant.
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. On
March 26, 2001, the U.S. District Court hearing this matter ruled that the
parties have entered into a settlement agreement under which each side will
dismiss its claims against the other.
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
6
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.
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
February 29, 2000 and February 28, 2001. This information does not necessarily
indicate future combined results of operations of the Company.
THREE MONTHS ENDED NINE MONTHS ENDED
--------------------------------- --------------------------------
FEBRUARY 29, FEBRUARY 28, FEBRUARY 29, FEBRUARY 28,
2000 2001 2000 2001
--------------- ---------------- --------------- ---------------
(in thousands, except per share data)
Revenues............................... $ 7,531 $ 14,439 $ 18,893 $ 35,571
Net loss............................... $ (59,785) $ (70,391) $ (165,279) $ (237,095)
Basic net loss per share............... $ (0.71) $ (0.68) $ (2.56) $ (2.33)
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 March 2001, the Company's Board of Directors approved a voluntary
option exchange program that will permit employees to cancel options with strike
prices above the current market value of its shares in exchange for receiving
new grants at market price after a delay of six months or more. The Company is
instituting this program, which is not available to its officers and directors,
in order to provide for employee retention and motivation as the Company gains
commercial momentum.
7
In March 2001, the Company entered into a binding Letter of
Understanding with a large cable services operator. The agreements between
the parties contemplate various payments, including the Company's purchase of
$2.0 million in various consulting, testing and market research services and
its purchase of advertising and marketing services to assist in promoting
interactive television services that have launched in select markets.
In conjunction with the Liberate Corporate Venture Fund, in April 2001,
the Company made a strategic investment of approximately $1.2 million in MetaTV,
Inc. in exchange for 512,821 shares of Series C Preferred stock of MetaTV.
In April 2001, the Company extended a loan in exchange for a promissory
note from Donald Fitzpatrick, its Executive Vice President of Sales and
Services. The loan is in the amount of $500,000 at 5.9% compounded annually and
is due and payable two years from issuance.
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, primarily 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 incorporated in Delaware. 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
8
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 nine months ended February 28, 2001, total service
revenues were $16.7 million, representing 47% 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 $57.6 million at February 28, 2001. 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. In addition, deferred revenues can
fluctuate significantly as a result of several factors, including the timing of
service performance, deployments and prepayments.
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 $1.0 million and $400,000 of our
total revenues for the quarters ended February 29, 2000 and February 28, 2001,
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
9
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 is being
amortized over the estimated economic life of the arrangements with the network
operators. As of February 28, 2001, 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
February 28, 2001, accumulated amortization for the warrants was $28.3 million.
If the remaining warrants are earned, we may be required to record significant
non-cash accounting expenses. 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.
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.
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.
In November 2000, we launched the Liberate Corporate Venture Fund, a $50.0
million fund dedicated to accelerating the development of interactive television
through strategic investments in key industry participants.
Since Liberate's inception, we have incurred net losses of $457.4 million.
These losses include write-offs totaling $82.5 million of acquired in-process
research and development related to our acquisitions, $135.9 million of research
and development expenditures, $193.6 million of amortization of purchased
intangibles, $28.3 million of amortization of warrants and $4.0 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 FEBRUARY 29, 2000 AND FEBRUARY 28, 2001
REVENUES
Total revenues increased 92%, from $7.5 million for the three months ended
February 29, 2000 to $14.4 million for the three months ended February 28, 2001.
LICENSE AND ROYALTY. License and royalty revenues increased 183%, from
$3.0 million for the three months ended February 29, 2000 to $8.6 million for
the three months ended February 28, 2001. The increase was primarily due to
increased deployments to our customers' subscribers. For the fourth quarter we
expect license and royalty revenues to be relatively flat or to grow modestly.
However, as we move into fiscal year 2002, we expect to see more growth for
license and royalty revenues as additional network operators begin to come on
line.
SERVICE. Service revenues increased 30%, from $4.5 million for the three
months ended February 29, 2000 to $5.8 million for the three months ended
February 28, 2001. 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 61%, from $5.1 million for the three
months ended February 29, 2000 to $8.2 million for the three months ended
February 28, 2001. 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 decreased 2%,
from $510,000 for the three months ended February 29, 2000 to $499,000 for the
three months ended February 28, 2001. These amounts represented 17% and 6% 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. Our full
amortization of certain third-party technology may decrease license and royalty
costs as a percentage of related revenues in the near term. However,
introduction of new third-party technologies would tend to increase license and
royalty cost as a percentage of related revenues.
SERVICE. Cost of service revenues increased 68%, from $4.6 million for the
three months ended February 29, 2000 to $7.7 million for the three months ended
February 28, 2001. These amounts represented 102% and 132% 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 both in absolute dollar
amounts and as a percentage of service revenues as we initiate new deployments
and support limited trial installations of our products.
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 53%,
from $9.6 million for the three months ended February 29, 2000 to $14.8 million
for the three months ended February 28, 2001. These amounts represented 128% and
102% of total revenues over the respective periods. The increase in absolute
dollar amounts was primarily due to increases in staffing and employee-related
expenses, mainly due to the SourceSuite and MoreCom acquisitions, and a
reduction in custom
11
development work. Research and development expenses are expected to remain
relatively flat in the near term.
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 12%, from $5.2 million for the three
months ended February 29, 2000 to $5.8 million for the three months ended
February 28, 2001. These amounts represented 69% and 40% of total revenues over
the respective periods. The increase in absolute dollar amounts was primarily
due to increased staffing and employee-related expenses and increased spending
on public relations, offset slightly by a reduction in commission expense. 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 24%, from
$2.4 million for the three months ended February 29, 2000 to $2.9 million for
the three months ended February 28, 2001. These amounts represented 31% and 20%
of total revenues over the respective periods. The increase in absolute dollar
amounts was primarily due to increased staffing and employee-related expenses,
expanded infrastructure outlays and higher outside professional service costs,
offset slightly by one-time merger termination costs recognized in the three
months ended February 29, 2000. We expect that these expenses will increase
modestly 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 February 29, 2000 and approximately $55.3
million for the three months ended February 28, 2001.
AMORTIZATION OF WARRANTS. As of February 28, 2001, 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 $4.0 million and $5.7 million for the
three months ended February 29, 2000 and February 28, 2001, respectively. This
increase was primarily due to amortization related to additional warrants earned
since February 29, 2000. We expect warrant amortization to continue to increase
as additional warrants are earned. If the remaining warrants are earned, we may
be required to record significant non-cash accounting expenses. 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 $518,000 and
$464,000 for the three months ended February 29, 2000 and February 28, 2001,
respectively. 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
approximately $2.2 million for the three months ended February 29, 2000 compared
to $7.9 million for the three months ended February 28, 2001. 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, foreign exchange gains and losses and other
non-operating income and expenses. Net other expense was approximately $123,000
for the three months ended February 29, 2000 compared to net other income of
$454,000 for the three months ended February 28, 2001. The change was primarily
due to the recording of sublease income in excess of related costs and a
one-time gain related to an investment sold during the period. These sources of
income were offset slightly by the loss on disposal of assets.
INCOME TAX PROVISION
Income tax provision is comprised primarily of foreign withholding tax
expense. Income tax provision was approximately $12,000 for the three months
ended February 29, 2000. There was no income tax provision for the three months
ended February 28, 2001.
13
NINE MONTHS ENDED FEBRUARY 29, 2000 AND FEBRUARY 28, 2001
REVENUES
Total revenues increased 88%, from $18.9 million for the nine months ended
February 29, 2000 to $35.6 million for the nine months ended February 28, 2001.
LICENSE AND ROYALTY. License and royalty revenues increased 190%, from
$6.5 million for the nine months ended February 29, 2000 to $18.9 million for
the nine months ended February 28, 2001. The increase was primarily due to
increased deployments to our customers' subscribers.
SERVICE. Service revenues increased 35%, from $12.4 million for the nine
months ended February 29, 2000 to $16.7 million for the nine months ended
February 28, 2001. 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 24%, from $16.9 million for the nine
months ended February 29, 2000 to $20.9 million for the nine months ended
February 28, 2001.
LICENSE AND ROYALTY. Cost of license and royalty revenues increased 9%,
from $1.6 million for the nine months ended February 29, 2000 to $1.8 million
for the nine months ended February 28, 2001. These amounts represented 25% and
9% 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 25%, from $15.3 million for
the nine months ended February 29, 2000 to $19.1 million for the nine months
ended February 28, 2001. These amounts represented 123% and 115% 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 80%,
from $21.3 million for the nine months ended February 29, 2000 to $38.3 million
for the nine months ended February 28, 2001. These amounts represented 113% and
108% of total revenues over the respective periods. The increase in absolute
dollar amounts was primarily due to increases in staffing and employee-related
expenses, mainly due to the SourceSuite and MoreCom acquisitions, and by fewer
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 37%, from $12.1 million for the nine
months ended February 29, 2000 to $16.6 million for the nine months ended
February 28, 2001. These amounts represented 64% and 47% 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 spending for trade shows, advertising and public
relations.
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 47%, from
$5.6 million for the nine months ended February 29, 2000 to $8.2 million for the
nine months ended February 28, 2001. These amounts represented 29% and 23% of
total revenues over the respective periods. The increase in absolute dollar
amounts was primarily due to increased staffing and related expenses, the
14
establishment of the infrastructure necessary to support our expansion and
higher outside professional service costs, offset slightly by one-time merger
termination costs recognized in the nine months ended February 29, 2000.
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 $4.6 million of amortization
expense for the nine months ended February 29, 2000 and approximately $160.8
million for the nine months ended February 28, 2001.
AMORTIZATION OF WARRANTS. As of February 28, 2001, 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 $5.1 million and $17.5 million for
the nine months ended February 29, 2000 and February 28, 2001, respectively.
This increase was primarily due to amortization related to additional warrants
earned since February 29, 2000.
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 $1.5 million for
the nine months ended February 29, 2000 and $1.4 million for the nine months
ended February 28, 2001.
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
approximately $5.1 million for the nine months ended February 29, 2000 compared
to $23.8 million for the nine months ended February 28, 2001. 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, foreign exchange gains and losses and other
non-operating income and expenses. Net other expense was approximately $683,000
and $115,000 for the nine months ended February 29, 2000 and February 28, 2001,
respectively. The change was primarily due to the recording of sublease income
in excess of related costs and a one-time gain related to an investment sold
during the period. These sources of income were offset slightly by the loss on
disposal of assets.
INCOME TAX PROVISION
Income tax provision is comprised primarily of foreign withholding tax
expense. Income tax provision was approximately $61,000 and $204,000 for the
nine months ended February 29, 2000 and February 28, 2001, respectively.
15
LIQUIDITY AND CAPITAL RESOURCES
Our principal source of liquidity was cash, cash equivalents and
short-term investments, which were approximately $313.4 million as of February
28, 2001. Additionally, we had approximately $162.9 million in long-term
investments.
Net cash used in operating activities was approximately $28.7 million and
$47.1 million for the nine months ended February 29, 2000 and February 28, 2001,
respectively, an increase of approximately $18.4 million from year to year. This
increase was primarily due to the increase in net loss and the decrease in
deferred revenues, which was offset by an increase in depreciation and
amortization as well as the write-off of acquired in-process research and
development related to the MoreCom acquisition for the nine months ended
February 28, 2001.
Net cash used in investing activities was approximately $82.9 million and
$42.7 million for the nine months ended February 29, 2000 and February 28, 2001,
respectively, a decrease of approximately $40.2 million from year to year. This
decrease was primarily due to the timing and mix of our investment activity.
Net cash provided by financing activities was approximately $410.7 million
and $105.2 million for the nine months ended February 29, 2000 and February 28,
2001, respectively, a decrease of approximately $305.5 million from year to
year. This decrease was primarily due to the fact that our net proceeds from our
secondary public offering, our initial public offering and a private placement
of our stock for the nine months ended February 29, 2000 were greater than the
net proceeds received by us from the sale of our common stock to Cisco Systems.
At February 28, 2001, we had approximately $148.8 million in cash and cash
equivalents and did not have any material commitments for capital expenditures,
other than a capital lease. At February 28, 2001, we also had approximately
$164.6 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 $1.9 million was paid for each of the nine months ended
February 29, 2000 and February 28, 2001.
In May 1998, we entered into a Technology License and Distribution
Agreement ("Agreement") with Sun Microsystems. During March 2001, we amended our
Agreement with Sun. This amendment requires us to pre-pay $1.4 million in
royalties and support fees in exchange for the right to certain Sun technology
and to maintain the status as a primary channel partner of Sun.
In November 2000, we launched the Liberate Corporate Venture Fund, a $50.0
million fund dedicated to accelerating the development of interactive television
through strategic investments in key industry participants. As part of the Fund,
we have made the following investments:
- 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. As of February 28, 2001, a total of $7.0 million has
been advanced to Two Way TV.
- In April 2001, we made a strategic investment of approximately $1.2
million in MetaTV, Inc. in exchange for 512,821 shares of Series C
Preferred stock of MetaTV.
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
16
retention agreement provides approximately $820,000 to the employee over the
next two years of continued service.
In April 2001, we extended a loan in exchange for a promissory note from
Donald Fitzpatrick, our Executive Vice President of Sales and Services. The loan
is in the amount of $500,000 at 5.9% compounded annually and is due and payable
two years from issuance.
In March 2001, we entered into a binding Letter of Understanding with a
large cable services operator. The agreements between the parties contemplate
various payments, including our purchase of $2.0 million in various
consulting, testing and market research services and our purchase of
advertising and marketing services to assist in promoting interactive
television services that have launched in select markets.
We believe that the net proceeds from our various offerings, together with
cash and cash equivalents generated from operations, will be more than
sufficient to meet our working capital requirements for at least the next 12
months.
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 in a new market 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 $227.0 million for the nine months ended
February 28, 2001. 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 $227.0 million for the nine months ended February 28, 2001 included a
$22.4 million charge for the MoreCom acquisition related to the acquired
in-process research and development, amortization of purchased intangibles of
$160.8 million and warrant amortization of $17.5 million. As of February 28,
2001, we had an accumulated deficit of approximately $457.4 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 that our costs of revenues and operating
expenses will continue to increase. 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 February 28, 2001, approximately 58% 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.
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
18
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, primarily 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 development of content and applications for information
appliances of interest to significant numbers of consumers and 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 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 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. The customization process for new customers 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.
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OUR PRODUCTS MAY CONTAIN ERRORS OR BE INFERIOR TO OUR COMPETITORS' PRODUCTS
Software development is an inherently complex and subjective process,
which frequently results in products that contain errors ("bugs"), as well as
defective or non-competitive features or functions. Moreover, 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. Any such failure would
cause severe customer service and public relations problems for our customers
and could result in delayed or lost revenue due to adverse customer reaction,
negative publicity and claims for substantial damages. Our current insurance
policies may not protect against all of these risks.
In addition, our competitors may develop products, capabilities or
technologies that render our products and services obsolete or noncompetitive or
that shorten the life cycles of our existing products and services.
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 or fail to develop and
market products and services that respond to technological changes or evolving
industry standards in a timely or cost effective manner.
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 upon 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.
20
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 licenses of Microsoft software for television set-top boxes.
Investments such as this may discourage our potential or current customers who
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 104,226,554 shares outstanding on February 28, 2001, Oracle
beneficially owns 33,899,843 shares, approximately 33% of our outstanding common
stock. No Oracle designee currently serves on our Board of Directors. While
Oracle has contributed these shares to a blind voting trust committed to vote
them in proportion to all other voted shares, if Oracle were to withdraw the
shares from this trust, it might 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 nine months
ended February 29, 2000, our five largest customers accounted for approximately
53% of our total revenues, with Cable & Wireless (recently acquired by NTL)
accounting for 18% of our total revenues and Wind River accounting for 17% of
our total revenues. For the nine months ended February 28, 2001, our three
largest customers accounted for approximately 51% of our revenues, with Telewest
and Cable & Wireless each accounting for 21% 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
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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.
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 and in customer deployments, the ability of our software platform to
support and manage a substantial number of users 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 52% of our total
revenues for the nine months ended February 29, 2000 and approximately 68% for
the nine months ended February 28, 2001. 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.
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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.
We cannot guarantee that an infringement claim will not be asserted against us
in the future, that the assertion of such a claim will not result in litigation,
that we would prevail in such litigation, or that we would be able to obtain a
license for the use of any infringed intellectual property 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, and 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
depends substantially 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 a number of 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.
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 expand our domestic and international
operations significantly 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
23
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.
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
THAT 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
24
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 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 is being amortized over the estimated economic life of the
arrangements with the network operators.
As of February 28, 2001, 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
February 28, 2001, accumulated amortization for the warrants was $28.3 million.
If the remaining warrants are earned, we may be required to record
significant non-cash accounting expenses. 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.
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 and cable and
satellite television broadcasts. Although there are currently few such laws and
regulations, state, federal and foreign governments may adopt a number of laws
and regulations that adversely affect us or our markets in any of the following
areas: user privacy, copyrights, consumer protection, taxation of e-commerce,
the online distribution of content, and 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 government agencies could enact regulations
affecting companies, like us, which provide software that facilitates e-commerce
and the distribution of content over the Internet. Moreover, the market for
television, and particularly cable and satellite television, is extensively
regulated by a large number of
25
national, state and local government agencies, including the Federal
Communications Commission. New or altered laws or regulations regarding
interactive television that change the competitive landscape or limit its market
or affect its pricing 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
more than 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 develop our products
and services, acquire complementary technologies or businesses, open new
offices, hire and retain employees, or respond to competitive pressures or new
business requirements.
PROVISIONS OF OUR CORPORATE DOCUMENTS AND DELAWARE LAW COULD DETER TAKEOVERS AND
PREVENT STOCKHOLDERS FROM RECEIVING A PREMIUM FOR THEIR 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 to increase
the number of outstanding shares and thwart a takeover attempt
- Require super-majority voting to make 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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WE RELY ON CONTINUOUS POWER SUPPLY TO CONDUCT OUR OPERATIONS, AND CALIFORNIA'S
CURRENT ENERGY CRISIS COULD DISRUPT OUR OPERATIONS AND INCREASE OUR EXPENSES
California is in the midst of an energy crisis that could disrupt our
operations and increase our expenses. In the event of an acute power shortage,
California may implement rolling blackouts throughout the state. If blackouts
interrupt our power supply, we may be temporarily unable to operate. Any such
interruption in our ability to continue operations could delay the development
of our products, interfere with our ability to provide customer support, damage
our reputation, and result in lost revenue, any of which could substantially
harm our business and results of operations.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
INTEREST RATE RISK
As of February 28, 2001, our investment portfolio includes $430.1 million
of U.S. government obligations, commercial paper and other corporate securities
that 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. The majority 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. On March 26, 2001, the U.S. District Court hearing this matter ruled that
the parties have entered into a settlement agreement under which each side will
dismiss its claims against the other.
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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 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 February 28, 2001.
ITEM 3. DEFAULTS IN SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5. OTHER INFORMATION
In March 2001, Barry Schuler resigned from our Board of Directors in
order to fulfill his new responsibilities as Chairman and Chief Executive
Officer of America Online, Inc., a subsidiary of AOL Time Warner, Inc.
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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).)
10.50 Promissory Note, dated April 6, 2001, for loan extended to Don
Fitzpatrick.
(b) REPORTS ON FORM 8-K
None
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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: April 12, 2001 by: /s/ Nancy J. Hilker
----------------------
Nancy J. Hilker,
Senior Vice President and
Chief Financial Officer
(duly authorized officer and
principal financial officer)
30