-----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, EXvGIeS0DmeYOE7gcQApdWZW3NpSvp81+B345EUMfPs7thHpKscYZ0QUA40oltZZ E6odArW4LRRCGzz6iHSGow== /in/edgar/work/0001012870-00-005755/0001012870-00-005755.txt : 20001115 0001012870-00-005755.hdr.sgml : 20001115 ACCESSION NUMBER: 0001012870-00-005755 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 20000930 FILED AS OF DATE: 20001114 FILER: COMPANY DATA: COMPANY CONFORMED NAME: DIVA SYSTEMS CORP CENTRAL INDEX KEY: 0001003439 STANDARD INDUSTRIAL CLASSIFICATION: [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: 764893 BUSINESS ADDRESS: STREET 1: 800 SAGINAW DRIVE CITY: REDWOOD CITY STATE: CA ZIP: 94063 BUSINESS PHONE: 6508596400 MAIL ADDRESS: STREET 1: 800 SAGINAW DRIVE CITY: REDWOOD CITY STATE: CA ZIP: 94063 10-Q 1 0001.txt FORM 10-Q 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 September 30, 2000. or [_] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the transition period from ____________ to ____________. Commission File No. 333-64483 DIVA Systems Corporation (Exa125 ct 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 October 31, 2000 was: Title of each class ------------------- Common Stock, $.001 par value 17,943,944 Class C Common Stock,$.001 par value 857,370 DIVA SYSTEMS CORPORATION Quarterly Report on Form 10-Q Table of Contents Quarter Ended September 30, 2000 PART I - FINANCIAL INFORMATION Item 1. Consolidated Financial Statements (Unaudited) Condensed Consolidated Balance Sheet at September 30, 2000 and June 30, 2000 1 Condensed Consolidated Statement of Operations for the three months ended September 30, 2000 and 1999 2 Condensed Consolidated Statement of Cash Flows for the three months ended September 30, 2000 and 1999 3 Notes to Condensed Consolidated Financial Statements 5 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 7 Item 3. Quantitative and Qualitative Disclosures about Market Risk 15 PART II - OTHER INFORMATION Item 2. Changes in Securities and Use of Proceeds 27 Item 4. Submission of Matters to a Vote of Security Holders 27 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 per share data) (unaudited)
September 30, June 30, Assets 2000 2000 ------------------ ------------------ Current assets: Cash and cash equivalents $ 47,659 $ 66,253 Short-term investments 30,360 26,429 Accounts receivable 13,961 264 Inventory 7,115 3,143 Prepaid expenses and other current assets 963 3,520 ------------------ ------------------ Total current assets 100,058 99,609 Property and equipment, net 12,101 12,648 Debt issuance costs, net 6,064 6,500 Deposits and other assets 578 596 Intangible assets, net 89 134 ------------------ ------------------ Total assets $ 118,890 $ 119,487 ================== ================== Liabilities, Redeemable Warrants and Stockholders' Deficit Current liabilities: Accounts payable $ 6,167 $ 5,121 Other current liabilities 3,253 4,441 Deferred revenue 983 1,015 Current portion of capital lease obligation 690 676 ------------------ ------------------ Total current liabilities 11,093 11,253 Notes payable 322,899 312,815 Redeemable put warrants 7,326 11,989 Long - term portion of lease payable 850 1,029 Deferred rent 810 780 ------------------ ------------------ Total liabilities 342,978 337,866 ------------------ ------------------ Redeemable warrants 4,603 7,007 ------------------ ------------------ Commitments and contingencies Stockholders' deficit: Preferred stock, $0.001 par value; 80,000,000 shares authorized; 25,051,528 and 24,495,463 shares issued and outstanding as of September 30, 2000, and June 30, 2000, respectively. Common stock, $0.001 par value; 165,000,000 shares authorized; 25 24 18,691,887 and 18,615,618 shares issued and outstanding as of September 30, 2000, and June 30, 2000, respectively. 19 19 Additional paid-in capital 147,249 138,211 Deferred compensation (6,491) (5,954) Accumulated deficit (369,493) (357,686) ------------------ ------------------ Total stockholders' deficit (228,691) (225,386) ------------------ ------------------ Total liabilities, redeemable warrants and stockholders' deficit $ 118,890 $ 119,487 ================== ==================
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 September 30, 2000 1999 ----------------- --------------- Revenues: Product $ 35 $ -- License 36 -- Service 314 68 ----------------- --------------- Total revenues 385 68 Operating expenses: Cost of product revenue 185 -- Programming 1,048 1,242 Operations 1,815 1,471 Engineering and development 8,011 5,281 Sales and marketing 1,472 1,613 General and administrative 5,505 4,690 Depreciation and amortization 1,522 1,474 Warrant benefit (181) -- Amortization of stock compensation 1,128 205 ----------------- --------------- Total operating expenses 20,505 15,976 ----------------- --------------- Operating loss 20,120 15,908 ----------------- --------------- Other (income) expense: Interest income (671) (1,585) Gain on sale of investments (12,896) -- Gain on sale of property and equipment (40) -- Interest expense 5,294 9,186 ----------------- --------------- Total other (income)/expense, (8,313) 7,601 net ----------------- --------------- Net loss 11,807 23,509 (Decrement)/Accretion of redeemable warrants (2,404) 152 ----------------- --------------- Net loss attributable to common stockholders $ 9,403 $ 23,661 ================= =============== Basic and diluted net loss per share: $ .50 $ 1.36 ================= =============== Shares used in per share computation 18,670 17,389 ================= ===============
See accompanying notes to interim condensed consolidated financial statements. 2 DIVA SYSTEMS CORPORATION AND SUBSIDIARIES Condensed Consolidated Statement of Cash Flows (in thousands) (unaudited)
Three Months Ended September 30, 2000 1999 ------------------- ---------------- Cash flows from operating activities: Net loss $ (11,807) $ (23,509) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization 1,522 1,474 (Gain)/loss on disposition of property and equipment (40) 74 Amortization of debt issuance costs and accretion of discount on notes payable 5,857 9,184 Amortization of deferred stock compensation 1,128 205 Warrant benefit (181) -- Changes in operating assets and liabilities: Other assets 558 333 Accounts receivable (11,699) -- Inventory (3,972) (409) Accounts payable 1,046 484 Other current liabilities (1,187) 225 Deferred rent 30 -- Deferred revenue (32) -- ------------------- ---------------- Net cash used for operating activities (18,777) (11,939) ------------------- ---------------- Cash flows from investing activities: Purchases of property and equipment (1,015) (2,377) Deposits on property and equipment 19 (31) Proceeds from the sale of assets 125 -- Purchases of short-term investments (3,931) (17,486) Proceeds from the sale of short-term investments -- 10,940 ------------------- ---------------- Net cash used for investing activities (4,802) (8,954) ------------------- ---------------- Cash flows from financing activities: Issuance of preferred stock, net 5000 -- Exercise of stock options, series AA preferred stock options and issuance of common stock 150 80 Payments on capital lease (165) -- Payments on note payable -- (4) ------------------- ---------------- Net cash provided by financing activities 4,985 76 ------------------- ---------------- Net decrease in cash and cash equivalents (18,594) (20,817) Cash and cash equivalents at beginning of period 66,253 89,239 ------------------- ---------------- Cash and cash equivalents at end of period $ 47,659 $ 68,422 =================== ================
3 DIVA SYSTEMS CORPORATION AND SUBSIDIARIES Condensed Consolidated Statement of Cash Flows (Continued) (in thousands) (unaudited) Noncash investing and financing activities: (Decrement)/Accretion of redeemable warrants $ (2,404) $ 152 =============== ============= Deferred compensation associated with stock options $ 1,665 $ -- =============== =============
See accompanying notes to interim condensed consolidated financial statements. 4 DIVA SYSTEMS CORPORATION AND SUBSIDIARIES NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) Note 1--The Company And Basis Of Presentation DIVA Systems Corporation (the Company), is a provider of interactive, video-on-demand products and services. 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 principal operations, which consists of manufacturing, selling, licensing and providing operational support for its video-on-demand products and services. The interim unaudited financial statements as of September 30, 2000, for the three months ended September 30, 2000 and 1999 have been prepared on substantially the same basis as the Company's audited financial statements for the year ended June 30, 2000 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, 2000 (Fiscal 2000). 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, (amounting to 44,775,430 shares of common stock) has 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, 7 and 8 of notes to consolidated financial statements included in the Company's Fiscal 2000 Form 10-K. Note 3--Revenue Recognition Policy The Company's contracts are generally multiple-element arrangements with a network operator involving a combination of video-on-demand hardware products, licenses for system software and selected content and operational services. As a result the Company recognizes revenue in accordance with the American Institute of Certified Public Accountants Statement of Position 97-2 (SOP 97-2), "Software Revenue Recognition," and Statement of Position 98-9 (SOP 98-9), "Software Revenue Recognition, with Respect to Certain Transactions." 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 5 evidence of the relative fair values of the elements. Vendor specific objective evidence is determined by the price charged when the element is sold separately. SOP 98-9 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, revenue for the undelivered elements is deferred and subsequently recognized in accordance with Statement of Position 97-2. Evidence of the fair value of the individual elements in our current agreements does not exist. As a result, upon the delivery of the Company's video-on-demand hardware products, revenue is recognized to the extent of the cost of these hardware products. Any remaining product revenue is amortized on a straight-line basis over the remaining term of the agreement. The Company recognizes license revenues ratably over the term of the agreement. If the Company's services are provided on a fee-for-service basis, service revenues are recognized as the services are performed. If the services are provided on a revenue sharing basis, service revenues are recognized based on program purchases by subscribers. The Company provides limited warranty rights to its customers. 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 considered significant. 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations The following discussion of our financial condition and results of operations should be read in conjunction with the unaudited consolidated interim financial statements for the three months ended September 30, 2000 and 1999 included elsewhere in this Form 10-Q. This discussion contains forward-looking statements that involve risks and uncertainties. Our actual results may differ materially from the results discussed in the forward-looking statements. Factors that might cause such a difference include, but are not limited to, those discussed below. The forward-looking statements contained herein are made as of the date hereof, and we assume no obligation to update such forward-looking statements or to update the reason actual results could differ materially from those anticipated in such forward-looking statements. Forward-looking statements are statements identified with an asterisk (*). All forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by the cautionary statements set forth below and in "Factors Affecting Operating Results." Overview We are a leading provider of interactive, on-demand television products and services. We have commercially deployed our video-on-demand service with several cable operators in North America. We have also recently introduced an interactive program guide as a stand-alone product. Both our video-on-demand service and interactive program guide operate on industry-standard digital set- top boxes and operating systems and provide flexible and cost-effective interactive television solutions for cable and other broadband operators, which we refer to as network operators. Since our inception, we have devoted substantially all of our resources to developing our video-on-demand products and services, establishing industry relationships, carrying out initial marketing activities, negotiating deployment agreements and establishing the operations necessary to support the commercial deployment of our video-on-demand products and services. Prior to June 1999, we offered our video-on-demand service only as an end- to-end system solution for network operators. Under this approach, we own, install and fund all hardware and software components of our system. We manage and deliver the end-to-end video-on-demand service offering to cable subscribers. We generate revenues from deployment agreements with network operators based on a share of the revenues generated by the network operators from video-on- demand revenues and other monthly subscriber fees. Beginning in June 1999, we shifted our sales and marketing strategy to emphasize selling our video-on-demand hardware products, licensing our system software, and providing a suite of content acquisition and operational support services on an a'la carte basis to network operators. Under this approach, the network operator purchases the video-on-demand system hardware and takes the capital and operating expense risk associated with such ownership. The network operator licenses our system software and can then select the other video-on-demand support services it wants to utilize. The network operator can select either the entire package of content and operational support services and pay us a portion of the revenues they receive from video-on-demand services, or select some or all of these services on a fee-for-service basis. We expect that the substantial majority of our future revenues will be derived from this new strategy.* 7 Through September 30, 2000, we have generated minimal revenues and have incurred significant losses and substantial negative cash flow, primarily due to engineering and development expenditures and other costs required to develop our video-on-demand products and services. Since our inception through September 30, 2000, we have an accumulated deficit of $369.5 million and have not achieved profitability on a quarterly or annual basis. We expect to continue to incur substantial net losses and negative cash flow for at least the next few years.* Our 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 us in future periods. Revenues Revenue is comprised of three components: product revenue resulting from the sale of our video-on-demand hardware products; licensing revenue resulting from the licensing of our systems software and on-screen video-on-demand navigator applications; and service revenue resulting from programming services and operations support services. Since our inception through September 30, 2000, we have not recognized any revenue from our interactive program guide. Our contracts are generally multiple-element arrangements with a network operator involving a combination of video-on-demand hardware products, licenses for system software and selected content and operational services. As a result we recognize revenue in accordance with the American Institute of Certified Public Accountants Statement of Position 97-2 (SOP 97-2), "Software Revenue Recognition," and Statement of Position 98-9 (SOP 98-9), "Software Revenue Recognition, with respect to certain arrangements." 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 of the relative fair values of the elements. Vendor specific objective evidence is determined by the price charged when the element is sold separately. SOP 98-9 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 Statement of Position 97-2. Evidence of the fair value of the individual elements in our current agreements does not exist. As a result, upon the delivery of our video-on-demand hardware products, revenue is recognized to the extent of the cost of these hardware products. Any remaining product revenue is amortized on a straight-line basis over the remaining term of the agreement. We recognize license revenues ratably over the term of the agreement. If our services are provided on a fee-for-service basis, service revenues are recognized as the services are performed. If the services are provided on a revenue sharing basis, service revenues are recognized based on program purchases by subscribers. Operating Expenses Cost of Product Revenue. Cost of product revenue consists of contract manufacturing costs, component and material costs, and other direct product expenditures associated specifically with our video-on-demand hardware products. 8 Programming. Programming expense includes license fees payable to content providers, costs related to the acquisition and production of digitally encoded programming content (including movies, videos, previews and promotions) and content duplication and distribution expenses. Historically, programming expense has represented a significant portion of our operating expenses, since we provided all programming content as an integral component of our end-to-end video-on-demand service. In the future, we expect that programming expenses will decrease as a percentage of total operating expenses because we anticipate that some larger network operators will take responsibility for acquiring their own content.* We expect to continue to incur programming expenses for network operators that elect to have us provide programming content or contract for an end-to-end video-on-demand service from us.* Operations. Operations expense includes the cost of field operations, both for initial launches and for ongoing support of our installed video-on-demand base. These costs include personnel and other costs for technical support, customer service training, installation, launch support, and maintenance costs for our video-on-demand system. In addition, operations expense includes personnel and other costs which support our ongoing manufacturing relationships for our video-on-demand hardware products with third-party manufacturers. We expect operations expense to increase in the future due to an increase in the manufacture and sale of our video-on-demand hardware.* To the extent network operators elect to contract with us for operations support, operations expense would increase in the area of field support and maintenance. Engineering and Development. Engineering and development expense consists of salaries, consulting fees, prototype hardware and other costs to support product development. Our engineering and development efforts involve ongoing system software development, system integration and new technology. To date, the most substantial portion of our operating expenses have been engineering and development expense. We expect to continue to incur significant engineering and development expenditures for continued development and enhancements to our video-on-demand products and services.* We believe these expenditures are necessary to remain competitive, to assure our products and services are integrated with industry standards and to offer new services, such as our recently introduced interactive program guide, and enhancements to our customers.* Sales and Marketing. To date, our sales and marketing expense has consisted of the costs of marketing our video-on-demand products and services to network operators and their customers and has included business development and marketing personnel, travel expenses, trade shows, consulting fees and promotional costs. Historically, our sales and marketing expense has also included telemarketing, direct mailings, targeted advertising and promotional campaigns and other direct marketing costs related to acquiring subscribers under our end-to-end video-on-demand service. In the future, we expect that direct marketing costs will not represent a significant component of total sales and marketing expense, as most network operators will take responsibility for marketing video-on-demand services to their subscribers.* To the extent we provide these services, they will likely be performed under individual service agreements with the network operators and, accordingly, will fluctuate with revenues. Our future sales and marketing costs will consist primarily of market development and product management expenses.* General and Administrative. General and administrative expense consists primarily of salaries and related expenses of management and administrative personnel, professional fees and general 9 corporate and administrative expenses. In addition, general and administrative expense includes costs associated with the development, support and growth of our management information system infrastructure. We expect general and administrative expense to increase over time to support the expansion of our business activities.* Depreciation and Amortization. Depreciation and amortization expense includes depreciation of property and equipment, including our video-on-demand 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. Historically, depreciation expense has been a significant component of our operating expenses. This resulted from the significant investment in capital equipment necessary to deploy our end-to-end video-on-demand service. We expect depreciation expense to decrease as a component of operating expense in the future as network operators purchase the various video-on-demand hardware components directly from us.* Warrant (Benefit)/Expense. Warrant (benefit)/expense represents the cost of the warrants issued to customers and a strategic business partner based on their estimated fair value, as determined using the Black-Scholes model, at the earlier of the grant date or the date it becomes probable that the warrants will be earned. Amortization of Deferred Stock Compensation. Deferred stock compensation represents the difference between the estimated fair value of our common stock for accounting purposes and the option exercise price of such options at the grant date. 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. Gain on sale of investments consists of proceeds from the sale of an investment in common stock held by us. Interest expense consists primarily of accreted interest on our outstanding debt and revaluation of redeemable put warrants. Results of Operations Revenue Total revenue for the three months ended September 30, 2000 was $385,000 compared to $68,000 for the three months ended September 30, 1999. Product revenue. Product revenue was $35,000 for the three months ended September 30, 2000. We did not record any product revenue for the three months ended September 30, 1999. License revenue. License revenue was $36,000 for the three months ended September 30, 2000. We did not record any license revenue for the three months ended September 30, 1999. 10 Service revenue. Service revenue was $314,000 and $68,000 for the three months ended September 30, 2000 and 1999, respectively. This increase was primarily due to an increase in the number of video-on-demand subscribers. Operating Expenses Cost of Product Revenue. Cost of product revenue was $185,000 for the three months ended September 30, 2000. We did not record cost of product revenue for the three months ended September 30, 1999. Programming. Programming expense was $1.0 million and $1.2 million for the three months ended September 30, 2000 and 1999, respectively. The decrease in programming expense was primarily attributable to reduced labor and other related program production service costs. In addition, we have reduced the number of trailers, previews, promotions, and other encoding related costs, resulting in a reduction of overall expenditures in this area. The three months ended September 30, 2000 reflect this reduced level of expenditures when compared to the three months ended September 30, 1999. Operations. Operations expense was $1.8 million and $1.5 million for the three months ended September 30, 2000 and 1999, respectively. The increase in operations expense was primarily attributable to increased personnel costs in the manufacturing area as we commercially introduced our video-on-demand products and services in multiple network operators' plants and increased expenses related to operations activity in our United Kingdom office. Engineering and Development. Engineering and development expense was $8.0 million and $5.3 million for the three months ended September 30, 2000 and 1999, respectively. The increase in engineering and development expense was attributable to the hiring of additional engineering and development personnel, outside consultants and other engineering expenses in connection with the further development and enhancement of our video-on-demand technology. In addition, the increase included expenditures for the development of new products and services such as our interactive program guide and integration activities related to digital broadcast platforms and middleware applications required for deployment by network operators. Included in engineering and development expenses for the three months ended September 30, 2000 was $1.1 million in development related expenses pursuant to a development contract with a third party. There was no similar expense for the three months ended September 30, 1999. Sales and Marketing. Sales and marketing expense was $1.5 million and $1.6 million for the three months ended September 30, 2000 and 1999, respectively. There was no significant variance in sales and marketing expense between the three months ended September 30, 2000 and 1999. General and Administrative. General and administrative expense was $5.5 million and $4.7 million for the three months ended September 30, 2000 and 1999, respectively. Overall, these expenses have increased as a direct result of the growth in all phases of our 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 relocation of our corporate headquarters to a new facility and international business development expenses, including the operations of an office in the United Kingdom and expenses related to the filing of a registration statement on Form S-1. 11 Depreciation and Amortization. Depreciation and amortization expense was $1.5 million for the three months ended September 30, 2000 and 1999. Amortization of Deferred Stock Compensation. Amortization of deferred stock compensation expense was $1.1 million and $205,000 for the three months ended September 30, 2000 and 1999, respectively. The increase in deferred stock compensation expense was related to an increase in stock options granted to employees and consultants. We expect to continue to grant options to employees which may result in an increase in deferred stock-based compensation which will be amortized over the applicable vesting periods of the options. Other Income and Expenses Interest income was $671,000 and $1.6 million for the three months ended September 30, 2000 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. Gain on sale of investments was $12.9 million for the three months ended September 30, 2000. Gain on sale of investment is due to the sale of shares of PMC-Sierra, Inc. common stock previously acquired by us in connection with the acquisition by PMC-Sierra, Inc., of a company in which we held a small minority interest. Interest expense was $5.3 million and $9.2 million for the three months ended September 30, 2000 and 1999, respectively. Included in interest expense for the three months ended September 30, 2000 is a gain on the revaluation of redeemable put warrants of $4.7 million. Provision for Income Taxes We have not provided for or paid federal income taxes due to our net losses. As of June 30, 2000, we had net operating loss carryforwards of approximately $215.7 million to offset future income subject to federal income taxes and $112.9 million available to offset future California taxable income. As of June 30, 2000, we had $21.8 million in net operating losses to offset future New Jersey taxable income and we had $11.0 million in net operating losses to offset future Pennsylvania 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 September 30, 2000, we have financed our operations primarily through the gross proceeds of private placements totaling approximately $108.3 million of equity and $250.0 million of high yield debt securities, net of repayments. During the three months ended September 30, 2000, we raised $5.0 million by issuing preferred stock to Charter Communications. As of September 30, 2000, we had cash and cash equivalents and short-term investments totaling $78.0 million. On February 19, 1998, we received $250.0 million in gross proceeds from an offering of 463,000 units consisting of senior discount 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. The notes are 12 senior unsecured indebtedness, and rank pari passu with any future unsubordinated unsecured indebtedness. The notes will be senior to any future subordinated indebtedness, but effectively will be subordinated to any future secured indebtedness. The indenture governing our senior discount notes imposes operating and financial restrictions on us and our subsidiaries. These restrictions in certain cases significantly limit or prohibit our ability directly and through our 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. These covenants may limit our ability to finance our future operations or to engage in other business activities that may be in our best interest. The senior discount notes were sold at a significant discount, and must be repaid at maturity on March 1, 2008. Commencing September 1, 2003, we are required to make semi-annual interest payments of $29.2 million, based on the aggregate par value of $463.0 million. There are no principal payments due on the senior discount notes prior to maturity on March 1, 2008. The net proceeds from the offering of the notes were approximately $199.9 million, after deducting placement fees and other offering costs, the extinguishment of all the subordinated discount notes issued in a previous offering and a premium paid in connection with the early extinguishment of these notes. In connection with the offering, we allocated approximately $18.1 million of the proceeds to the warrants. We expect to require significant working capital and incur significant operating expenses in the future.* Working capital requirements include inventory expenditures for our video-on-demand and interactive program guide hardware and general capital expenditures associated with our anticipated growth. Our working capital needs will, in part, be determined by the rate at which network operators purchase and introduce our video-on-demand products and services. In addition to working capital, we intend to make significant expenditures for continued development and enhancement of our video-on-demand technology, development of new services and other expenses associated with the delivery of our video-on-demand products and services. Our actual cash requirements may vary from expectations and will depend on numerous factors and conditions, many of which are outside of our control. We may also use a portion of our cash resources to purchase some of our outstanding indebtedness in the open market from time to time depending on market conditions. We believe our cash, cash equivalents and short-term investments will be sufficient to satisfy our cash requirements at least through the current fiscal year.* Thereafter, we will need to raise significant additional funds to support our operations. However, we may need to raise additional funds earlier if our estimates of working capital and operating expenditure requirements change or prove to be inaccurate. We 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. We have no present commitments or arrangements assuring us of any future equity or debt financing, and there can be no assurance that we will be able to obtain any such equity or debt financing on favorable terms or at all. In the event that we are unable to obtain such additional capital, we will be required to delay the expansion of our business or take other actions that would harm our business and our ability to achieve sufficient cash flow to service our indebtedness. To the extent we raise additional cash by issuing equity securities, our existing stockholders will be diluted. 13 Recent Accounting 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. In June 2000, the FASB issued Statement of Financial Accounting Standards No. 138, "Accounting for Certain Derivative Instruments and Certain Hedging Activities, and amendment to FASB Statement No. 133". Statement No. 138 addresses a limited number of issues causing implementation difficulties for companies that are required to apply Statement No.133. Statement 133, as amended by SFAS No. 137, "Accounting for Derivative Instruments and Hedging Activities-Deferral of the effective date of FASB Statement No. 133", and Statement No. 138 are effective for all fiscal quarters of all fiscal years beginning after June 15, 2000. The adoption of SFAS 133 and SFAS 138 has not had a material effect on our financial position or results of operations. In December 1999, the Securities and Exchange Commission issued SAB No. 101, "Revenue Recognition in Financial Statements," which is effective in the first quarter of fiscal 2001 but does not have to be adopted till the fourth quarter of fiscal 2001. We are currently analyzing this statement, but do not expect it to have a material impact on our consolidated financial statements. In March 2000, the Financial Accounting Standards Board issued Financial Accounting Standard Interpretation No. 44 (FIN 44) "Accounting for Certain Transactions Involving Stock Compensation - an Interpretation of Accounting Principles Board Opinion (APB) No. 25." FIN 44 clarifies the application of APB Opinion No. 25 and is effective July 1, 2000. The adoption of FIN 44 has not had a material effect on our financial position or results of operations. 14 Item 3. Quantitative and Qualitative Disclosures about Market Risk The following discussion about our market risk disclosures contains forward-looking statements. Forward-looking statements are subject to risks and uncertainties. Actual results could differ materially from those discussed in the forward-looking statements. We are exposed to market risk related to changes in interest rates, foreign currency exchange rates and derivatives. Interest Rate Sensitivity We maintain a short-term investment portfolio consisting mainly of income securities with an average maturity of less than one year. These available-for-sale securities are subject to interest rate risk and will fall in value if market interest rates increase. We have the ability to hold our fixed income investments until maturity and therefore, we would not expect our operating results or cash flows to be affected to any significant degree by the effect of a sudden change in market interest rates on its securities portfolio. Our short-term investments have generally been available-for-sale. Gross unrealized gains and losses were not significant as of September 30, 2000. The following table presents the principal amounts and related weighted-average yields for our fixed rate investment portfolio (in thousands, except average yields) at September 30, 2000.
Carrying Average Amount Yield -------- ------- U.S government obligation $ 8,316 6.32% Commercial paper 46,589 6.56% Certificates of deposits 2,103 4.55% Money market instruments 4,111 6.25% Auction rate preferred stock certificates 16,900 6.55% ------- Total 78,019 Included in cash and cash equivalents 47,659 Included in short-term investments 30,360 ------- Total $78,019 =======
Foreign Currency Risks We believe that our exposure to currency exchange fluctuation risk is insignificant because our transactions with international vendors are generally denominated in U.S. dollars, which is considered to be the functional currency for our company and subsidiaries.*The currency exchange impact on intercompany transactions was $106,000. Factors Affecting Operating Results We will require a significant amount of cash to service our indebtedness, and our ability to generate cash depends on many factors beyond our control We expect to continue to generate substantial net losses and negative cash flow for the next few years. We may be unable to achieve a level of cash flow from operations sufficient to permit us to pay the principal and interest on our current indebtedness and any additional indebtedness we may incur. The senior discount notes were sold at a significant discount and must be repaid at maturity on March 1, 2008. Commencing September 1, 2003, we are required to make semi-annual interest payments of $29.2 million, based on the aggregate par value of $463.0 million. Our ability to make scheduled debt service payments will depend upon our ability to achieve significant and sustained growth in our cash from operations and to complete necessary additional financings. If we are unable to generate sufficient cash from operations to service our indebtedness, we may have to forego or delay development and enhancement of our video-on-demand system and service, restructure or refinance our indebtedness or seek additional equity capital or debt financing. We may not be able to effect any refinancing or new financing strategy on satisfactory terms, if at all. If we fail to satisfy our obligations with respect to our indebtedness, this could result in a default under the indenture governing our senior discount notes and could cause a default under agreements governing our other indebtedness. In the event of a default, the holders of indebtedness would have enforcement rights, including the right to accelerate the debt and the right to commence an involuntary bankruptcy proceeding against us. This would significantly harm the price of our common stock. Absent successful commercial deployments of our video-on-demand and interactive program guide services, ongoing technical development and enhancement of our video-on-demand system and significant growth of our cash flow, we will not be able to service our indebtedness. Our leverage is substantial and will increase, making it more difficult to respond to changing business conditions We are highly leveraged. As of September 30, 2000, we had senior discount notes payable of approximately $322.9 million. The senior discount notes were sold at a significant discount and must be repaid at maturity on March 1, 2008 at the aggregate par value of $463.0 million. The degree to which we are leveraged could have important consequences to us and our investors, including, but not limited to, the following: . our ability to obtain additional financing in the future for working capital, operating expenses in connection with system deployments, development and enhancement of our video-on-demand 15 system, capital expenditures, acquisitions and other general corporate purposes may be materially limited or impaired; . our cash flow, if any, will not be available for our business because a substantial portion of our cash flow must be dedicated to the payment of principal and interest on our indebtedness; . the terms of future permitted indebtedness may limit our ability to redeem our outstanding senior discount notes in the event of a change of control; and . our high degree of leverage may make us more vulnerable to economic downturns, may limit our ability to withstand competitive pressures and may reduce our flexibility in responding to changing business and economic conditions. Our indebtedness contains restrictive covenants that could significantly limit our ability to engage in business activities that may be in our best interest The indenture governing our senior discount notes imposes operating and financial restrictions on us and our subsidiaries. These restrictions in specified cases significantly limit or prohibit our ability 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. These covenants may limit our ability to finance our future operations or to engage in other business activities that may be in our best interest. We are an early stage company with limited revenues and a history of losses, we expect to continue to incur substantial losses and negative cash flow and we may never achieve or sustain profitability We are an early stage company with limited commercial operating history. We have generated revenues of $2.7 million and have incurred net losses of approximately $369.4 million since our inception through September 30, 2000. We expect to continue to incur substantial losses and experience substantial negative cash flow for at least the next few years as we continue to develop our video-on-demand service capability and sell and license our products and services. We do not expect to generate substantial revenues unless and until our video-on-demand products and services are deployed at a significant number of additional cable systems and a significant number of viewers access our service. If we do not achieve and sustain profitability in the future, then we may be unable to continue our operations. Our prospects should be considered in light of the risks, expenses and difficulties frequently encountered by companies in their early stage of development, particularly companies in new and rapidly evolving markets. Our future success depends on a number of factors, including the following: . our ability to enter into agreements for broad distribution of our video-on-demand and interactive program guide products and services to network operators; 16 . the extent to which network operators upgrade their cable plant to enable two-way operation and deploy digital set-top boxes; . the extent to which viewers use our products and services for interactive, on-demand television; . our ability to continue integrating our software and hardware with other digital applications and services selected by network operators in the United States and internationally, including set-top boxes, application managers and set-top box operating systems, cable system components and electronic program guides; . the extent to which third-party cable suppliers adapt their equipment to integrate with our equipment and reduce the cost and physical space requirements for their equipment; . our ability to continue further technical development of our video server, our access equipment, our service software and our other video-on-demand system components in order to reduce their manufacturing cost and enhance their functionality; and . our ability to operate existing contracted video-on-demand deployments with acceptable system performance and viewer acceptance. Because we have a limited operating history, we have limited historical financial data on which to base planned operating expenses, and investors may find it difficult to evaluate our business and future prospects Our limited operating history makes it very difficult to evaluate our business and future prospects. As a result of our limited operating history, it is difficult for us to accurately forecast our revenues, and we have limited meaningful historical financial data on which to base planned operating expenses. We are unable to accurately forecast our revenues because: . we participate in an emerging market; . our current deployment agreements with network operators are for a single system or a limited number of systems, and we are unable to predict whether they will be expanded to cover additional systems; . we cannot predict the rate at which cable subscribers will sign up for our service; . we expect to sign new sales, service and licensing agreements on an irregular basis, if at all, and there may be long periods of time during which we do not enter into new agreements or expanded arrangements; and . we have a lengthy sales cycle, which makes it difficult to forecast the quarter during which a sale will occur. We have recently expanded our sales and marketing strategy, from one under which we owned all hardware and software components of our video-on-demand system and delivered the video-on-demand service offering to cable subscribers, to include the option under which the network operator purchases, owns and maintains all or part of the video-on-demand system hardware and takes the capital and operating expense risk associated with such ownership. It is difficult to predict the timing and amount of revenue that will be generated following this change in strategy. We expect our financial results to fluctuate significantly because we depend on a small number of relatively large orders and other factors 17 Our quarterly operating results will fluctuate significantly in the future as a result of a variety of factors, either alone or in combination. In the short term, we expect our quarterly revenues to be significantly dependent on a small number of relatively large orders for our products and services. As a result, our quarterly operating results may fluctuate significantly if we are unable to complete one or more substantial sales in any given quarter. Factors that will affect our quarterly results, many of which are outside our control, include: . the timing of deployments by network operators of our video-on-demand and interactive program guide products and services; . the terms of our contractual arrangements with network operators, who may either contract to have us manage and operate an end-to-end solution or purchase software and hardware components separately to create their own video-on-demand systems; . the mix of services revenues, which depends on the extent to which network operators purchase services from us on a fee-for-service basis or a revenue sharing basis; . competitive pressure, which may cause us to change our pricing structures; and . demand for and viewer acceptance of our video-on-demand service. A significant portion of our operating expenses are relatively fixed and necessary to develop our business. These expenses are largely independent of the revenue generated in any given quarter from sales of products and services to network operators. To the extent that increased expenses are not subsequently followed by increased revenues, our operating results will suffer. If revenue falls below expectations in any quarter, the adverse impact of the revenue shortfall on operating results in that quarter may be increased by our inability to adjust fixed spending to compensate for the shortfall. Due to these and other factors, we believe that period-to-period comparisons of our operating results may not be meaningful or indicative of future performance. You should not rely on our results for any one quarter as an indication of our future performance. It is likely that in some future quarters or years our operating results will fall below the expectations of securities analysts or investors. If we do not achieve broad deployment of our video-on-demand and interactive program guide products and services, our business will not grow Our future success depends in large part on our ability to sell our products and services and deploy our video-on-demand system in a broad base of cable systems, on terms that will generate a profit. We believe that network operators will initially be unwilling to commit to broad deployments of our video-on-demand services and products until they have completed trials of our services as well as those of competitors.* Our ability to achieve broad network operator deployments will depend on our success in demonstrating that: . our products and services are reliable and scalable and integrate with products and services provided by other cable industry suppliers chosen by the network operator; . video-on-demand is a compelling consumer product and viewers will purchase video-on-demand content at prices and in quantities that will justify the network operator's investment in our video-on-demand products and services rather than alternative entertainment services such as pay-per-view and near-video-on-demand; 18 . our video-on-demand and interactive program guide products are compatible with industry standards as they evolve; and. . our technology enables the network operator to add new revenue generating services. If we are unable to persuade network operators to purchase our products or services and deploy video-on-demand broadly in their cable systems, the growth of our business will suffer. If the limited commercial deployments of our video-on-demand service with network operators are not expanded, our results of operations and our reputation will suffer We have deployed our video-on-demand service in two cable systems owned by Charter, a multiple-headend cable system owned by AT&T, and three cable systems owned by Insight. In May 2000, we entered into an agreement with Charter to deploy our video-on-demand service in a number of additional cable systems. In September 2000, we entered into an agreement with AT&T to deploy our video-on-demand service in a number of cable systems owned by AT&T. The existing deployments with Charter, Chambers, Insight and AT&T, currently serve a limited number of approximately 35,000 customers. These network operators may not continue these deployments beyond the terms of our existing agreements, and they may choose not to broadly deploy our video-on-demand service in existing or additional cable systems. In the past, we had limited scope video-on-demand trials with other network operators that did not result in broad deployments. If we are unable to add a substantial number of cable systems to the existing contracts with the network operators currently deploying our products and services, our results of operations will suffer. In addition, our reputation and our ability to enter into agreements with other network operators could be impaired. Our products and services will not achieve widespread adoption unless network operators upgrade their cable plant, deploy digital set-top boxes, roll out our service and market our services to subscribers, all of which are beyond our control Our video-on-demand service and interactive program guide require deployment on cable systems upgraded to hybrid fiber/coaxial 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 hybrid fiber/coaxial 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. The failure of network operators to complete planned upgrades in a timely and satisfactory manner, and the lack of suitable cable plant, would harm our business. Our ability to achieve widespread adoption of our video-on-demand and interactive program guide products and services also depends on a number of other factors, many of which are beyond our control, including: . the rate at which network operators upgrade their cable infrastructures and deploy digital set-top boxes; . the ability of network operators to coordinate timely and effective marketing campaigns with the availability of cable infrastructure upgrades; . the ability of network operators to maintain their cable infrastructure and headends in accordance with system specifications provided by us; 19 . the success of network operators in marketing our video-on-demand service; . the prices that network operators set for our video-on-demand service and for its installation; . the speed at which network operators can complete the installations required to initiate service for new subscribers; . the quality of customer and technical support provided by us and network operators; and . the quality of content delivered to subscribers through our video-on-demand service. We expect rapid technological developments to occur in our industry and, accordingly, must continue to enhance our current products as well as develop new technologies, or competitors could render our products and services obsolete We expect rapid technological developments to occur in the market for interactive home video entertainment products and services. As a result, we have modified and expect to continue to modify our engineering and development plans. These modifications have resulted in delays and increased costs. Furthermore, we expect that we will be required to continue to enhance our current video-on-demand products and services and develop and introduce increased functionality and performance to keep pace with technological developments and consumer preferences. In addition, we may not be successful in developing and marketing product and service enhancements or new services that respond to technological and market changes, and we may experience difficulties that could delay or prevent the successful development, introduction and marketing of such new product and service enhancements. Our failure to successfully develop these projects could harm our business. We have encountered delays in product development, service integration and field tests and other difficulties affecting both software and hardware components of our system and our ability to operate successfully over hybrid fiber/coaxial plant. In addition, many of our competitors have substantially greater resources than we to devote to further technological and new product development. Technological and market changes or other significant developments by our competitors may render our video-on-demand and interactive program guide products and services obsolete. Our interactive program guide is a new product that has not been accepted by network operators and competes with well-established products from competitors having significantly greater resources Our interactive program guide is a new product in a well-established market. The market for electronic program guides has two major participants, TV Guide and Gemstar, which have agreed to merge into one company. Our interactive program guide competes with those companies' guides, which are already broadly deployed by network operators. Our guide also competes with interactive guides being introduced by TV Guide and Gemstar and with an interactive program guide currently being deployed by Interactive Channel. We expect that our interactive program guide will not be broadly deployed until its features are fully developed and field tested. In addition, network operators' acceptance of our interactive program guide will depend on the appeal of our business model for the guide, which is unproven. As a result, network operators may not accept our interactive program guide and may choose to use guides from more well-established competitors. Our competitors have significantly greater resources than we do, and TV Guide has an exclusive long-term agreement with the largest cable operator, AT&T. Consequently, we may not be able to compete effectively or at all in the electronic program guide market. 20 If we do not obtain substantial additional funds in the future, we may be unable to continue to grow our business or repay our indebtedness We will require substantial additional funds in order to continue the development, sale, license and provision of our video-on-demand and interactive program guide products and services and, commencing on September 1, 2003, to make cash interest payments on our indebtedness. We have made and expect to continue to make significant investments in working capital in order to fund development activities, commercially deploy our video-on-demand service, sell our products and services and fund operations. We expect to continue to incur significant operating losses and expect that our operating cash flow will be increasingly negative over at least the next few years. We believe our existing cash, cash equivalents and short-term investments will be sufficient to meet our cash requirements through the next twelve months.* However, we may need to raise additional funds earlier if our estimates of working capital or capital expenditure requirements change or prove to be inaccurate. We may also need to raise significant additional funds in order to respond to unforeseen technological, marketing or competitive hurdles or to take advantage of unanticipated opportunities. We have no present commitments or arrangements assuring us of any future equity or debt financing, and we may not be able to obtain any equity or debt financing on favorable terms or at all. In the event that we are unable to obtain additional capital, we will need to delay the expansion of our business or take other actions that could harm our business and may need to cease operations. We may also not be able to pay interest and principal on our indebtedness when due. Our lengthy sales cycle may cause fluctuations in our operating results We believe that the purchase of our products and services involves a significant commitment of capital and other resources by a network operator. In many cases, the decision to purchase our products and services requires network operators to change their established business practices and conduct their business in new ways. As a result, we need to educate network operators on the use and benefits of our products and services, which can require significant time and resources without necessarily resulting in revenues. In addition, network operators generally must consider a wide range of other issues before committing to purchase and incorporate our technology into their offerings and obtain approval at a number of levels of management. Our sales cycle has ranged from six months to a number of years. Our lengthy sales cycle limits our ability to forecast the timing and amount of specific sales. The market for our video-on-demand products and services is intensely competitive, and our current and potential competitors have significantly greater resources than we do. Consequently, we may not be able to compete effectively, which would harm our operating results Competition in both the video-on-demand market and the broader market for in-home video entertainment is intense and subject to rapid technological change. We expect competition in the market for video-on-demand products and services to intensify in the future. We categorize our video-on-demand competitors as follows: . server manufacturers, such as Concurrent, nCUBE and SeaChange; . software providers, such as Prasara and Scientific-Atlanta; and 21 . system integrators, such as Time Warner and Scientific-Atlanta. We provide products and services that compete in all three categories. Although none of our video-on-demand competitors offer products and services in all of these categories, some of them may form alliances in order to develop an integrated end-to-end video-on-demand system that may be more attractive to network operators and their subscribers than ours. Some of our video-on-demand competitors have long standing business relationships with network operators and may be able to use those relationships to gain a competitive advantage over us. In addition to video-on-demand competitors, we compete in the market for in-home video entertainment. We believe our competitors fall into three groups: . companies that provide in-home video entertainment over cable networks, including providers of pay-per-view and near-video-on-demand; . companies that deliver in-home video entertainment over networks, such as regular telephone lines, digital subscriber lines, or DSL, satellite or the Internet, and some providers of video streaming technology; and . companies that enable the viewer to store and access content on an "on-demand" basis, including providers of personal video recorders, such as TiVo and Replay, and companies that rent and sell videotapes. Many of our competitors and potential competitors have longer operating histories, greater name recognition and significantly greater financial, technical, marketing and distribution resources than we have. As a result, they may be able to respond to new or emerging technologies and changes in customer requirements faster than we do. They may also be able to devote greater resources to the development, promotion and sale of their products and services in a more effective manner. We may be unable to compete successfully against current or future competitors, and competitive pressures that we face may harm our business. If we fail to manage our growth effectively, our ability to implement our business strategies may be limited In order to execute our business strategy, we must meet aggressive engineering, integration, product delivery and installation targets. The growth in our business has placed and is expected to continue to place significant demands on our management, operating, development, third party manufacturing and financial and accounting resources. Our ability to manage growth effectively will require continued implementation of and improvements to our operating, manufacturing, development and financial and accounting systems and will require us to expand and continue to train and manage our employee base. These demands likely will require the addition of new management personnel and the development of additional expertise by existing management personnel. Our systems, procedures or controls or financial resources may be inadequate to support our operations, and our management may be unable to keep pace with this growth. If we are unable to manage our growth effectively, our business ability to successfully implement our business strategies will suffer. 22 If we are unable to adequately protect or enforce our intellectual property rights, we could suffer competitively, incur costly litigation expenses or lose valuable assets Our future success depends, in part, on our ability to protect our intellectual property and maintain the proprietary nature of our technology through a combination of patents, licenses and other intellectual property arrangements. We have been awarded patents and have filed applications and intend to file additional applications for patents covering various aspects of our video-on-demand and interactive program guide products and services. Any patents issued may be challenged, invalidated or circumvented, and the rights granted under any patents may not provide proprietary protection to us. We may not be successful in maintaining these proprietary rights, and our competitors may independently develop or patent technologies that are substantially equivalent or superior to our technologies. To the extent we integrate our products with those of third parties, we may be required to disclose or license intellectual property to those companies, and these companies could appropriate our technology or otherwise improperly exploit the information gained through this integration. If we believe third parties are infringing our intellectual property, we may be forced to expend significant resources enforcing our rights or suffer competitive injury. If third parties claim that we infringe their intellectual property, our ability to use some technologies and products could be limited, and we may incur significant costs to resolve these claims From time to time, we have received notices from third parties claiming infringement of intellectual property rights. Although we do not believe that we infringe any third party's intellectual property rights, we could encounter similar claims or litigation in the future. Gemstar, a primary provider of interactive program guides, has actively assembled and continues to acquire a portfolio of intellectual property in the field of interactive program guides and has aggressively sought recourse against any parties that it believes infringes its intellectual property. Although we believe that we do not infringe any published patents relating to our implementation of an interactive program guide and have not been served notice of any potential infringement, this provider may make such a claim in the future, which could result in legal action. Because patent applications in the United States are not publicly disclosed until the patent has been issued, applications may have been filed that, if issued as patents, would relate to our products. In addition, we have not completed a comprehensive patent search relating to the technology used in our video-on-demand and interactive program guide products and services. Parties making claims of infringement may be able to obtain injunctive or other equitable relief that could effectively block our ability to provide our products and services in the United States and internationally and could result in an award of substantial damages. In the event of a successful claim of infringement, we and our customers may be required to obtain one or more licenses from third parties, which may not be available 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 our ability to provide our video-on-demand or interactive program guide products or services, any of which could harm our business. 23 We rely on several sole or limited source suppliers and manufacturers, and our production will be seriously harmed if these suppliers and manufacturers are not able to meet our demand and alternative sources are not available We subcontract manufacturing of our hardware to a single contract manufacturer. We do not have a contract with this manufacturer and operate on a purchase order basis. Because of the complexity of our hardware components, manufacturing and quality control are time consuming processes. Our contract manufacturer may be unable to meet our requirements in a timely and satisfactory manner, and we may be unable to find or maintain a suitable relationship with alternate qualified manufacturers. Our reliance on a third-party manufacturer 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 we are unable to obtain such manufacturing on commercially reasonable terms, our production would be seriously harmed. Various subassemblies and components used in our video server and access equipment are procured from single sources and others are procured only from a limited number of sources. Consequently, we may be adversely affected by worldwide shortages of components, significant price increases, reduced control over delivery schedules, and manufacturing capability, quality and cost. Although we believe alternative suppliers of products, services, subassemblies and components are available, the lack of alternative sources could harm our ability to deploy our video-on-demand and interactive program guide systems. Manufacturing lead times can be as long as nine months for some critical components. Therefore, we may require significant working capital to pay for such components well in advance of both hardware orders and revenues. Moreover, a prolonged inability to obtain components could harm our business and could result in damage to network operator relationships. If we are unable to acquire programming content on reasonable terms, our ability to derive revenues from deployments where we provide programming content will be limited In those network operator deployments where we provide programming content, our success will depend, in part, on our 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 we have entered into arrangements with most of the major movie studios and a number of other content providers for our initial deployments, we may not be able to continue to obtain the content during the segment of time available to video-on-demand providers and others such as pay-per-view providers, to support our video-on-demand service beyond the geographic area of our initial deployments. Studios may require us to make prepayments prior to the time that customers pay for viewing a title or require us to enter into long-term contracts with minimum payments. Further, studios may increase the license fees currently charged to us. If we are unable to obtain timely access to content on commercially acceptable terms, our ability to obtain revenue from deployments where we provide content will be limited. Competition for qualified personnel is intense in technology industries such as ours, and we may not be able to maintain or expand our business if we are unable to hire and retain sufficient technical, sales, marketing and managerial personnel 24 Competition for qualified personnel in technology industries is intense, particularly in Silicon Valley. We may not be able to attract and retain qualified personnel in the future. If we are unable to hire and retain sufficient technical, sales and marketing and managerial personnel, our business will suffer. Our future success depends in part on the continued service of our key engineering, sales, marketing, manufacturing, finance and executive personnel. If we fail to retain and hire a sufficient number and type of personnel, we will not be able to maintain and expand our business. We intend to expand our international offering and operations, and these efforts may not be successful in generating revenues sufficient to offset the associated expense Although we have yet to generate any international revenue, we plan to create an international product offering and to increase our international sales and operations. We expect to expend significant financial and managerial resources to do so. If our revenues from international operations do not meet our expectations, our operating results will be adversely affected. We face risks inherent in conducting business internationally, including: . unexpected changes in regulatory requirements and tariffs that may be imposed on our services; . difficulties and costs of staffing and managing international operations; . differing technology standards and difficulties in obtaining export and import licenses; . longer payment cycles, difficulties in collecting accounts receivable and longer collection periods; . political and economic instability; . fluctuations in currency exchange rates; . imposition of currency exchange controls; . potentially adverse tax consequences; and . reduced protection for intellectual property rights in some countries. Any of these factors could adversely affect our international operations and, consequently, our business and operating results. Specifically, our failure to successfully manage our international growth could result in higher operating costs than anticipated, or could delay or preclude our ability to generate revenues in key international markets. Network operators are subject to government regulations that could require us to change our products and services In the United States, the Federal Communications Commission, or FCC, has broad jurisdiction over network operators. The FCC does not regulate us, but requirements imposed on network operators could force us to undertake development that would consume significant resources and require changes to our products and services. If we do not change our products so that they comply with FCC rules, or if our products are not integrated with ones that comply with FCC requirements, our products and services will not be broadly deployed, and our business will suffer. In addition, video-on-demand services in Canada and in the United Kingdom and other European Union members are licensed in a variety of ways. We are seeking to determine how best to offer our video-on-demand products and services in Canada, the United Kingdom and other European Union countries. We may not be able to obtain distribution rights to movie titles in non-U.S. jurisdictions under regulatory and financial arrangements acceptable to us. 25 Control by Insiders Our executive officers and named directors, together with entities affiliated with such individuals, and Acorn Ventures, Inc. beneficially own approximately 34.7% of the Common Stock (assuming conversion of all outstanding Preferred Stock into Common Stock). Accordingly, these stockholders have significant influence over our affairs. This concentration of ownership could have the effect of delaying or preventing a change in control of the Company. 26 PART II OTHER INFORMATION Item 1, Item 3 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 September 30, 2000, we issued and sold an aggregate of 76,269 shares of Common Stock to our employees and consultants for an aggregate purchase price of $149,705 pursuant to exercises of options under its 1995 and 1998 Stock Plans. These issuances were deemed exempt from registration under the Securities Act of 1933, as amended, in reliance upon Rule 701 promulgated thereunder. In addition, during the three months ended September 30, 2000 we issued and sold 555,556 shares of Series F Preferred Stock for an aggregate purchase price of $5,000,000 to one strategic investor. This issuance was deemed exempt from registration under the Securities Act in reliance upon Section 4(2) thereof. Item 4. Submission of Matters to a Vote of Security Holders On August 23, 2000, we held an annual meeting of Shareholders for which we solicited votes by proxy. The following is a brief description of the matters voted upon at the meeting and a statement of the number of votes cast for and against, and the number of abstentions as to each matter. 1. Election of the Directors of the Company: NOMINEES For Withheld Alan H. Bushell 32,009,928 4,149 Paul M. Cook 32,007,403 6,674 John W. Goddard 32,012,125 0 Jules Haimovitz 32,011,452 673 John A. Rollwagen 32,011,813 312 Barry E. Taylor 32,011,813 312 David F. Zucker 32,008,595 312 2. To approve an amendment to the 1995 Stock Plan to increase the number of shares of Common Stock reserved for issuance by 3,300,000 shares. For: 28,007,317 Against: 5,500,760 Abstained: 0 3. To approve an amendment to our Certificate of Incorporation to authorize 2,000,000 shares on non-voting Series D-1 Preferred Stock and 2,000,000 shares of non-voting Class B Common Stock. COMMON: For: 15,745,352 Against: 0 Abstained: 650 PREFERRED: For: 17,760,773 Against: 0 Abstained: 1,302 SERIES A, 27 SERIES B, SERIES C& SERIES D: For: 13,248,952 Against: 0 Abstained: 0 4. To approve an Amended and Restated Certificate of Incorporation effective upon the closing of our Initial Public Offering. COMMON: For: 14,275,352 Against: 1,470,000 Abstained: 650 PREFERRED: For: 17,736,773 Against: 24,000 Abstained: 1,302 SERIES A, SERIES B, SERIES C& SERIES D: For: 13,224,952 Against: 24,000 Abstained: 0 5. To approve the Amended and Restated Bylaws effective upon the closing of our Initial Public Offering. COMMON: For: 14,275,146 Against: 1,470,000 Abstained: 856 PREFERRED: SERIES A, SERIES B, SERIES C& SERIES D: For: 13,224,952 Against: 24,000 Abstained: 0 6. To approve the 2000 Employee Stock Purchase Plan with 750,000 shares of Common Stock reserved for issuance, effective upon the closing of our Initial Public Offering. For: 32,013,387 Against: 1,494,361 Abstained: 0 7. To approve the 2000 Stock Plan with 3,000,000 shares of Common Stock reserved for issuance. For: 32,013,716 Against: 1,494,361 Abstained: 0 8. To ratify the appointment of KPMG LLC as our independent auditors for the fiscal year ending June 30, 2001. For: 32,013,716 Against: 1,494,361 Abstained: 0 28 Item 6. Exhibits and Reports on Form 8-K: a. Exhibits. 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 September 30, 2000. 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 Senior Vice President, Finance and Administration, and Chief Financial Officer Dated: November 14, 2000 30 EX-27.1 2 0002.txt FINANCIAL DATA SCHEDULE
5 1,000 3-MOS JUN-30-2001 JUL-01-2000 SEP-30-2000 47,659 30,360 13,961 0 7,115 100,058 33,680 21,579 118,890 11,093 322,899 0 25 19 (228,691) 118,890 385 385 185 20,505 0 0 5,294 (11,807) 0 (11,807) 0 0 0 (11,807) .50 .50
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