-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, DthQhmrARxtVP7jXbqZcKw4ZVoJ+qUIiMcslbFh2YZpM4ByTr2PQUlnuuUpDrvvW MJgpi4YJO0x1OEoTyUkplQ== 0001012870-00-000667.txt : 20000215 0001012870-00-000667.hdr.sgml : 20000215 ACCESSION NUMBER: 0001012870-00-000667 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 19991231 FILED AS OF DATE: 20000214 FILER: COMPANY DATA: COMPANY CONFORMED NAME: DIVA SYSTEMS CORP CENTRAL INDEX KEY: 0001003439 STANDARD INDUSTRIAL CLASSIFICATION: CABLE & OTHER PAY TELEVISION SERVICES [4841] IRS NUMBER: 943226532 STATE OF INCORPORATION: DE FISCAL YEAR END: 0630 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 333-64483 FILM NUMBER: 539229 BUSINESS ADDRESS: STREET 1: 333 RAVENSWOOD AVE STREET 2: BUILDING 205 CITY: MENLO PARK STATE: CA ZIP: 94025 BUSINESS PHONE: 6508596400 MAIL ADDRESS: STREET 1: 333 RAVENSWOOD AVE STREET 2: BLDG 205 CITY: MENLO PARK STATE: CA ZIP: 94025 10-Q 1 FORM 10-Q FOR THE PERIOD ENDED 12/31/1999 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, DC 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 December 31, 1999. 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 No. 333-64483 DIVA Systems Corporation (Exact name of Registrant as specified in its charter) Delaware 94-3226532 (State or other jurisdiction of (IRS Employer Incorporation or organization) Identification Number) 800 Saginaw Drive Redwood City, CA 94063 (Address of principal executive offices) (650) 779-3000 (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. [X] Yes [ ] No The number of shares of Registrant's classes of Common Stock at February 7, 2000 was: Title of each class Common Stock, $.001 par value 17,377,433 Class C Common Stock, $.001 par value 857,370 DIVA SYSTEMS CORPORATION Quarterly Report on Form 10-Q Table of Contents Quarter Ended December 31, 1999 PART I -- FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements (Unaudited) Condensed Consolidated Balance Sheet at December 31, 1999 and June 30, 1999 1 Condensed Consolidated Statement of Operations for the three months and six months ended December 31, 1999 and 1998 2 Condensed Consolidated Statement of Cash Flows for the six months ended December 31, 1999 and 1998 3 Notes to Condensed Consolidated Financial Statements 4 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 6 PART II -- OTHER INFORMATION Item 2. Changes in Securities and Use of Proceeds 29 Item 6. Exhibits and Reports on Form 8-K 29 Signatures 30
PART I ITEM 1. FINANCIAL STATEMENTS DIVA SYSTEMS CORPORATION AND SUBSIDIARIES Condensed Consolidated Balance Sheets (in thousands, except share data) (unaudited)
December 31, June 30, Assets 1999 1999 -------------- --------- Current assets: Cash and cash equivalents $ 52,907 89,239 Short-term investments 57,262 41,498 Inventory 2,714 2,663 Prepaid expenses and other current assets 708 2,096 -------------- --------- Total current assets 113,591 135,496 Property and equipment, net 11,602 9,792 Debt issuance costs, net 7,335 8,114 Deposits and other assets 581 550 Intangible assets, net 222 312 -------------- --------- Total assets $ 133,331 154,264 ============== ========= Liabilities, Redeemable Warrants, and Stockholders' Deficit Current liabilities: Accounts payable $ 2,115 2,784 Other current liabilities 1,674 1,221 Deferred revenue 731 -- Current portion of capital lease obligation 489 -- -------------- --------- Total current liabilities 5,009 4,005 -------------- --------- Notes payable 293,564 275,564 Long -- term portion of lease payable 1,000 -- -------------- --------- Total liabilities 299,573 279,569 -------------- --------- Redeemable warrants 2,411 2,108 -------------- --------- Commitments and contingencies Stockholders' deficit: Preferred stock, $0.001 par value; 30,000,000 shares authorized; 22,239,605 and 21,390,283 shares issued and outstanding as of December 31, 1999, and June 30, 1999 respectively. 22 21 Common stock, $0.001 par value; 65,000,000 shares authorized; 17,960,958 and 17,463,574 shares issued and outstanding as of December 31, 1999, and June 30, 1999 respectively. 18 17 Additional paid-in capital 124,428 117,170 Deferred compensation (863) (1,248) Accumulated deficit (292,258) (243,373) -------------- ---------- Total stockholders' deficit (168,653) (127,413) -------------- ---------- Total liabilities, redeemable warrants, and stockholders' deficit $ 133,331 154,264 ============== ==========
See accompanying notes to interim condensed consolidated financial statements. 1 DIVA SYSTEMS CORPORATION AND SUBSIDIARIES Condensed Consolidated Statements of Operations (in thousands, except per share data) (unaudited)
Three Months Ended Six Months Ended December 31, December 31, 1999 1998 1999 1998 ---------- --------- -------- ------- Revenues: Product $ 944 -- 944 -- Services 103 57 171 120 ---------- --------- -------- ------- Total revenues 1,047 57 1,115 120 ---------- --------- -------- ------- Cost of product revenue 1,103 -- 1,103 -- ---------- --------- -------- ------- Gross profit (loss) (56) 57 12 120 Operating expenses: Programming 1,023 2,068 2,265 3,939 Operations 1,529 1,936 3,000 4,102 Engineering and development 6,922 6,230 12,203 11,248 Sales and marketing 1,680 1,381 3,293 2,606 General and administrative 4,248 3,819 9,143 6,792 Depreciation and amortization 1,801 2,446 3,275 4,692 ---------- --------- -------- ------- Total operating expenses 17,203 17,880 33,179 33,379 ---------- --------- -------- ------- Operating loss 17,259 17,823 33,167 33,259 ---------- --------- -------- ------- Other (income) expense, net: Interest income (1,514) (2,317) (3,099) (4,991) Interest expense 9,631 8,387 18,817 16,408 ---------- --------- -------- ------- Total other expense, net 8,117 6,070 15,718 11,417 ---------- --------- -------- ------- Net loss 25,376 23,893 48,885 44,676 Accretion of redeemable warrants 152 137 304 522 ---------- --------- -------- ------- Net loss attributable to common stockholders $ 25,528 24,030 49,189 45,198 ========== ========= ======== ======= Basic and diluted net loss per share: $ 1.44 1.40 2.79 2.65 ========== ========= ======== ======= Shares used in per share computation 17,689 17,116 17,600 17,063 ========== ========= ======== =======
See accompanying notes to interim condensed consolidated financial statements. 2 DIVA SYSTEMS CORPORATION AND SUBSIDIARIES Condensed Consolidated Statement of Cash Flows (in thousands) (unaudited)
Six Months Ended December 31, 1999 1998 ------- ------- Cash flows from operating activities: Net loss $(48,885) (44,676) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization 3,275 4,781 Loss on disposition of property and equipment 74 1,161 Amortization of debt issuance costs and accretion of discount on notes payable 18,790 16,404 Amortization of deferred stock compensation 385 318 Changes in operating assets and liabilities: Other assets 1,388 (432) Inventory 256 -- Accounts payable (669) 1,376 Other current liabilities 453 (396) Deferred revenue 731 -- -------- ------- Net cash used in operating activities (24,202) (21,464) -------- ------- Cash flows from investing activities: Purchases of property and equipment (3,800) (7,912) Deposits on property and equipment (31) (4) Purchase of short-term investments (15,764) (26,296) -------- ------- Net cash used in investing activities (19,595) (34,212) -------- ------- Cash flows from financing activities: Issuance of preferred stock, net 7,000 -- Exercise of common stock options, series AA preferred stock options and issuance of common stock 563 182 Payments on capital lease (87) -- Payments on note payable (11) (10) -------- ------- Net cash provided by financing activities 7,465 172 -------- ------- Net increase (decrease) in cash and cash equivalents (36,332) (55,504) Cash and cash equivalents at beginning of period 89,239 167,549 -------- ------- Cash and cash equivalents at end of period $ 52,907 112,045 ======== ======= Noncash investing and financing activities: Reclassification of equipment to inventory $ 307 -- ======== ======= Accretion of redeemable warrants $ 304 522 ======== ======= Equipment acquired under capital lease obligations $ 1,576 -- ======== ======= Deferred compensation expense associated with stock option activity $ -- 1,986 ======== =======
See accompanying notes to interim condensed consolidated financial statements. 3 DIVA SYSTEMS CORPORATION AND SUBSIDIARIES NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) Note 1--The Company And Basis Of Presentation DIVA Systems Corporation ("DIVA" or the "Company"), a Delaware corporation, was formed in July 1995 to design, develop, and market video-on-demand ("VOD") products and services for the cable television industry. The Company was in the development stage from July 1, 1995 (inception) to September 30, 1999, and its primary activity was performing research and development, licensing program content, manufacturing the necessary equipment, developing a service offering, establishing strategic alliances, deploying service trials and limited commercial launches with cable operators and raising capital. As of October 1, 1999, the Company commenced principle operations, which consists of manufacturing, selling, licensing and providing operational support for its VOD products and services. The interim unaudited financial statements as of December 31, 1999, for the three and six months ended December 31, 1998 and 1999 have been prepared on substantially the same basis as the Company's audited financial statements for the year ended June 30, 1999 and include all adjustments, consisting only of normal recurring adjustments, that, in the opinion of management, are necessary for a fair presentation of the financial information set forth herein. The results of operations for current interim periods are not necessarily indicative of results to be expected for the current year or any other period. These interim unaudited financial statements should be read in conjunction with the Company's annual financial statements, included in the Company's Form 10-K for the year ended June 30, 1999 ("Fiscal 1999"). Note 2--Basic and Diluted Net Loss Per Share Basic and diluted net loss per share is computed using net loss adjusted for the accretion of the redeemable warrants and the weighted-average number of outstanding shares of common stock. Potentially dilutive securities, including options, warrants, restricted common stock, and preferred stock, have been excluded from the computation of diluted net loss per share because the effect of this inclusion would be antidilutive. Information pertaining to potentially dilutive securities is included in Notes 6 and 7 of notes to consolidated financial statements included in the Company's Fiscal 1999 Form 10-K. Note 3--Stockholders' Equity In December 1999, the Company completed the sale of 777,778 shares of Series E Preferred Stock for approximately $7.0 million in gross proceeds from a strategic business partner. The rights, preferences, and privileges of the holders of Series E convertible preferred stock are as follows: . Dividends are noncumulative and payable only upon declaration by the Board of Directors at a preference rate of $0.54 per share. . Holders have a liquidation preference of $9.00 per share, plus any declared but unpaid dividends over holders of common stock. . Each holder has voting rights equal to common stock on an "as if converted" basis. . Each share of preferred stock may be converted into common stock at the option of the holder on a one-for-one basis, subject to adjustment to protect against dilution. In addition, the Company also entered into a development agreement with the strategic business partner. In conjunction with this agreement, the Company granted a warrant to purchase 388,888 shares of Series E Preferred Stock exercisable at $9.00 per share. The warrant expires the earlier of December 14, 2004 or under certain conditions as a result of a merger or acquisition of the Company. The warrant becomes exercisable in accordance with the achievement of certain milestones in the development agreement. 4 Note 4--Revenue Recognition Policy The Company recognizes revenue in accordance with the American Institute of Certified Public Accountants ("AICPA") issued Statement of Position 97-2, "Software Revenue Recognition" ("SOP 97-2"). SOP 97-2 generally requires revenue earned on software arrangements involving multiple elements to be allocated to each element based on the relative fair values of the elements. The fair value of an element must be based on Vendor Specific Objective Evidence ("VSOE") of the relative fair values of the elements. VSOE is determined by the price charged when the element is sold separately. In December 1998, the Accounting Standards Executive Committee issued Statement of Position 98-9("SOP 98-9"), "Software Revenue Recognition, with respect to certain arrangements", which requires recognition of revenue using the residual method in a multiple element arrangement when fair value does not exist for one or more of the delivered elements in the arrangement. Under the residual method, the total fair value of the undelivered elements is deferred and subsequently recognized in accordance with SOP 97-2. SOP 98-9 must be adopted by the Company in Fiscal 2001. The Company's contracts are generally multiple-element arrangements involving the delivery of a combination of hardware, software and other services to a customer. When evidence of fair value for post contract customer support in the Company's current agreements does not exist, revenue is recognized to the extent of the cost of the hardware delivered. Any remaining revenue is amortized on a straight-line basis over the post contract customer support period. Monthly per-view movie and subscription revenues are recognized in the period in which the services are provided. The Company provides limited warranty rights to its customers, which are accounted for in accordance with SFAS No. 5, "Accounting for Contingencies". Estimated warranty obligations are provided by charges to operations in the period in which the related revenue is recognized. To date, the estimated warranty obligations have not been significant. 5 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations The following discussion of the financial condition and results of operations of the Company should be read in conjunction with the unaudited Consolidated Interim Financial Statements for the three months and six months ended December 31, 1999. This discussion contains forward-looking statements that involve risks and uncertainties, including but not limited to, certain assumptions regarding increases in customers, revenues and certain expenses. Forward-looking statements are identified with an asterisk (*) and reflect the Company's current expectations. Although the Company believes that its plans, intentions and expectations reflected in such forward-looking statements are reasonable, it can give no assurance that such plans, intentions or expectations will be achieved. Actual results will differ and such differences may be material. All forward-looking statements attributable to the Company or persons acting on its behalf are expressly qualified in their entirety by the cautionary statements set forth below and in "--Factors Affecting Operating Results." Overview The Company was founded in July 1995 and since inception, the Company has devoted substantially all of its resources to developing its video-on-demand system, establishing strategic relationships, negotiating deployment agreements, carrying out initial marketing activities and establishing the operations necessary to support the commercial launch of the Company's VOD service. Through December 31, 1999, the Company has generated minimal revenues, has incurred significant losses and has substantial negative cash flow, primarily due to the engineering and development and start-up costs required to develop its VOD products and services. Since inception through December 31, 1999, the Company had an accumulated deficit of $292.3 million. The Company currently expects to incur substantial additional net losses and negative cash flow for at least the next several years.* Results of Operations Since its inception, the Company has engaged primarily in technology development and activities related to the startup of business operations. Accordingly, the Company's historical revenues and expenditures are not necessarily indicative of, and should not be relied upon as an indicator of, revenues that may be attained or expenditures that may be incurred by the Company in future periods. Revenues Total revenues are comprised of two components: revenues from per-movie fees and sales ("Services revenues") and revenues resulting from the sale and licensing of VOD products and software ("Product revenues"). Total revenues for the three months ended December 31, 1999 were approximately $1.0 million, an increase of $991,000 from $57,000 for the same period of Fiscal 1999. Total revenues for the six months ended December 31, 1999 were approximately $1.1 million, an increase of $995,000 from $120,000 for the same period of Fiscal 1999. 6 Services revenues consist of per-movie viewing fees, monthly service fees and the sale of monthly subscription packages. The majority of Services revenues consist of per-movie viewing fees paid by customers to view movies on demand. As of December 31, 1999, the Company's VOD service was deployed at six multiple system operator ("MSO") locations. Services revenues for the three months ended December 31, 1998 and December 31, 1999 was $57,000 and $103,000, respectively. Services revenues for the six months ended December 31, 1998 and December 31, 1999 was $120,000 and $171,000, respectively. The Company realizes monthly revenue pursuant to deployment agreements with MSOs only when its VOD system is successfully integrated and operating and customer billing commences. Generally, the timing and extent of deployment under each agreement is conditioned on a successful initial deployment phase, followed by a larger rollout in the applicable MSO system based on an agreed upon schedule. Product revenues consist of revenues from the sale of the Company's VOD products such as the DIVA Video Server (the "Video Server") and the DIVA Digital Link (the "DDL") and license revenues from its DIVA System Manager ("DSM") software. In addition, the Company can provide operational support services including content acquisition and management, engineering services, billing and navigator services at the option of the MSO. Product revenues for the three months ended December 31, 1998 and December 31, 1999 and for the six months ended December 31, 1998 and December 31, 1999 was $0 and $944,000, respectively. The increase in Product revenue was primarily due to the recognition of revenues related to the Company's hardware. In addition, at December 31, 1999, the Company received $731,000 for the future delivery of certain DDL products, which was recorded as deferred revenue. Such revenue will be recognized when the DDL products are delivered and installed. The Company believes that revenues will fluctuate significantly from period to period and its success will depend on a number of factors including the Company's ability to commercially deploy its VOD products and services in a significant number of large headend locations.* See"--Factors Affecting Operating Results - Uncertainty of Future Revenues; Fluctuating Operating Results and Dependence on Cable Operator Participation; Consolidation in Cable System Ownership; Unproven and Evolving Business Models." Cost of Product Revenues The Company's cost of revenues consists of contract manufacturing costs, component and material costs, and other direct product expenditures. Gross Profit (Loss) Gross margin was a 5% loss for the three months ended December 31, 1999 and 1% profit for the six months ended December 31, 1999. The Company anticipates that future gross profit will vary significantly as a result of a number of factors including the Company's ability to commercially deploy its VOD products and services in a significant number of headend locations.* See "--Factors Affecting Operating Results - Uncertainty of Future Revenues; Fluctuating Operating Results and Dependence on Cable Operator Participation; Consolidation in Cable System Ownership; Unproven and Evolving Business Models." 7 Operating Expenses Programming expense. Programming expense includes license fees payable to content providers, costs for the acquisition and production of digitally encoded programming content (i.e. movies, videos, previews, promotions, etc.) and content duplication and distribution expenses. Programming expense was $2.1 million and $1.0 for the for the three months ended December 31, 1998 and 1999, respectively, and $3.9 million and $2.3 million for the six months ended December 31, 1998 and 1999, respectively. The decrease in programming expenses was primarily attributable to reduced labor and other related costs in the area of program production services. The Company has reduced the number of trailers, previews, promotions, and other content related material, which it produced internally resulting in a reduction of overall expenditures in this area. In addition, the Company has significantly reduced the number of titles digitally encoded in the MPEG - 1 format and is currently encoding program content in the MPEG - 2 format only. The current quarter and year-to-date amounts reflect this reduced level of expenditures when compared to the same periods in Fiscal 1999. The Company expects to continue to experience cost reductions in this area.* Operations Expense. Operations expense includes the cost of field operations, both for initial launches and for the ongoing operations of the Company's VOD service. These costs include technical support, customer service training, installation and launch support, maintenance costs for headend equipment and other field support costs. In addition, operations expense includes personnel and other costs which support the Company's ongoing manufacturing relationships with third-party manufacturers for the Company's Video Server, DDL and other related headend equipment. Operations expense was $1.9 million and $1.5 million for the three months ended December 31, 1998 and 1999, respectively, and $4.1 million and $3.0 million for the six months ended December 31, 1998 and 1999, respectively. The decrease in operations expenses is primarily the result of the Company's decision to discontinue the manufacture of its own proprietary set-top box in the third quarter of Fiscal 1999. As a result, manufacturing related costs have decreased in the current quarter when compared to the comparable quarter in Fiscal 1999. However, the Company expects operations expense to increase in the future due to an increase in the level of activity related to the production of the Company's Video Servers, DDLs and related headend equipment.* Engineering and Development Expense. Engineering and development expense consists of salaries, consulting fees and other costs to support product development, prototype hardware costs, ongoing system software, system integration and new services technology. To date, the most substantial portion of the Company's operating expenses has been engineering and development expense. Engineering and development expense was $6.2 million and $6.9 million for the three months ended December 31, 1998 and 1999, respectively, and $11.2 million and $12.2 million for the six months ended December 31, 1998 and 1999, respectively. The increase in engineering and development expense was attributable to the hiring of additional engineering and development personnel and outside consultants in connection with the Company's further development and refinement of its VOD technology and the development of new products and services. The Company intends to increase engineering and development expenses to fund continued development and enhancements of its VOD products and services.* The Company believes significant investments in engineering and development will be necessary to remain competitive and to respond to market pressures.* 8 Sales and Marketing Expense. Sales and marketing expense consists of the costs of marketing the Company's VOD products and services to MSOs and their customers and includes business development and marketing personnel, travel expenses, trade shows, consulting fees and promotional costs. In addition, sales and marketing expense includes direct costs related to acquiring customers, such as telemarketing, direct mailings, targeted advertising and promotional campaigns. Sales and marketing expense was $1.4 million and $1.7 million for the three months ended December 31, 1998 and 1999, respectively, and $2.6 million and $3.3 million for the six months ended December 31, 1998 and 1999, respectively. The primary items contributing to the increase in marketing expense were promotional expenditures in connection with the Company's recent commercial deployments, continued business development activities and product management costs. The Company expects sales and marketing expense to continue to increase as the Company pursues and enters into new agreements.* General and Administrative Expense. General and administrative expense consists primarily of salaries and related expenses of management and administrative personnel, professional fees and general corporate and administrative expenses. General and administrative expense covers a broad range of the Company's infrastructure including corporate functions such as executive, administration, finance, legal, human resources, international business development and facilities. In addition, general and administrative expense includes costs associated with the development, support and growth of the Company's complex information system infrastructure. General and administrative expense was $3.8 million and $4.2 million for the three months ended December 31, 1998 and 1999, respectively, and $6.8 million and $9.1 million for the six months ended December 31, 1998 and 1999, respectively. Overall, general and administrative expense has increased as a direct result of the growth of the Company in all phases of its operations. In addition to the increase in personnel related expenses, the increase in general and administrative expense is the result of increased rent expense due to the Company's relocation of its corporate headquarters to a new facility and international business development expenses, including the operations of an office in the United Kingdom. General and administrative expense is expected to increase substantially in order to support expansion of the Company's business.* Depreciation and Amortization. Depreciation and amortization expense includes depreciation of property and equipment, including DIVA Video Servers and other headend hardware. Generally, depreciation is calculated using the straight-line method over the estimated useful lives of the assets, which range from three to five years. Depreciation and amortization expense was $2.5 million and $1.8 million for the three months ended December 31, 1998 and 1999, respectively, and $4.7 million and $3.3 million for the six months ended December 31, 1998 and 1999, respectively. The decrease in depreciation and amortization expense is the result of approximately $9.1 million in write-downs recorded in the fourth quarter of Fiscal 1999 related to older, prototype Video Servers and other server related hardware and components. In addition, approximately $2.7 million of previously capitalized equipment was transferred to inventory in the fourth quarter of Fiscal 1999. Although, depreciation and amortization expense decreased for the current period, it is expected to increase in the future due to planned expenditures for capital equipment and other capital costs associated with the deployment and expansion of the Company's overall business operations.* 9 Other Income and Expense Other income and expense primarily consists of interest income and interest expense. Interest income consists of earnings on cash, cash equivalents and short-term investments. Interest income was $2.3 million and $1.5 million for the three months ended December 31, 1998 and 1999, respectively, and $5.0 million and $3.1 million for the six months ended December 31, 1998 and 1999, respectively. The decrease in interest income is the result of a decrease in cash and cash equivalent balances which are invested in short-term interest bearing accounts and a decrease in short-term investments. Interest expense consisted primarily of accreted interest on the Company's outstanding debt. Interest expense was $8.4 million and $9.6 million for the three months ended December 31, 1998 and 1999, respectively, and $16.4 million and $18.8 million for the six months ended December 31, 1998 and 1999, respectively. The increase in interest expense was due to the significant increase in the Company's debt as a result of the offering of the Company's 12-5/8% Senior Discount Notes due 2008 (the "1998 Notes") which was completed on February 19, 1998. The 1998 Notes were issued at a substantial discount from their aggregate principal amount at maturity of $463.0 million. Although cash interest is not payable on the 1998 Notes prior to September 1, 2003, the Company's interest expense includes the accretion of such interest expense. The carrying amount of the 1998 Notes will accrete to its face value by March 1, 2003. Beginning September 1, 2003, cash interest will be payable on the notes semi-annually in arrears on each March 1st and September 1st at a rate of 12 5/8% per annum. Provision for Income Taxes The Company has not provided for or paid federal income taxes due to the Company's net losses. As of June 30, 1999, the Company had net operating loss carryforwards of approximately $152.3 million to offset future income subject to federal income taxes and $82.0 million available to offset future California taxable income. As of June 30, 1999, the Company had $6.5 million in net operating losses to offset future New Jersey taxable income. The extent to which such loss carryforwards can be used to offset future taxable income may be limited because of ownership changes pursuant to Section 382 of the Internal Revenue Code of 1986, as amended. Liquidity and Capital Resources From inception through December 31, 1999, the Company has financed its operations primarily through the gross proceeds of private placements totaling approximately $83.3 million of equity and $250.0 million of high yield debt securities, net of repayments. As of December 31, 1999, the Company had cash and cash equivalents and short-term investments totaling $110.2 million. In May 1996, the Company received $25.0 million in gross proceeds from the sale of 47,000 units, consisting of 1996 Notes with an aggregate principal amount at maturity of $47.0 million and warrants to purchase an aggregate of 1,898,800 shares of Common Stock. Aggregate proceeds of $285,000 were attributed to these warrants. In connection with the offering of the 1998 Notes, the Company subsequently retired all of the 1996 Notes in a debt exchange. In July and August 1996, the Company completed the sale of Series C Preferred Stock for approximately $25.9 million in gross proceeds. 10 In August and September 1997, the Company completed the sale of Series D Preferred Stock for approximately $47.4 million in gross proceeds. On February 19, 1998, the Company received $250.0 million in gross proceeds from an offering of 463,000 units consisting of 1998 Notes with an aggregate principal amount at maturity of $463.0 million and warrants to purchase an aggregate of 2,778,000 shares of Common Stock. Of these units, a total of 404,998 units were offered for sale and an additional 58,002 units were exchanged for all the 1996 Notes. Each unit consists of one 1998 Note and three warrants each exercisable to purchase two shares of the Company's Common Stock at $0.005 per share. The 1998 Notes are senior unsecured indebtedness of the Company, and rank pari passu with any future unsubordinated unsecured indebtedness. The 1998 Notes will be senior to any future subordinated indebtedness of the Company, but effectively will be subordinated to any secured indebtedness of the Company. The 1998 Notes were issued at a substantial discount from their aggregate principal amount at maturity of $463.0 million. Although cash interest is not payable on the 1998 Notes prior to September 1, 2003, the Company's interest expense includes the accretion of such interest expense and the carrying amount of the 1998 Notes will accrete to face value by March 1, 2003. Beginning September 1, 2003, cash interest will be payable on the notes semi-annually in arrears on each March 1 and September 1 at the rate of 12-5/8% per annum. There are no principal payments due on the 1998 Notes prior to maturity on March 1, 2008. The gross proceeds to the Company from the issuance of the 1998 Notes were approximately $250.0 million. In connection with the offering, the Company allocated approximately $18.1 million of the proceeds to the warrants. The net proceeds from the offering of the 1998 Notes were approximately $200.0 million, after deducting placement fees and other offering costs, the extinguishment of the 1996 Notes and a premium paid in connection with the early extinguishment of the 1996 Notes. In December 1999, the Company completed the sale of 777,778 shares of Series E Preferred Stock for approximately $7.0 million in gross proceeds. In December 1999, the Company entered into a three year capital lease for office equipment, for approximately $1.6 million. The Company expects to require significant working capital and incur significant operating expenses in the future.* Working capital requirements include inventory expenditures for Video Servers, DDLs and other related headend equipment, and general capital expenditures associated with the anticipated growth of the Company. The Company's working capital needs will, in part, be driven by the rate at which cable operators purchase and introduce the Company's VOD products and services. In addition to working capital, the Company anticipates expending a significant portion of its resources for continued development and enhancement of its VOD technology, development of new services and other expenses associated with the delivery of its VOD products and services.* The Company's actual funding requirements may vary from expectations and will depend on numerous future factors and conditions, many of which are outside of the Company's control, including, but not limited to (i) the ability of the Company to meet its platform development and product integration schedules; (ii) the accuracy of the Company's assumptions regarding the rate and extent of commercial deployment and 11 market acceptance of its VOD products and services; (iii) the number and timing of VOD product sales, license and service agreements with cable operators; (iv) the nature and cable operator acceptance of new products and services to be offered by the Company; (v) unanticipated costs; and (vi) the need to respond to competitive pressures and technological changes. The Company may also use a portion of its cash resources to purchase some of its outstanding indebtedness in the open market from time to time depending on market conditions. The Company believes that its cash, cash equivalents and short-term investments at December 31, 1999 will be sufficient to satisfy the Company's liquidity at least through the end of calendar 2000.* Thereafter, the Company will need to raise significant additional funds to support its operations. However, the Company may need to raise additional funds earlier if its estimates of working capital and operating expenditure requirements change or prove to be inaccurate. The Company may also need to raise significant additional funds in order to respond to unforeseen technological or marketing hurdles or to take advantage of unanticipated opportunities. The Company has no present commitments or arrangements assuring it of any future equity or debt financing, and there can be no assurance that the Company will be able to obtain any such equity or debt financing on favorable terms or at all. In the event that the Company is unable to obtain such additional capital, the Company will be required to delay the expansion of its business or take other actions that could have a material adverse effect on the Company's business, operation results, financial condition and its ability to achieve sufficient cash flow to service its indebtedness. To the extent the Company raises additional cash by issuing equity securities, existing stockholders of the Company will be diluted. Financial Market Risks The Company is exposed to financial market risks, including changes in interest rates and marketable equity security prices. The Company typically does not attempt to reduce or eliminate its market exposures on its investment securities because the majority of the Company's investments are short-term. The fair value of the Company's investment portfolio or related income would not be significantly impacted by either a 100 basis point increase or decrease in interest rates due mainly to the short-term nature of the major portion of the Company's investment portfolio. All of the potential changes noted above are based on a sensitivity analysis performed on the Company's balances as of June 30, 1999. Year 2000 The following provides a year 2000 update and supplements the discussion included in the Company's annual financial statements, included in the Company's Form 10-K for Fiscal 1999. Through the first month of calendar year 2000, the Company completed the transition from calendar year 1999 to 2000 and did not experience any material disruption to operations as a result of the transition. Recent Account Pronouncements In June 1998, SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities" was issued. SFAS No. 133 establishes accounting and reporting standards for derivative instruments, hedging activities, and exposure definition. SFAS No. 133 requires that an entity recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. The Statement is effective for all fiscal quarters of fiscal years beginning after June 15, 2000. Earlier application of the Statement is permitted. The Company does not expect it to have a material impact on its consolidated results of operations or financial position. 12 In March 1998, the American Institute of Certified Public Accountants (AICPA) issued Statement of Position ("SOP") No. 98-1, "Software for Internal Use," which provides guidance on accounting for the cost of computer software developed or obtained for internal use. SOP No. 98-1 is effective for financial statements for fiscal years beginning after December 15, 1998. The Company does not expect that the adoption of SOP No. 98-1 will have a material impact on its consolidated financial statements. Factors Affecting Operating Results Substantial Leverage; Ability to Service Indebtedness; Restrictive Covenants As a result of the issuance of the 1998 Notes, the Company is highly leveraged. As of December 31, 1999, the Company had total debt of approximately $293.6 million, accreting to $463.0 million in 2003. The Company believes its existing cash, cash equivalents and short-term investments at December 31, 1999 will be sufficient to meet its cash requirements at least through the end of calendar year 2000.* Thereafter, the Company will require substantial additional capital to fund operating deficits, the continued development and enhancement of its VOD system and working capital and other expenditures in connection with commercial deployment of its system. See "--Substantial Future Capital Requirements." As a result, the Company expects that it will continue to have substantial indebtedness.* The degree to which the Company is leveraged could have important consequences to the Company and its investors, including, but not limited to, the following: (i) the Company's ability to obtain additional financing in the future for working capital, operating expense in connection with system deployments, development and enhancement of its VOD system, capital expenditures, acquisitions and other general corporate purposes may be materially limited or impaired; (ii) the Company's cash flow, if any, will not be available for the Company's business because a substantial portion of the Company's cash flow must be dedicated to the payment of principal and interest on its indebtedness; (iii) the terms of future permitted indebtedness may limit the Company's ability to redeem the 1998 Notes in the event of a Change of Control (as defined); and (iv) the Company's high degree of leverage may make it more vulnerable to economic downturns, may limit its ability to withstand competitive pressures and may reduce its flexibility in responding to changing business and economic conditions. The ability of the Company to make scheduled debt service payments (including with respect to the 1998 Notes) will depend upon the Company's ability to achieve significant and sustained growth in its cash from operations and to complete necessary additional financings. The Company's ability to generate sufficient cash from operations is dependent upon, among other things, the market acceptance of its VOD products and services; the Company's ability to successfully continue the development and enhancement of its VOD system, including compatibility with evolving industry standards as they are defined; the future operating performance of the Company; integration of its digital products and services with those provided by major cable industry suppliers; the Company's ability to obtain broad distribution of its products and services to MSOs and the rate of and success of commercial deployment of its VOD system. The Company expects that it will continue to generate substantial operating losses and negative cash flow for at least the next several years.* No assurance can be given that the Company will be successful in achieving and maintaining a level of cash from operations sufficient to permit it to pay the principal, premium, if any, and interest on its indebtedness. If the Company is unable to generate sufficient cash from operations to service its indebtedness, it may have to forego or delay development 13 and enhancement of its VOD system and service, restructure or refinance its indebtedness or seek additional equity capital or debt financing. There can be no assurance that (i) any such strategy could be effected on satisfactory terms, if at all, in light of the Company's high leverage or (ii) any such strategy would yield sufficient proceeds to service the Company's indebtedness, including the 1998 Notes. Any failure by the Company to satisfy its obligations with respect to the 1998 Notes or any other indebtedness could result in a default under the indenture governing the 1998 Notes (the "Indenture") and could cause a default under agreements governing other indebtedness of the Company. In the event of such a default, the holders of such indebtedness would have enforcement rights, including the right to accelerate such debt and the right to commence an involuntary bankruptcy proceeding against the Company. Absent a certain level of successful commercial deployment of its VOD service, ongoing technical development and enhancement of its VOD system and significant growth of its cash flow, the Company will not be able to service its indebtedness. The Indenture imposes operating and financial restrictions on the Company and its subsidiaries. These restrictions affect, and in certain cases significantly limit or prohibit, among other things, the ability of the Company and its subsidiaries to incur additional indebtedness, create liens upon assets, apply the proceeds from the disposal of assets, make investments, make dividend payments and other distributions on capital stock and redeem capital stock. There can be no assurance that such covenants will not adversely affect the Company's ability to finance its future operations or to engage in other business activities that may be in the interest of the Company. However, the limitations in the Indenture are subject to a number of important qualifications and exceptions. In particular, while the Indenture restricts the Company's ability to incur indebtedness by requiring that specified leverage ratios are met, it permits the Company and its subsidiaries to incur substantial indebtedness (which may be secured indebtedness), without regard to such ratios, to finance the acquisition of equipment, inventory or network assets or to finance or support working capital and operating expenditures for its business. Substantial Future Capital Requirements The Company will require substantial additional funds for the continued development of its VOD system and the sale, license and provision of underlying products and services. As of December 31, 1999, the Company had approximately $110.2 million in cash, cash equivalents and short-term investments. From inception until December 31, 1999, the Company had an accumulated deficit of $292.3 million. The Company has made significant investments in working capital and capital expenditures in order to fund development activities, commercially deploy its VOD service, sell its products and services and fund operations. The Company expects to continue to make significant investments in working capital in order to continue these activities under its evolving business model until such time, if at all, as the Company begins to generate positive cash flows from operations.* The Company expects that its cash flow from operating and investing activities will be increasingly negative over at least the next several years.* The Company believes that its existing cash, cash equivalents and short-term investments at December 31, 1999 will be sufficient to meet its working capital and capital expenditure requirements at least through the end of calendar year 2000.* Thereafter, the Company will require substantial additional capital to fund operating deficits, the continued development and enhancement of its VOD system, working capital and other operating expenditures that support 14 commercial deployments of its VOD system. However, the Company may need to raise additional funds earlier if its estimates of working capital and/or capital expenditure requirements change or prove to be inaccurate. The Company may also need to raise significant additional funds in order to respond to unforeseen technological or marketing hurdles or to take advantage of unanticipated opportunities. Actual capital requirements may vary from expectations and will depend on numerous future factors and conditions, many of which are outside of the Company's control, including, but not limited to (i) the ability of the Company to meet its platform development and product integration schedules; (ii) the accuracy of the Company's assumptions regarding the rate and extent of commercial deployment and market acceptance of its VOD products and services; (iii) the number and timing of VOD product sales, license and service agreements with cable operators; (iv) the nature and cable operator acceptance of new products and services to be offered by the Company; (v) unanticipated costs; and (vi) the need to respond to competitive pressures and technological changes. The Company has no present commitments or arrangements assuring it of any future equity or debt financing, and there can be no assurance that the Company will be able to obtain any such equity or debt financing on favorable terms or at all. In the event that the Company is unable to obtain such additional capital, the Company will be required to delay the expansion of its business or take other actions that could have a material adverse effect on the Company's business, operating results, financial condition and its ability to achieve sufficient cash flow to service its indebtedness. Limited Revenues; History of Losses The Company has a limited commercial operating history, having commercially deployed its VOD service on a limited basis beginning in September 1997. The Company has incurred substantial net losses since inception through December 31, 1999 of approximately $292.3 million. The Company expects to continue to incur substantial losses and experience substantial negative cash flow for at least the next several years as it continues to develop its VOD service capability and sell and license its products and services.* The Company's limited operating history makes the prediction of future operating results difficult or impossible. The Company does not expect to generate any substantial revenues unless and until its VOD service is deployed at a significant number of additional cable headend locations.* The Company's prospects should be considered in light of the risks, expenses and difficulties frequently encountered by companies recently commencing principle operations, particularly companies in new and rapidly evolving markets. The Company's future success depends in part on its ability to accomplish a number of objectives, including, but not limited to (i) entering into agreements for broad distribution of its products and services to MSOs; (ii) integrating its digital platform and software with other digital applications and services selected by the cable operator, including integration of set-top boxes, headend components and electronic program guides; (iii) modifying its headend equipment and headend equipment provided by cable industry suppliers and further integration of all such headend equipment and related systems in order to achieve cost reductions and reduce physical space requirements for widespread VOD deployment in a large number of headends; (iv) completing further technical development of the Video Server, DDL and other VOD system components in order to reduce their cost of manufacture; (v) modifying the Video Server, other system components and service software to enable enhanced functionality, such as music videos and time-shifting; (vi) continued scaling of its VOD system solution for use with larger numbers of customers and an increased number of movie 15 titles; and (vii) implementing existing contracted VOD deployments with acceptable system performance and consumer acceptance. Uncertainty of Future Revenues; Fluctuating Operating Results As a result of the Company's limited operating history, the emerging nature of the market in which it competes, and the unproven nature of both its initial and new business models, the Company is unable to accurately forecast its revenues. The timing and amount of future revenues will depend in large part upon the business model employed with each MSO and the date of installation and deployment of VOD products and services purchased by the MSO for each headend and the terms of the contractual arrangement with the MSO. New sales, service and licensing agreements are expected to be secured on an irregular basis, if at all, and there may be prolonged periods of time during which the Company does not enter into new agreements or expanded arrangements. Further, the Company's quarterly operating results may fluctuate significantly in the future as a result of a variety of factors, either alone or in combination. Many of these factors are outside DIVA's control. Factors that may affect DIVA's quarterly operating results relating to provision of its VOD products and services include (i) the Company's success in obtaining agreements with MSOs to purchase the Company's products and services for deployment in large numbers of cable system headends (See "--Dependence on Cable Operator Participation; Consolidation in Cable System Ownership; Unproven Business Models."); (ii) the mix and timing of revenues under the Company's various business models; (iii) the timing and completion of MSO upgrades of their distribution infrastructures (See "-- Dependence on Advanced Cable Distribution Networks and Deployment of Digital Set-Top Boxes."); (iv) the effectiveness of MSO marketing of VOD services and related operations; (v) demand for and consumer acceptance of digital tier services that include VOD as either a core or value added service; (vi) the evolution of alternative forms of in-home entertainment systems; and (vii) the market for home video entertainment services. Factors that may affect DIVA's quarterly operating results generally include (i) the amount and timing of operating expenses devoted to compliance with cable industry standards and technical integration of the Company's VOD products with products and services provided by third party cable industry suppliers (See "--Compliance with Industry Standards; Need to Integrate with Third Party Products."); (ii) the amount and timing of operating expenses devoted to research and development to modify DIVA's products to keep pace with technological developments (See "--Risk of Technological Change and New Product Development."); (iii) the introduction of new products and services by the Company or its competitors and price competition among VOD product and service providers (See "--Competition Among VOD Suppliers."); and (iv) general economic conditions and economic conditions specific to the cable industry. A significant portion of DIVA's expenses are operating costs that are relatively fixed and necessary to develop the Company's business and independent of revenue generated by sales of products and services to MSOs. If revenue falls below expectations in any quarter, the adverse impact of the revenue shortfall on operating results in that quarter may be magnified by the Company's inability to adjust fixed spending to compensate for the shortfall. 16 Any one of these factors, most of which are outside of the Company's control, could cause the Company's operating results to fluctuate significantly in the future. In response to a changing competitive environment, the Company may choose or may be required from time to time to make certain pricing, service or marketing decisions or enter into strategic alliances or investments or be required to develop upgrades or enhancements to its system that could have a material adverse effect on the Company's business, operating results, financial condition and its ability to generate sufficient cash flow to service its indebtedness. The Company believes that its quarterly revenues, expenses and operating results will vary significantly in the future and that period-to- period comparisons are not meaningful and are not indicative of future performance.* As a result of the foregoing factors, it is likely that in some future quarters or years the Company's operating results will fall below the expectations of securities analysts or investors, which would have a material adverse effect on the trading price of the 1998 Notes.* Dependence on Cable Operator Participation; Consolidation in Cable System Ownership; Unproven and Evolving Business Models DIVA's future success depends in large part on its ability to sell its products and services and deploy its VOD system in a broad base of cable system headends, on terms and conditions that will generate a profit. Broad MSO deployments will in turn depend upon, among other things, DIVA's success in demonstrating to MSOs that (i) DIVA's technical solution is reliable and scalable; (ii) VOD is a compelling consumer product and MSO customers will purchase VOD content at prices and in quantities that will justify the MSO's investment in DIVA's VOD system, products and services rather than alternative entertainment services such as pay-per-view ("PPV") and near video-on-demand ("NVOD"); (iii) the Company's VOD system performs and has features that are as compelling, and at competitive prices, as other VOD products offered or in development by competitors; (iv) DIVA's VOD system will be integrated with third party products and services provided by other cable industry suppliers chosen by the MSO; (v) DIVA will evolve its VOD products to be compatible with OpenCable and other cable industry standards as they are finalized; (vi) the Company will continue research and development efforts to assure that its VOD platform will enable new value-added services and functions; and (vii) DIVA's VOD products will have open interfaces to ensure compatibility with commercially available hardware and software. To date, the Company has entered into multiple cable headend contracts with Chambers Communications Corp. ("Chambers"), Insight Communications Co., L.P. ("Insight"), MediaOne of Colorado, Inc. ("MediaOne"), and NTL Group Limited ("NTL"), and a contingent single headend contract, subject to significant conditions, with R & A Management LLC ("Rifkin"). The Company is in discussions with various other cable operators regarding the sale of DIVA products and services in order to deploy VOD in specific systems. The Company recently completed limited initial deployments with Adelphia Communications Corporation ("Adelphia") and Cablevision Systems Corporation ("Cablevision") under contingent contracts. In both cases, DIVA and the MSO have mutually agreed to terminate the contingent contracts. The Company's agreement with Lenfest Communications, Inc. ("Lenfest") has also been terminated. The Lenfest cable systems were sold to Comcast Cable Communications, Inc. ("Comcast") in January, 2000. Comcast has elected to continue the Company's existing VOD deployment served by the Wallingford, Pennsylvania headend under a new contingent agreement. There can be no assurance that the Company will be able to add new cable system headends to the existing contracts with these MSOs, to remove the contingencies and complete or expand deployment sites under the two existing contingent MSO contracts, or to enter into definitive agreements with any 17 other cable operators. If cable operators are not persuaded to purchase DIVA's products or services to deploy VOD broadly in their cable systems, there can be no assurance that the Company can modify its VOD system and successfully market it to alternative video providers, and such modifications would require additional time and capital if pursued. Initially, the Company directed its marketing efforts to medium sized cable operators which had not pursued and would not likely undertake the development of their own VOD solutions. While the Company currently has contracts with one large U.S. MSOs (MediaOne) and one large European MSO (NTL), the current consolidation of cable properties in the U.S. and in Europe is resulting in the absorption of medium sized cable operators into the large MSOs. There can be no assurance that such large MSOs will be willing to purchase VOD products and services from the Company or be willing to do so on terms and conditions which are economically justifiable to the Company. Further, there can be no assurance that any new large MSO will select DIVA or any other single VOD product or service provider for deployments in all of its upgraded cable systems, and instead it is highly likely that large MSOs will choose to purchase VOD products and services from a variety of competing providers. In light of the consolidation of cable system ownership, and in response to reaction of larger MSOs to DIVA's original business model, the Company has changed its business proposition to offer the MSO more choices and more control of the VOD service. The Company's original business model was significantly different from those commonly employed in the cable television industry. Under the Company's original business model, DIVA owned, installed and funded all headend hardware and software components of its VOD system, acquired, assembled, managed and delivered the VOD service offering to cable subscribers, and intended to generate earnings through long-term deployment agreements with MSOs based on a share of "per view" and other content prices set by the Company. It is likely under this initial standard VOD service model that MSOs found it difficult to determine the net effect on revenue of either adding the Company's service to their product mix, or replacing elements of their service offerings with the Company's VOD service. Further, larger MSOs expressed reluctance to have DIVA or any other third party own and operate a VOD system interfaced to their cable distribution networks. As a result, the Company has recast its business model so that the Company sells its Video Server and DDL to MSOs, licenses the DSM software to MSOs, and provides a suite of content acquisition and management services, engineering services, and business and operations support services at the election of the MSO. The new business model anticipates that VOD service enabled by DIVA's system will be a part of the entry level digital tier of services provided by the MSO. Under this new business model, the cable operator purchases, owns and maintains the VOD system hardware and takes the capital and operating expense risk associated with such ownership. The MSO can then select such DIVA VOD support services as it wants to employ, thereby having an alternative to the original turnkey approach. The MSO can choose the entire package of content and management services provided by DIVA for a share of "per view" revenue, or some or all of these services on a contract fee for service basis. DIVA's first three existing MSO contracts are under the initial business model. The recent contracts with Insight, MediaOne and NTL represent varying combinations of the elements of the new business model. To date, DIVA's VOD system solution has not been rolled out to a large number of digital customers in any MSO deployment. See "--Limited Commercial Deployments to Date; Scalability Not Proven." Consequently, until the economics under either of DIVA's business models are proven, cable operators may be reluctant to broadly deploy the Company's VOD products and services in their systems 18 or may be unwilling to purchase its VOD offerings at all. There can be no assurance that the Company will be able to expand the scope of deployments using its initial business model, convert existing turnkey VOD contracts to the new suite of offerings, or broadly deploy under its new business model, or that cable operators will be willing to purchase the Company's VOD products and services on these or any other terms. VOD is a new market, and the Company's VOD system solution is only one possible means available to cable operators for providing movies in the home. The inability of the Company to enter into definitive agreements with cable operators for the DIVA VOD solution, or the lack of acceptance of VOD as a consumer product by cable operators and their subscribers, would have a material adverse effect on the Company's business, operating results, financial condition and its ability to generate sufficient cash flow to service its indebtedness. Limited Commercial Deployments to Date; Scalability Not Proven The Company has commercially deployed its VOD service in a single headend location in cable systems owned by Comcast and Rifkin, in two headend locations in cable systems owned by Chambers, and in three headend locations in cable systems owned by Insight. The Company's agreements with Comcast and Rifkin are conditioned upon completion of an initial deployment phase designed to enable the cable operator to verify the business viability of DIVA's VOD service. DIVA is in the initial deployment phase with both MSOs. If the Company's VOD service does not demonstrate business viability or if the cable operator otherwise determines that such service does not meet its business or operational expectations, neither Comcast nor Rifkin is obligated to deploy the Company's VOD service. There can be no assurance that the Company will successfully complete these initial commercial deployment phases or that its VOD system and service will be deployed beyond the initial phases in any such cable operator's systems. The existing commercial deployments with Chambers and Insight, while not conditioned upon completion of an initial commercial phase, are not yet rolled out to the full extent of available upgraded cable plant and currently serve a limited number of customers. Commercial deployment has not yet begun with MediaOne and NTL. Until the Company's VOD products are deployed on a large scale in one cable system, the scalability of the Company's VOD system will remain unproven. Further, there can be no assurance that unforeseen problems will not develop as the Company evolves its technology, products and services, or that the Company will be successful in the continued development, cost reduction, integration and commercial implementation of its technology, products and services on a wide scale. Competition for VOD Services The market for in-home video entertainment services is intensely competitive, rapidly evolving and subject to rapid technological change. The Company expects competition in the market for VOD products and services to intensify and increase in the future.* A number of companies have announced an intention to introduce a VOD service or deliver VOD components that might be deployed by a video service provider. Intertainer, a company owned in part by Microsoft Corporation ("Microsoft"), Comcast Cable Communications ("Comcast"), Intel Corporation ("Intel"), Sony Corp. of America and NBC, is currently conducting trials with 19 Comcast and US West to provide VOD and other services over high speed networks such as ADSL (Asymmetric Digital Subscriber Line) and cable modems primarily to the personal computer, but plans to provide services to television sets in the future. It is possible that companies currently operating overseas will adapt their technology and offer it through high-speed networks in the United States. Elmsdale Media is currently conducting a trial for its VOD system in Cardiff, Wales for NTL. VideoNet is conducting a trial in Britain over telephone wires offering VOD and other interactive services to non-paying customers. Hongkong Telecom began offering commercial interactive services, including VOD, in March 1998. Other companies internationally and domestically have also announced plans to provide VOD services which vary in degree of commercial viability. There can be no assurance that these or other companies will not provide equivalent or more attractive capabilities that could be more acceptable to cable operators and their subscribers. It is also possible that competitors may form alliances, develop a competitive VOD service and rapidly acquire significant market share. Such competition would materially and adversely affect the Company's business, operating results and financial condition. Companies that are or may be capable of delivering VOD components include Concurrent Computer Corp, Celerity Systems Inc., Mitsubishi Electronics America, Nippon Electric Corp., nCUBE, Pioneer and its affiliates, SeaChange International, Inc., Silicon Graphics Inc., Unisys, General Instrument, Scientific-Atlanta, Sony Corporation, Vivid Technology Inc. and FreeLinQ Communications Corporation. Some of these competitors have developed VOD products that have undergone tests or trials and may succeed in obtaining market acceptance of their products more rapidly than the Company. In addition, Time Warner Inc. previously field tested an integrated system solution utilizing components from a number of the aforementioned entities. This trial has since been terminated. Notwithstanding termination of its field trial in Orlando, Time Warner Inc. has reached agreements with certain industry suppliers for elements that might be used in designing and integrating a next generation VOD system solution for an initial deployment in 2000. Cablevision has operated limited trials of in-house VOD solutions. Certain of the Company's competitors or potential competitors have developed affiliations with cable operators or alternative distribution providers to develop services or technologies that may be better or more cost effective than the Company's VOD service. These services or technologies may be more attractive to cable operators. In addition, certain of these potential competitors are either directly or indirectly affiliated with content providers and cable operators and could therefore materially impact the Company's ability to sign long-term service contracts with such cable operators and obtain content from such providers. Although the Company is pursuing joint development efforts to port its VOD service to digital platforms that are or will be broadly deployed in the cable industry, these third party equipment manufacturers have the financial and technical ability to develop and sustain deployment of their own proprietary VOD platforms. There can be no assurance that the Company will not face competition from these suppliers or their affiliates or that they will support the integration of Company's VOD service with their own components. See "--Compliance with Industry Standards; Need to Integrate with Set-Top Box Manufacturers." The Company may also face competition from cable operators or other organizations, including but not limited to the telephone companies, providers of direct broadcast satellite ("DBS"), PPV and NVOD, cable programmers and Internet service providers, who could provide VOD-like services through cable and alternative delivery platforms, including the Internet, telephone lines and satellite and other wireless services. Recent announcements of combinations of DBS services DirecTV and the Dish Network with digital recording devices from Replay Networks and TiVo may represent stronger competition through the ability to store 20 and replay broadcast programming with pause, play, fast-forward and reverse capability. For example, the Company could encounter competition from companies such as Microsoft/WebTV Plus, Excite@Home or video streaming companies that in the future may be able to deliver movies over the Internet to the television, or from consumer use of purchased or rented digital video discs or variants thereof. In addition, the competitive environment in which the Company will operate may inhibit its ability to offer its VOD service to cable operators and other types of operators that compete with one another in the same territory. A cable operator may require the Company to provide its VOD service exclusively to such cable operator in a particular territory. Further, cable operators themselves may offer competing services, including increased NVOD offerings, or may be unwilling to use the Company's VOD service and/or products exclusively. There can be no assurance that any cable operator will commit exclusively to the Company's VOD service and/or products. In particular, cable operators may trial a number of different alternatives. The Company will also face competition for viewers from providers of home video rentals, which are increasingly entering into revenue sharing arrangements with content providers. These arrangements have resulted in a significant increase in the number of copies available for rental and an extension in the rental period at major video chains and, accordingly, have made home video rentals more attractive to consumers. Many of the Company's competitors and potential competitors have longer operating histories, greater name recognition, and significantly greater financial, technical, marketing and distribution resources than the Company. As a result, they may be able to respond to new or emerging technologies and changes in customer requirements or to devote greater resources to the development, promotion and sale of their products and services more effectively than the Company. There can be no assurance that the Company will be able to compete successfully against current or future competitors or that competitive pressures faced by the Company will not materially adversely affect its business, operating results, financial condition and its ability to achieve sufficient cash flow to service its indebtedness. Risks Associated with Anticipated Growth The Company believes the opportunities presented by MSO reaction to its new business model may require it to meet multiple aggressive engineering, integration, product delivery and installation targets.* The growth in size and scale of the Company's business has placed and is expected to continue to place significant demands on its management, operating, development, third party manufacturing and financial resources. The Company's ability to manage growth effectively will require continued implementation of and improvements to its operating, manufacturing, development and financial systems and will require the Company to expand and continue to train and manage its employee base. These demands likely will require the addition of new management personnel and the development of additional expertise by existing management personnel. Although the Company believes that it has made adequate allowances for the costs and risks associated with future growth, there can be no assurance that the Company's systems, procedures or controls or financial resources will be adequate to support the Company's operations or that management will be able to keep pace with such growth. If the Company is unable to manage its growth effectively, the Company's business, operating results, financial condition and ability to generate sufficient cash flow to service its indebtedness will be materially adversely affected. 21 Dependence on Advanced Cable Distribution Networks and Deployment of Digital Set-Top Boxes The Company's VOD service requires deployment on cable systems upgraded to hybrid fiber/coaxial ("HFC") architecture with the return path from the customer to the headend activated to enable two-way operation. According to the Cablevision Blue Book, approximately 45% of the total U.S. homes passed by cable had been upgraded to HFC architecture with return path capability at the end of 1998, but only a limited portion of the upgraded plant is currently activated for two-way transmission. A number of cable operators have announced and begun to implement major infrastructure investments to deploy two-way capable HFC systems which require significant financial, managerial, operating and other resources. HFC upgrades have been, and likely will continue to be, subject to delay or cancellation. In addition, the Company believes that the widespread deployment of VOD services will not occur until MSOs decide to deploy digital services through this upgraded plant and invest in new digital set-top boxes.* Although set-top box manufacturers have announced major orders of digital set-top boxes by MSOs, the availability of commercial quantities of field tested digital set-top boxes with cable return path capability cannot be predicted or assured. There can be no assurance that MSOs deploying digital set-top boxes or any other cable operators will continue to upgrade their cable plant or that sufficient, suitable cable plant will be available in the future that is capable of supporting deployment of the Company's VOD products and services. The failure of cable operators to complete planned upgrades in a timely and satisfactory manner, or at all, and the lack of suitable cable plant would have a material adverse effect on the Company's business, operating results, financial condition and its ability to generate sufficient cash flow to service its indebtedness. In addition, the reliable performance of the VOD products and services provided by the Company is highly dependent on cable operators maintaining their cable infrastructure and headends in accordance with system specifications provided by the Company. Therefore, the future success and growth of the Company's business will be subject to economic and other factors affecting the ability of cable operators to finance substantial capital expenditures to maintain and upgrade the cable infrastructure to enable VOD system deployment. Risk of Technological Change and New Product Development Rapid technological developments are expected to occur in the home video entertainment industry. As a result, the Company has modified and expects to continue to modify its research and development plan.* Such modifications, including those related to the set-top box integration, have resulted in delays and increased costs. Furthermore, the Company expects that it will be required to continue to enhance its current VOD products and services and develop and introduce increased functionality and performance to keep pace with technological developments and consumer preferences.* In particular, the Company must accomplish a number of objectives, including, but not limited to (i) modification of its headend equipment and of headend equipment provided by cable industry suppliers and further integration of all such headend equipment and related systems in order to achieve cost reductions and reduce physical space requirements for widespread VOD deployment in a large number of headends; (ii) integrating its digital platform and software with other digital applications and services selected by the cable operator, including integration of set-top box, headend components and electronic program guides; (iii) further technical development of and reduction of the cost of manufacturing the DIVA Video Server and other system components and modification of the service software for future advances; (iv) continued scaling of the VOD system for use with larger numbers of customers and an increased number of movie titles; and (v) enhancing its system to enable additional services, including music videos and time-shifting.* There can be no assurance that the Company will, on a satisfactory timetable, be able to accomplish any 22 of these tasks or do so while maintaining the same functionality. There can be no assurance that the Company will be successful in developing and marketing product and service enhancements or new services that respond to technological and market changes or that the Company will not experience difficulties that could delay or prevent the successful development, introduction and marketing of such new services or enhancements. Failure to successfully develop these projects could have a material adverse effect on the Company's business, operating results, financial condition and its ability to generate sufficient cash flow to service its indebtedness. The Company has encountered delays in product development, service integration and field tests and other difficulties affecting both software and hardware components of its system and its ability to operate successfully over HFC plant. In addition, many of the Company's competitors have substantially greater resources than the Company to devote to further technological and new product development. See "--Competition for VOD Services." There can be no assurance that technological and market changes or other significant developments in VOD technology by the Company's competitors will not render its VOD products and services obsolete. Compliance with Industry Standards; Need to Integrate with Third-Party Products The cable industry has launched an initiative called OpenCable which will redefine the requirements and features of digital set-top converters as well as the requirements and features of their control systems located in the boxes themselves and in cable headends. The OpenCable initiative is managed by CableLabs on behalf of the cable MSOs and is supported by some of the cable equipment manufacturers, including General Instrument and Scientific-Atlanta. The OpenCable initiative is defining future digital platform requirements as they relate to set-top box requirements and control systems, which could affect DIVA's digital platform and its efforts to integrate its digital platform and VOD application with digital set-top and headend equipment manufactured by third party cable industry suppliers. There can be no assurance that the Company will be successful in complying with the requirements of the OpenCable initiative as they are finally adopted, or that compliance will not cause difficulties that could delay or prevent successful development, introduction or broad deployment of its VOD products and services. Although the Company developed a set-top box that was able to meet MSO requirements for a single box that both enables VOD and processes broadcast analog and digital cable signals, the Company determined that it needs to port its VOD solution to other digital platforms that are or will be broadly deployed in the cable industry, including those that may be offered by General Instrument, Scientific-Atlanta, Pace and other companies. The Company and General Instrument have demonstrated the successful port of the Company's VOD application to General Instrument's DNS, the initial implementation of this integration was tested on a limited, non-commercial basis with Comcast, and a commercial version has been launched in systems owned by Chambers and Insight. The Company and General Instrument are continuing joint development efforts to more closely integrate the VOD products with DNS, including achieving cost reductions, reducing physical space requirements of headend equipment and enabling industry accepted VOD encryption capability. There can be no assurance that the Company will be successful in accomplishing continued General Instrument integration on a cost-effective basis or at all. The Company is party to a developer agreement with Scientific-Atlanta which should enable the Company to access the necessary information and material to effectively port its VOD system products to the Scientific-Atlanta platform. However, there can be no assurance that the Company and Scientific-Atlanta will be able to achieve compatibility between their respective systems. The Company's ability 23 to enter into relationships with MSOs that require a single box solution and choose to deploy Scientific-Atlanta's Digital Broadband Delivery System could therefore be significantly impaired. Although the Company has developed an on-screen interactive guide or navigator that is closely integrated with its VOD service, MSO customers and their subscribers are likely to expect a seamless link between the navigator and third party electronic programming guides ("EPGs") that provide information regarding programming schedules. The ability to create cross access points between the navigator and various EPGs may be limited by the engineering and memory characteristics of the digital platforms and EPG applications provided by major cable industry suppliers. Further, positioning the navigator as the first or one of the first screens viewed by a subscriber, which would create enhanced revenue and promotional opportunities, may be limited by these third-party platform characteristics or by existing or future agreements between EPG providers and MSOs. Reliance on Third-Party Manufacturers; Exposure To Component Shortages The Company depends and will continue to depend on third parties to manufacture the major elements of its VOD system. The Company subcontracts manufacturing of its proprietary components of its Video Server and the DDL to third-party manufacturers. All of such subcontractors are bound by confidentiality agreements. As a result of the complexity of the Company's hardware components, manufacturing and quality control are time consuming processes. Consequently, there can be no assurance that these manufacturers will be able to meet the Company's requirements in a timely and satisfactory manner or the Company would be able to find or maintain a suitable relationship with alternate qualified manufacturers for any such elements. The Company's reliance on third-party manufacturers involves a number of additional risks, including the absence of guaranteed capacity and reduced control over delivery schedules, quality assurance, production yields and costs. In the event the Company is unable to obtain such manufacturing on commercially reasonable terms, its business, operating results, financial condition and its ability to achieve sufficient cash flow to service its indebtedness would be materially adversely affected. Certain of the Company's subassemblies and components used in the Video Server and the DDL are procured from single sources and others are procured only from a limited number of sources. Consequently, the Company may be adversely affected by worldwide shortages of certain components, significant price increases, reduced control over delivery schedules, and manufacturing capability, quality and cost. Although the Company believes alternative suppliers of products, services, subassemblies and components are available, the lack of alternative sources could materially impair the Company's ability to deploy its VOD system. Manufacturing lead times can be as long as nine months for certain critical components. Therefore, the Company may require significant working capital to pay for such components well in advance of revenues. Moreover, a prolonged inability to obtain certain components could have a material adverse effect on the Company's business, operating results, financial condition and its ability to achieve sufficient cash flow to service its indebtedness and could result in damage to MSO or customer relationships. Uncertainty of Protection of Patents and Proprietary Rights The Company's future success depends, in part, on its ability to protect its intellectual property and maintain the proprietary nature of its technology through a combination of patents, licenses and other 24 intellectual property arrangements. The Company has licensed rights to the DIVA Video Server and the DIVA set-top decoder initially developed by The Sarnoff Corporation ("Sarnoff"). Sarnoff and the Company have been awarded patents and have filed applications and intend to file additional applications for patents covering the DIVA Video Server. Sarnoff and the Company have filed applications for patents covering the set-top decoder, and the Company has filed patent applications, and intends to file additional and derivative patent applications covering the interactive service and its technology. There can be no assurance, however, that any patents issued to Sarnoff or the Company will not be challenged, invalidated or circumvented, or that the rights granted thereunder will provide proprietary protection to the Company. Despite the efforts of Sarnoff and the Company to safeguard and maintain these proprietary rights, there can be no assurance that the Company will be successful in doing so or that the Company's competitors will not independently develop or patent technologies that are substantially equivalent or superior to the Company's technologies. From time to time, the Company has received notices from third parties claiming infringement of certain intellectual property rights. Although the Company does not believe it infringes any third party's intellectual property rights, DIVA could encounter similar claims in the future.* Since patent applications in the U.S. are not publicly disclosed until the patent has been issued, applications may have been filed that, if issued as patents, would relate to the Company's products. In addition, the Company has not conducted a comprehensive patent search relating to the technology used in the DIVA Video Server or the Company's VOD system. The Company is subject to the risk of claims and litigation alleging infringement of the intellectual property rights of others. There can be no assurance that third parties will not assert infringement claims against the Company in the future based on patents or trade secrets or that such claims will not be successful. Parties making such claims may be able to obtain injunctive or other equitable relief which could effectively block the Company's ability to provide its VOD service in the U.S. and internationally, and could result in an award of substantial damages. In the event of a successful claim of infringement, the Company, its MSOs and other end users may be required to obtain one or more licenses from third parties. There can be no assurance that the Company or its customers could obtain necessary licenses from third parties at a reasonable cost or at all. The defense of any lawsuit could result in time consuming and expensive litigation regardless of the merits of such claims, and damages, license fees, royalty payments and restrictions on the Company's ability to provide its VOD products or services, any of which could have a material adverse effect on the Company's business, operating results, financial condition and its ability to generate sufficient cash flow to service its indebtedness. Risks Associated with Programming Content In those MSO deployments where DIVA provides programming content, the Company's success will depend, in part, on its ability to obtain access to sufficient movies (including new releases and library titles), special interest videos and other programming content on commercially acceptable terms. Although the Company has entered into arrangements with most of the major movie studios and a number of other content providers for its initial deployments, there can be no assurance that the Company will be able to continue to obtain the content, during the segment of time available to VOD 25 providers and others such as PPV, to support its VOD service beyond the geographic area of its initial deployments. Studios may require the Company to make prepayments prior to the time that customers pay for viewing a title or require the Company to enter into long-term contracts with minimum payments. Further, studios may increase the license fees currently charged to the Company. The Company's failure to obtain timely access to such content on commercially acceptable terms could have a material adverse effect on its business, operating results, financial condition and its ability to generate sufficient cash flow to service its indebtedness. Dependence on Key Personnel The Company's performance is substantially dependent on the performance of its officers and key employees, and its ability to retain and motivate qualified personnel, especially its management. The Company does not have "key person" life insurance policies on any of its employees. There can be no assurance that key personnel will continue to be employed by the Company or that the Company will be able to attract and retain qualified personnel in the future. The Company's future success also depends on its ability to identify, hire, train and retain technical, sales, marketing and managerial personnel. Competition for such personnel is intense, and there can be no assurance that the Company will be able to attract, assimilate or retain such personnel in the future. The inability to attract and retain its officers and key employees and the necessary technical, sales, marketing and managerial personnel could have a material adverse effect upon the Company's business, operating results, financial condition and its ability to achieve sufficient cash flow to service its indebtedness. Government Regulation The Federal Communications Commission ("FCC") has broad jurisdiction over the telecommunications and cable industries. The majority of FCC regulations, while not directly affecting the Company, do affect cable companies, the primary potential purchasers of DIVA's VOD products and services. As such, the indirect effect of these regulations may adversely affect the Company's business. The Communications Act of 1934, as significantly amended by Congress in 1992 and more recently by the Telecommunications Act of 1996 (as so amended, the "Act"), provides a significant regulatory framework for the operation of cable systems. Rules promulgated by the FCC under the Act impose restrictions and obligations that could affect how the cable operator offers or prices the VOD service enabled by the Company's products and services. None of these impose direct rate or service restrictions on the Company. In addition, certain FCC rules, and FCC rulemakings in process or required in the future under the Act could directly affect the joint efforts of the Company and third-party equipment manufacturers such as General Instrument to port the Company's VOD solution to digital platforms that are broadly deployed in the cable industry. FCC rules to date have focused on analog equipment, rather than digital equipment such as the Company's. However, it is anticipated that as digital equipment, transmission and services are deployed by cable operators, the FCC will extend analog rules to digital transmission, or craft rules specific to digital platforms. An example being discussed is digital "must carry" which would require cable operators to transmit on their systems not only the analog channels of local broadcast television stations in all markets, but the newly authorized digital broadcast channels as well. Digital "must carry" for local over-the-air broadcast licensees could consume a significant amount of the increased channel capacity being created by cable operators through their upgrades. There can be no 26 assurance that any MSO will elect to launch VOD using the Company's or any competitor's VOD products and services as opposed to other, less expensive analog and digital services using the transmission capacity that remains after implementation of digital "must carry" in any local market. Local franchising authorities retain certain statutory and general regulatory authority with respect to cable operators including the ability to regulate or exclude content that they deem inappropriate under local community standards. In MSO deployments where DIVA provides programming content, the MSO has the option of including adult offerings in its VOD service. Because local community standards will vary, the local cable operator may decide to either restrict the scope or entirely exclude adult content. The Company's VOD system also enables individual subscribers to exclude entirely or restrict access to such content. To the extent that DIVA shares in "per view" revenues in any MSO system that restricts or excludes adult content, the Company's operating results could be impacted by the decisions of local regulatory authorities and cable operators regarding such content. Finally, the Act authorizes, but does not require, local franchising authorities to impose a fee of up to 5% on the gross revenues derived by third parties from the provision of cable service over a cable system. To the extent that the Company assembles and provides a VOD service directly to cable subscribers (rather than providing it to cable operators for resale to cable subscribers) and the local franchise agreement has been amended or renewed and includes appropriate language, the Company could be required to pay a franchise fee of up to 5% of gross revenues derived from its VOD service in a specific franchise area to the local franchising authority. There are other rulemakings that have been and still are being undertaken by the FCC which will interpret and implement provisions of the Act. It is anticipated that the Act will stimulate increased competition generally in the telecommunications and cable industries, which may adversely impact the Company. No assurance can be given that changes in current or future laws or regulations, including those limiting or abrogating exclusive MSO contracts, in whole or in part, adopted by the FCC or other federal, state or local regulatory authorities would not have a material adverse effect on the Company's business. In addition, VOD services in Canada are licensed by the Canadian Radio and Telecommunications Commission, and VOD services are licensed in a variety of ways if provided in the United Kingdom and other EU member countries in which DIVA is marketing its VOD products and services. The Company is seeking to determine the basis on which it may offer its VOD products and services in Canada, the UK and EU, the extent of regulatory controls and the terms of any revenue arrangements that may be required as conditions to the deployment of its VOD service in such countries. The Company may not be able to obtain distribution rights to movie titles in non-U.S. jurisdictions under regulatory and financial arrangements acceptable to the Company. Control by Insiders The Company's executive officers and directors, together with entities affiliated with such individuals, and Acorn Ventures, Inc. beneficially own approximately 47.4% of the Common Stock (assuming conversion of all outstanding Preferred Stock into Common Stock). Accordingly, these stockholders have significant influence over the affairs of the Company. This concentration of ownership could have the effect of delaying or preventing a change in control of the Company. 27 Forward-Looking Statements The statements contained in the "Factors Affecting Operating Results" section that are not historical facts are "forward-looking statements," which can be identified by the use of forward-looking terminology such as "estimates," "projects," "anticipates," "expects," "intends," "believes," or the negative thereof or other variations thereon or comparable terminology, or by discussions of strategy that involve risks and uncertainties. These forward-looking statements, including statements regarding market opportunity, deployment plans, market acceptance, the Company's business models, capital requirements, anticipated net losses and negative cash flow, revenue growth, anticipated operating expenditures and product development plans are only estimates or predictions and cannot be relied upon. No assurance can be given that future results will be achieved; actual events or results may differ materially as a result of risks facing the Company or actual results differing from the assumptions underlying such statements. Such risks and assumptions include, but are not limited to, those discussed in this "Factors Affecting Operating Results" section, which could cause actual results to vary materially from the future results indicated, expressed or implied in such forward-looking statements. The Company disclaims any obligation to update information contained in any forward-looking statement. 28 PART II OTHER INFORMATION Item 1, Item 3, Item 4 and Item 5 are not applicable with respect to the current reporting period. Item 2. Changes in Securities and Use of Proceeds During the three months ended December 31, 1999, the Company issued and sold an aggregate of 424,990 shares of Common Stock to employees and consultants for an aggregate purchase price of $480,092 pursuant to exercises of options under its 1995 Stock Plan. These issuances were deemed exempt from registration under the Securities Act of 1933, as amended, in reliance upon Rule 701 promulgated thereunder. In December 1999, the Company completed the sale of 777,778 shares of Series E Preferred Stock to one investor for approximately $7.0 million in gross proceeds. This issuance was deemed exempt from registration under the Securities Act of 1933, as amended, in reliance upon Section 4(2) thereunder. Item 6. Exhibits and Reports on Form 8-K: a. Exhibits. 3.1 Certificate of Designation of Series E Preferred Stock 27.1 Financial Data Schedule b. Reports on Form 8-K. No reports on Form 8-K were filed with the Securities and Exchange Commission during the quarter ended December 31, 1999. 29 SIGNATURES Pursuant to the requirements of the Securities and Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized. DIVA SYSTEMS CORPORATION By: /s/ WILLIAM M. SCHARNINGHAUSEN -------------------------------- William M. Scharninghausen Vice President, Finance and Administration, and Chief Financial Officer Dated: February 14, 2000 30 EX-3.1 2 CERTIFICATE OF DESIGNATION OF SERIES E PREFERRED STOCK EXHIBIT 3.1 CERTIFICATE OF DESIGNATIONS, PREFERENCES AND RIGHTS OF SERIES E PREFERRED STOCK OF DIVA SYSTEMS CORPORATION Pursuant to Section 151 of the General Corporation Law of the State of Delaware DIVA Systems Corporation, a Delaware corporation (the "Corporation"), certifies that pursuant to the authority contained in Article IV of its Certificate of Incorporation, and in accordance with the provisions of Section 151 of the General Corporation law of the State of Delaware, its Board of Directors (the "Board of Directors") has adopted the following resolutions creating a series of its Preferred Stock, par value of $0.001 per share, designated as the Series E Preferred Stock: RESOLVED, that a series of the class of authorized Preferred Stock, par value $0.001 per share, of the Corporation be, and it hereby is created, and that the designation and amount thereof and the voting powers, preferences and relative, participating, optional and other special rights of the shares of such series, and the qualifications, limitations or restrictions thereof are as follows: 1. Title of Series. The series of the Preferred Stock shall be designated as the Series E Preferred Stock (the "Series E Preferred"). 2. Number of Shares in Series; Par Value. The number of authorized shares of Series E Preferred shall be one million one hundred sixty- six thousand six hundred sixty-six (1,166,666) shares, par value $0.001 per share. 3. Dividends. Subject to the prior preferences and other rights of any stock having any preference or priority as to dividends or assets superior to any such preference or priority of the Series E Preferred ("Senior Stock") and the provisions of Article IV of the Corporation's Certificate of Incorporation (the "Certificate of Incorporation"), the holders of the Series E Preferred shall be entitled to receive in any fiscal year, out of any funds legally available therefor dividends at the rate of $0.54 per share (adjusted for any subdivisions, combinations, consolidations or stock distributions or stock dividends with respect to such shares), per annum, on each outstanding share of Series E Preferred, payable in preference and priority to any payment of any dividend on the Common Stock, when and as declared by the Board of Directors. For purposes of this Certificate of Designations, "Senior Stock" includes Series B Preferred Stock, Series C Preferred Stock, Series D Preferred Stock, and any other series of Preferred Stock that the Board of Directors of the Corporation may authorize. The right to such dividends on the Series E Preferred shall not be cumulative, and no right shall accrue to holders of Series E Preferred by reason of the fact that dividends on such shares are not declared or paid in any prior year, nor shall any undeclared or unpaid dividend accrue interest. Dividends may be delivered and paid upon shares of Series E Preferred in any fiscal year of the Corporation only if dividends shall have been paid to or declared and set apart upon all outstanding Series E Preferred at such annual rate specified. No dividends shall be paid on any share of Common Stock unless a dividend is paid with respect to all outstanding shares of Series E Preferred in an amount for each such share of Series E Preferred equal to or greater than the aggregate amount of such dividends for all shares of Common Stock into which each such share of Series E Preferred could then be converted. 4. Liquidation Preference. (a) Preference. After payment of the full preferential amounts to the holders of the Senior Stock, in the event of any liquidation, dissolution or winding up of the Corporation, either voluntarily or involuntarily, the holders of the Series E Preferred and Series A Preferred shall be entitled to receive, prior and in preference to any distribution of any of the assets or surplus funds of the Corporation to the holders of the Series AA Preferred, Series BB Preferred or Common Stock by reason of their ownership of such stock, the amount of $9.00 for each share of Series E Preferred then held by them, and the amount of $0.50 for each share of Series A Preferred then held by them, in each case adjusted for any subdivisions, combinations, consolidations or stock distributions or dividends with respect to such shares and, in addition, an amount equal to all declared but unpaid dividends on the Series E Preferred or Series A Preferred. If upon the occurrence of such event the assets and funds thus distributed among the holders of the Series E Preferred and Series A Preferred shall be insufficient to permit the payment to such holders of the full preferential amount, then the entire assets and funds of the Corporation legally available for distribution shall be distributed among the holders of the Series E Preferred on a on a pro rata basis, based on the aggregate liquidation preference of the shares of Series E Preferred and aggregate liquidation preference of the shares of Series A Preferred then held by each holder. (b) After setting apart or paying in full the preferential amounts due to the holders of the Senior Stock, the Series E Preferred, the Series A Preferred, the Series AA Preferred, the Series BB Preferred, the Class C Common Stock and the Common Stock (other than the Class B Common Stock) the remaining assets of the Corporation available for distribution to stockholders, if any, shall be distributed to the holders of the Senior Stock, the Series E Preferred, the Series A Preferred, the Class C Common Stock and the Common Stock (other than Class B Common Stock) on a pro rata basis, based on the number of shares of Common Stock then held by each holder on an as-converted basis. (c) A consolidation or merger of the Corporation with or into any other corporation or corporations, or a sale, conveyance or disposition of all or substantially all of the assets of the Corporation or the effectuation by the Corporation of a transaction or series of related transactions in which more than 50% of the voting power of the Corporation is disposed of shall be deemed to be a liquidation, dissolution or winding up within the meaning of this Section 4. -2- (d) Notwithstanding paragraph (a) hereof, the Corporation may at any time, out of funds legally available therefor, repurchase shares of Common Stock of the Corporation issued to or held by employees, officers, contractors or consultants of the Corporation or its subsidiaries upon termination of their employment or services, pursuant to any agreement providing for such right of repurchase, whether or not dividends on the Series E Preferred shall have been declared and funds set aside therefor and such repurchases shall not be subject to the liquidation preferences of the Series E Preferred. 5. Voting Rights. Except as otherwise required by law or as set forth herein, the holder of each share of Series E Preferred shall be entitled to the number of votes equal to the number of shares of Common Stock into which such share of Series E Preferred could be converted at the record date for determination of the stockholders entitled to vote on such matters, or, if no such record date is established, at the date such vote is taken or any written consent of stockholders is solicited, such votes to be counted together with all other shares of stock of the Corporation having general voting power and not counted separately as a class. Holders of Series E Preferred shall be entitled to notice of any stockholders' meeting in accordance with the Bylaws of the Corporation. 6. Conversion. Subject to the conversion rights of the Senior Stock, the holders of the Series E Preferred have conversion rights as follows (the "Conversion Rights"): (a) Right to Convert. Each share of Series E Preferred shall be convertible, at the option of the holder thereof, at any time after the closing of a transaction or series of related transactions in which more than 50% of the voting power of the Corporation is transferred, into such number of fully paid and nonassessable shares of Common Stock as is determined by dividing $9.00 by the Series E Conversion Price, as hereinafter provided, in effect at the time of the conversion. The price at which shares of Common Stock shall be deliverable upon conversion of the Series E Preferred (the "Series E Conversion Price") shall initially be $9.00 per share of Common Stock. Such initial Series E Conversion Price shall be subject to adjustment as hereinafter provided. (b) Automatic Conversion. Each share of Series E Preferred shall automatically be converted into shares of Common Stock at the then effective applicable Series E Conversion Price immediately prior to the closing of a firm commitment underwritten public offering pursuant to an effective registration statement under the Securities Act of 1933, as amended, covering the offer and sale of securities for the account of the Corporation to the public at an aggregate offering price (net of all registration and selling expenses) of not less than Fifteen Million Dollars ($15,000,000). (c) Mechanics of Conversion. No fractional shares of Common Stock shall be issued upon conversion of Series E Preferred. In lieu of any fractional shares to which the holder would otherwise be entitled, the Corporation shall pay cash equal to such fraction multiplied by the then effective respective Series E Conversion Price. Before any holder of Series E Preferred shall be entitled to convert the same into full shares of Common Stock and to receive certificates therefor, he shall surrender the certificate or certificates therefor, duly endorsed, at the office of the Corporation or of any transfer agent for the Series E Preferred and shall give written notice to the Corporation at such office that he elects to convert the same. The Corporation shall, as soon as practicable thereafter, issue and deliver at such office to such holder of Series E Preferred, a certificate or -3- certificates for the number of shares of Common Stock to which he shall be entitled as aforesaid and a check payable to the holder in the amount of any cash amounts payable as the result of a conversion into fractional shares of Common Stock. Such conversion shall be deemed to have been made immediately prior to the close of business on the date of such surrender of the shares of Series E Preferred, to be converted, and the person or persons entitled to receive the shares of Common Stock issuable upon such conversion shall be treated for all purposes as the record holder or holders of such shares of Common Stock on such date. (d) Reservation of Stock Issuable Upon Conversion. The Corporation shall at all times reserve and keep available out of its authorized but unissued shares of Common Stock solely for the purpose of effecting the conversion of the shares of the Series E Preferred such number of its shares of Common Stock as shall from time to time be sufficient to effect the conversion of all outstanding shares of the Series E Preferred; and if at any time the number of authorized but unissued shares of Common Stock shall not be sufficient to effect the conversion of all then outstanding shares of the Series E Preferred, in addition to such other remedies as shall be available to the holder of such Series E Preferred, this Corporation will take such corporate action as may, in the opinion of its counsel, be necessary to increase its authorized but unissued shares of Common Stock to such number of shares as shall be sufficient for such purposes. (e) Adjustments to Series E Conversion Price. (i) Special Definitions. For purposes of this Section (e), the following definitions shall apply: (A) "Options" shall mean rights, options or warrants to subscribe for, purchase or otherwise acquire either Common Stock or Convertible Securities. (B) "Original Issue Date" for the Series E Preferred shall mean the date on which the first share of Series E Preferred was issued. (C) "Convertible Securities" shall mean any evidences of indebtedness, shares (other than the Series AA Preferred, Series BB Preferred, Series A Preferred, Series B Preferred, Series C Preferred, Series D Preferred, Series E Preferred and Common Stock) or other securities directly or indirectly convertible into or exchangeable for Common Stock. (D) "Additional Shares of Common Stock" shall mean all shares (including reissued shares) of Common Stock issued (or, pursuant to paragraph (e)(iii), deemed to be issued) by the Corporation after the Original Issue Date, other than: (1) shares of Common Stock issued upon conversion of the Series AA Preferred, Series BB Preferred, Series A Preferred, Series B Preferred, Series C Preferred, Series D Preferred, Series E Preferred and Class C Common Stock authorized herein; (2) shares of Common Stock (including any of such shares which are repurchased) issued to officers, directors, employees and consultants of the Corporation pursuant to stock option or purchase plans approved by a majority of the members of the Board of -4- Directors and any other shares of Common Stock held by officers, directors, employees and consultants which are repurchased at cost subsequent to the Original Issue Date; (3) as a dividend or distribution on Series A Preferred, Series B Preferred, Series C Preferred, Series D Preferred or Series E Preferred or any event for which adjustment is made pursuant to paragraph (e)(vi) or (e)(vii) hereof; (4) shares of Common Stock issued or deemed issued upon exercise of warrants of the Corporation outstanding as of the Original Issue Date; (5) up to an aggregate of 3,934,360 shares of Common Stock issued in connection with a licensing agreement for technology and the acquisition of a company; (6) Options (or shares of Common Stock issued upon exercise thereof) issued in connection with the issuance of the Subordinated Notes or the Senior Notes; or (7) shares of Series AA Preferred Stock issued, or issuable upon exercise of options assumed, pursuant to the acquisition by the Corporation of Sarnoff Real Time Corporation. (E) "Senior Notes" shall mean the 12.625% Senior Discount Notes due March 1, 2008 issued on February 19, 1998 as governed by the Indenture between the Corporation and the Bank of New York as Trustee dated as of February 19, 1998. (F) "Subordinated Notes" shall mean the 13% Subordinated Discount Notes due May 15, 2006 issued on May 30, 1996 as governed by the Indenture between the Corporation and The Bank of New York as Trustee dated as of May 30, 1996. (ii) No Adjustment of Conversion Price. No adjustment in the Conversion Price of the Series E Preferred shall be made in respect of the issuance of Additional Shares of Common Stock unless the consideration per share for an Additional Share of Common Stock issued or deemed to be issued by the Corporation is less than the applicable Conversion Price of such series in effect on the date of and immediately prior to such issue. (iii) Deemed Issue of Additional Shares of Common Stock. In the event the Corporation at any time or from time to time after the Original Issue Date shall issue any Options or Convertible Securities or shall fix a record date for the determination of holders of any class of securities entitled to receive any such Options or Convertible Securities, then the maximum number of shares (as set forth in the instrument relating thereto without regard to any provisions contained therein for a subsequent adjustment of such number that would result in an adjustment pursuant to clause (B) below) of Common Stock issuable upon the exercise of such Options or, in the case of Convertible Securities and Options therefor, the conversion or exchange of such Convertible Securities, shall be deemed to be Additional Shares of Common Stock issued as of the time of such issue or, in case such a record date shall have been fixed, as of the close of business on such record -5- date, provided that Additional Shares of Common Stock shall not be deemed to have been issued unless the consideration per share (determined pursuant to paragraph (E)(v) hereof) of such Additional Shares of Common Stock would be less than the applicable Conversion Price of the Series E Preferred in effect on the date of and immediately prior to such issue, or such record date, as the case may be, and provided further that in any such case in which Additional Shares of Common Stock are deemed to be issued: (A) no further adjustment in the Conversion Price shall be made upon the subsequent issue of Convertible Securities or shares of Common Stock upon the exercise of such Options or conversion or exchange of such Convertible Securities; (B) if such Options or Convertible Securities by their terms provide, with the passage of time or otherwise, for any increase or decrease in the consideration payable to the Corporation, or increase or decrease in the number of shares of Common Stock issuable, upon the exercise, conversion or exchange thereof, the Conversion Price computed upon the original issue thereof (or upon the occurrence of a record date with respect thereto), and any subsequent adjustments based thereon, shall, upon any such increase or decrease becoming effective, be recomputed to reflect such increase or decrease insofar as it affects such Options or the rights of conversion or exchange under such Convertible Securities; (C) upon the expiration of any such Options or any rights of conversion or exchange under such Convertible Securities which shall not have been exercised, the Conversion Price computed upon the original issue thereof (or upon the occurrence of a record date with respect thereto), and any subsequent adjustments based thereon, shall, upon such expiration, be recomputed as if: (1) in the case of Convertible Securities or Options for Common Stock, the only Additional Shares of Common Stock issued were shares of Common Stock, if any, actually issued upon the exercise of such Options or the conversion or exchange of such Convertible Securities and the consideration received therefor was the consideration actually received by the Corporation for the issue of all such Options, whether or not exercised, plus the consideration actually received by the Corporation upon such exercise, or for the issue of all such Convertible Securities which were actually converted or exchanged, plus the additional consideration, if any, actually received by the Corporation upon such conversion or exchange, and (2) in the case of Options for Convertible Securities, only the Convertible Securities, if any, actually issued upon the exercise thereof were issued at the time of issue of such Options, and the consideration received by the Corporation for the Additional Shares of Common Stock deemed to have been then issued was the consideration actually received by the Corporation for the issue of all such Options, whether or not exercised, plus the consideration deemed to have been received by the Corporation upon the issue of the Convertible Securities with respect to which such Options were actually exercised; (D) no readjustment pursuant to clause (B) or (C) above shall have the effect of increasing the Conversion Price to an amount which exceeds the lower of (i) the -6- Conversion Price on the original adjustment date, or (ii) the Conversion Price that would have resulted from any issuance of Additional Shares of Common Stock between the original adjustment date and such readjustment date; and (E) in the case of any Options which expire by their terms not more than 30 days after the date of issue thereof, no adjustment of the Conversion Price shall be made until the expiration or exercise of all such Options, whereupon such adjustment shall be made in the manner provided in clause (C) above. (iv) Adjustment of Conversion Price of Series E Preferred Upon Issuance of Additional Shares of Common Stock. In the event that after the Original Issue Date the Corporation shall issue Additional Shares of Common Stock (including Additional Shares of Common Stock deemed to be issued pursuant to paragraph (e)(iii)) without consideration or for a consideration per share less than the Conversion Price of the Series E Preferred in effect on the date of and immediately prior to such issue, then and in such event, such Conversion Price of the Series E Preferred be reduced, concurrently with such issue, to a price (calculated to the nearest cent) determined by multiplying such Conversion Price of the Series E Preferred, by a fraction, the numerator of which shall be the number of shares of Common Stock outstanding immediately prior to such issue plus the number of shares of Common Stock which the aggregate consideration received by the Corporation for the total number of Additional Shares of Common Stock so issued would purchase at such Conversion Price; and the denominator of which shall be the number of shares of Common Stock outstanding immediately prior to such issue plus the number of such Additional Shares of Common Stock so issued; and provided further that, for the purposes of this subsection (iv), all shares of Common Stock issuable upon conversion of outstanding Preferred Stock and outstanding Convertible Securities or exercise of outstanding Options shall be deemed to be outstanding, and immediately after any Additional Shares of Common Stock are deemed issued pursuant to subsection (e)(iii), such Additional Shares of Common Stock shall be deemed to be outstanding. (v) Determination of Consideration. For purposes of this Section e, the consideration received by the Corporation for the issue of any Additional Shares of Common Stock shall be computed as follows: (A) Cash and Property: Except as provided in clause (B) below, such consideration shall: (1) insofar as it consists of cash, be computed at the aggregate amount of cash received by the Corporation excluding amounts paid or payable for accrued interest or accrued dividends; (2) insofar as it consists of property other than cash, be computed at the fair value thereof at the time of such issue, as determined in good faith by the Board; provided, however, that no value shall be attributed to any services performed by any employee, officer or director of the Corporation; and -7- (3) in the event Additional Shares of Common Stock are issued together with other shares or securities or other assets of the Corporation for consideration which covers both, be the proportion of such consideration so received with respect to such Additional Shares of Common Stock, computed as provided in clauses (1) and (2) above, as determined in good faith by the Board. (B) Expenses. In the event the Corporation pays or incurs expenses, commissions or compensation, or allows concessions or discounts to underwriters, dealers or others performing similar services in connection with such issue, in an aggregate amount in excess of 10% of the aggregate consideration received by the Corporation for such issue, as determined in clause (A) above, consideration shall be computed as provided in clause (A) above after deducting the aggregate amount in excess of 10% of the aggregate consideration received by the Corporation for the issue. (C) Options and Convertible Securities. The consideration per share received by the Corporation for Additional Shares of Common Stock deemed to have been issued pursuant to Section (e)(iii), relating to Options and Convertible Securities, shall be determined by dividing (1) the total amount, if any, received or receivable by the Corporation as consideration for the issue of such Options or Convertible Securities, plus the minimum aggregate amount of additional consideration (as set forth in the instruments relating thereto, without regard to any provision contained therein for a subsequent adjustment of such consideration) payable to the Corporation upon the exercise of such Options or the conversion or exchange of such Convertible Securities, or in the case of Options for Convertible Securities, the exercise of such Options for Convertible Securities and the conversion or exchange of such Convertible Securities by (2) the maximum number of shares of Common Stock (as set forth in the instruments relating thereto, without regard to any provision contained therein for a subsequent adjustment of such number) issuable upon the exercise of such Options or the conversion or exchange of such Convertible Securities. (vi) Adjustments for Stock Dividends, Subdivisions, Combinations or Consolidations of Common Stock. In the event the outstanding shares of Common Stock shall be subdivided (by stock dividend, stock split, or otherwise), into a greater number of shares of Common Stock, the Series E Conversion Price then in effect shall, concurrently with the effectiveness of such subdivision, be proportionately decreased. In the event the outstanding shares of Common Stock shall be combined or consolidated, by reclassification or otherwise, into a lesser number of shares of Common Stock, the Series E Conversion Price then in effect shall, concurrently with the effectiveness of such combination or consolidation, be proportionately increased. (vii) Adjustments for Other Distributions. In the event the Corporation at any time or from time to time makes, or fixes a record date for the determination of holders of Common Stock entitled to receive any distribution payable in securities or assets of the Corporation -8- other than shares of Common Stock then and in each such event provision shall be made so that the holders of Series E Preferred shall receive upon conversion thereof, in addition to the number of shares of Common Stock receivable thereupon, the amount of securities or assets of the Corporation which they would have received had their Series E Preferred been converted into Common Stock on the date of such event and had they thereafter, during the period from the date of such event to and including the date of conversion, retained such securities or assets receivable by them as aforesaid during such period, subject to all other adjustments called for during such period under this Section 8 with respect to the rights of the holders of the Series E Preferred. (viii) Adjustments for Reclassification, Exchange and Substitution. If the Common Stock issuable upon conversion of the Series E Preferred shall be changed into the same or a different number of shares of any other class or classes of stock, whether by capital reorganization, reclassification or otherwise (other than a subdivision or combination of shares provided for above), then and in each such event the holder of each share of Series E Preferred shall have the right thereafter to convert such share into the kind and amount of shares of stock and other securities and property receivable upon such reorganization or reclassification or other change by holders of the number of shares of Common Stock that would have been subject to receipt by the holders upon conversion of the Series E Preferred immediately before that change, all subject to further adjustment as provided herein. (f) No Impairment. Without the prior written consent of the holders of a majority of the Series E Preferred, the Corporation will not, by amendment of its Certificate of Incorporation, Certificate of Designations or through any reorganization, transfer of assets, consolidation, merger, dissolution, issue or sale of securities or any other voluntary action, avoid or seek to avoid the observance or performance of any of the terms to be observed or performed hereunder by the Corporation but will at all times in good faith assist in the carrying out of all the provisions of Section 6 and in the taking of all such action as may be necessary or appropriate in order to protect the Conversion Rights of the holders of the Series E Preferred against impairment. (g) Certificate as to Adjustments. Upon the occurrence of each adjustment or readjustment of the Series E Conversion Price pursuant to paragraph (e), the Corporation at its expense shall promptly compute such adjustment or readjustment in accordance with the terms hereof and furnish to each holder of Series E Preferred a certificate setting forth such adjustment or readjustment and showing in detail the facts upon which such adjustment or readjustment is based. The Corporation shall, upon the written request at any time of any holder of Series E Preferred, furnish or cause to be furnished to such holder a like certificate setting forth (i) such adjustments and readjustments, (ii) the Series E Conversion Price at the time in effect, and (iii) the number of shares of Common Stock and the amount, if any, of other property which at the time would be received upon the conversion of Series E Preferred. 7. Notices of Record Date. In the event that the Corporation shall propose at any time: (a) to declare any dividend or distribution upon its Common Stock, whether in cash, property, stock or other securities, whether or not a regular cash dividend and whether or not out of earnings or earned surplus; -9- (b) to offer for subscription pro rata to the holders of any class or series of its stock any additional shares of stock of any class or series or other rights; (c) to effect any reclassification or recapitalization of its Common Stock outstanding involving a change in the Common Stock; or (d) to merge or consolidate with or into any other corporation, or sell, lease or convey all or substantially all its property or business, or to liquidate, dissolve or wind up, then, in connection with each such event, the Corporation shall send to the holders of the Series E Preferred: (i) at least 10 days' prior written notice of the date on which a record shall be taken for such dividend, distribution or subscription rights (and specifying the date on which the holders of Common Stock shall be entitled thereto) or for determining rights to vote in respect of the matters referred to in (c) and (d) above; and (ii) in the case of the matters referred to in (c) and (d) above, at least 10 days' prior written notice of the date when the same shall take place (and specifying the date on which the holders of Common Stock shall be entitled to exchange their Common Stock for securities or other property deliverable upon the occurrence of such event). Each such written notice shall be delivered personally or given by first class mail, postage prepaid, addressed to the holders of the Series E Preferred at the address for each such holder as shown on the books of this Corporation. [REMAINDER OF THIS PAGE INTENTIONALLY LEFT BLANK] -10- IN WITNESS WHEREOF, said Corporation has caused this Certificate to be signed by David Zucker, the Chief Executive Officer of the Corporation. The signature below shall constitute the affirmation or acknowledgment, under penalties of perjury, that the facts herein stated are true. Dated: December 15, 1999 DIVA SYSTEMS CORPORATION /s/ David F. Zucker ______________________________________ David F. Zucker Chief Executive Officer -11- EX-27.1 3 FINANCIAL DATA SCHEDULE
5 1,000 3-MOS 6-MOS JUN-30-2000 JUN-30-2000 OCT-01-1999 JUL-01-1999 DEC-31-1999 DEC-31-1999 52,907 57,907 57,262 57,262 0 0 0 0 2,714 2,714 113,591 113,591 28,496 28,496 (16,894) (16,894) 133,331 133,331 5,009 5,009 293,564 293,564 0 0 22 22 18 18 (168,653) (168,653) 133,331 133,331 1,047 1,115 1,047 1,115 1,103 1,103 17,203 33,179 0 0 0 0 9,631 18,817 (25,376) (48,885) 0 0 (25,376) (48,885) 0 0 0 0 0 0 (25,376) (48,885) (1.44) (2.79) (1.44) (2.79)
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