-----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, P62t7OnLU7K27bnoNXXglBGaSGwbZeQy/QEVCmDuee6Q19wEo+ZGLpegTDy7uT7S OYJdjnC9aynoYV2Dxv/NjA== 0000893220-99-001259.txt : 19991115 0000893220-99-001259.hdr.sgml : 19991115 ACCESSION NUMBER: 0000893220-99-001259 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 19990930 FILED AS OF DATE: 19991112 FILER: COMPANY DATA: COMPANY CONFORMED NAME: GENERAL INSTRUMENT CORP CENTRAL INDEX KEY: 0001035881 STANDARD INDUSTRIAL CLASSIFICATION: RADIO & TV BROADCASTING & COMMUNICATIONS EQUIPMENT [3663] IRS NUMBER: 364134221 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 001-12925 FILM NUMBER: 99751017 BUSINESS ADDRESS: STREET 1: 101 TOURNAMENT DRIVE CITY: HORSHAM STATE: PA ZIP: 19044 BUSINESS PHONE: 2153231000 MAIL ADDRESS: STREET 1: 101 TOURNAMENT DRIVE CITY: HORSHAM STATE: PA ZIP: 19044 FORMER COMPANY: FORMER CONFORMED NAME: NEXTLEVEL SYSTEMS INC DATE OF NAME CHANGE: 19970314 10-Q 1 10-Q REPORT FOR PERIOD ENDING 9/30/99 1 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 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 number 001-12925 GENERAL INSTRUMENT CORPORATION (Exact name of registrant as specified in its charter) DELAWARE 36-4134221 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 101 TOURNAMENT DRIVE, HORSHAM, PENNSYLVANIA, 19044 (Address of principal executive offices) (Zip Code) (215) 323-1000 (Registrant's telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] As of October 31, 1999, there were 174,023,789 shares of Common Stock outstanding. 2 GENERAL INSTRUMENT CORPORATION INDEX TO FORM 10-Q
PAGES ----- PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS Consolidated Balance Sheets 3 Consolidated Statements of Operations 4 Consolidated Statement of Stockholders' Equity 5 Consolidated Statements of Cash Flows 6 Notes to Consolidated Financial Statements 7-15 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 16-23 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 24 PART II. OTHER INFORMATION ITEM 1. Legal Proceedings 25-26 ITEM 5. Other Information 27 ITEM 6. Exhibits and Reports on Form 8-K 27 SIGNATURE 28
3 PART I FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS GENERAL INSTRUMENT CORPORATION CONSOLIDATED BALANCE SHEETS (In thousands, except share data)
(UNAUDITED) SEPTEMBER 30, DECEMBER 31, 1999 1998 ----------- ----------- Assets Cash and cash equivalents $ 447,963 $ 148,675 Short-term investments 183,761 4,865 Accounts receivable, less allowance for doubtful accounts of $6,948 and $3,833, respectively (includes accounts receivable from related party of $17,455 and $81,075, respectively) 342,067 340,039 Inventories 229,970 281,451 Deferred income taxes 42,919 100,274 Other current assets 10,677 15,399 ----------- ----------- Total current assets 1,257,357 890,703 Property, plant and equipment, net 231,637 237,131 Intangibles, less accumulated amortization of $107,997 and $97,630, respectively 487,522 497,696 Goodwill, less accumulated amortization of $132,991 and $122,110, respectively 444,491 455,466 Deferred income taxes 2,286 1,999 Investments and other assets 123,301 104,765 ----------- ----------- TOTAL ASSETS $ 2,546,594 $ 2,187,760 =========== =========== LIABILITIES AND STOCKHOLDERS' EQUITY Accounts payable $ 260,196 $ 267,565 Other accrued liabilities 223,268 186,113 ----------- ----------- Total current liabilities 483,464 453,678 Deferred income taxes 10,815 15,913 Other non-current liabilities 88,249 67,998 ----------- ----------- Total liabilities 582,528 537,589 ----------- ----------- Commitments and contingencies (See Note 5) Stockholders' Equity: Preferred Stock, $.01 par value; 20,000,000 shares authorized; no shares issued -- -- Common Stock, $.01 par value; 400,000,000 shares authorized; 180,894,275 and 173,393,275 shares issued, respectively 1,809 1,734 Additional paid-in capital 1,957,312 1,742,824 Note receivable from stockholder (34,168) (40,615) Retained earnings 135,511 36,214 Accumulated other comprehensive income, net of taxes of $50,672 and $1,020, respectively 83,436 2,845 ----------- ----------- 2,143,900 1,743,002 Less - Treasury Stock, at cost, 7,271,338 and 4,619,069 shares, respectively (179,834) (92,831) ----------- ----------- Total stockholders' equity 1,964,066 1,650,171 ----------- ----------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 2,546,594 $ 2,187,760 =========== ===========
See notes to consolidated financial statements. 3 4 GENERAL INSTRUMENT CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited - In thousands, except per share information)
THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, --------------------------- -------------------------- 1999 1998 1999 1998 ------------- ------------ ------------ ------------ NET SALES $ 544,263 $ 518,196 $ 1,590,354 $ 1,423,621 Cost of sales 386,008 365,333 1,135,895 1,036,649 ----------- ----------- ----------- ----------- GROSS PROFIT 158,255 152,863 454,459 386,972 ----------- ----------- ----------- ----------- OPERATING EXPENSES: Selling, general and administrative 40,855 46,237 131,654 148,005 Litigation costs 43,000 -- 43,000 -- Research and development 41,903 42,227 124,793 200,396 Goodwill amortization 3,610 3,562 10,891 10,685 ----------- ----------- ----------- ----------- Total operating expenses 129,368 92,026 310,338 359,086 ----------- ----------- ----------- ----------- OPERATING INCOME 28,887 60,837 144,121 27,886 Other income (expense) - net (including equity interest in Partnership losses of $5,635, $4,940, $17,240 and $22,793, respectively) 547 1,291 (607) (8,513) Interest income - net 4,038 1,389 12,108 125 ----------- ----------- ----------- ----------- INCOME BEFORE INCOME TAXES 33,472 63,517 155,622 19,498 Provision for income taxes (11,130) (24,108) (56,325) (10,018) ----------- ----------- ----------- ----------- NET INCOME $ 22,342 $ 39,409 $ 99,297 $ 9,480 =========== =========== =========== =========== Earnings Per Share - Basic $ 0.13 $ 0.23 $ 0.57 $ 0.06 =========== =========== =========== =========== Earnings Per Share - Diluted $ 0.12 $ 0.22 $ 0.52 $ 0.06 =========== =========== =========== =========== Weighted-Average Shares Outstanding - Basic 173,455 168,932 173,907 156,679 Weighted-Average Shares Outstanding - Diluted 190,117 179,068 189,440 165,164
See notes to consolidated financial statements. 4 5 GENERAL INSTRUMENT CORPORATION CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (UNAUDITED - IN THOUSANDS)
NOTE ADDITIONAL RECEIVABLE COMMON STOCK PAID-IN FROM ------------------------ SHARES AMOUNT CAPITAL STOCKHOLDER ----------- ----------- ------------- ------------- Balance, January 1, 1999 173,393 $ 1,734 $ 1,742,824 $ (40,615) Net income -- -- -- -- Other comprehensive income, net-of-tax: Unrealized gains on available-for-sale securities -- -- -- -- Foreign currency translation adjustments -- -- -- -- Comprehensive income Treasury stock purchases (5,300 shares) -- -- -- -- Exercise of stock options and related tax benefit (2,648 shares issued from Treasury) -- -- 4,059 -- Issuances of shares 7,501 75 187,425 -- Payment of note receivable from stockholder -- -- -- 6,447 Warrant costs related to customer purchases -- -- 23,004 -- ----------- ----------- ----------- ----------- BALANCE, SEPTEMBER 30, 1999 180,894 $ 1,809 $ 1,957,312 $ (34,168) =========== =========== =========== ===========
ACCUMULATED OTHER TOTAL RETAINED COMPREHENSIVE TREASURY STOCKHOLDERS' EARNINGS INCOME, NET STOCK EQUITY ----------- ------------- ------------ ----------- Balance, January 1, 1999 $ 36,214 $ 2,845 $ (92,831) $ 1,650,171 Net income 99,297 -- -- 99,297 Other comprehensive income, net-of-tax: Unrealized gains on available-for-sale securities -- 81,110 -- 81,110 Foreign currency translation adjustments -- (519) -- (519) ----------- Comprehensive income 179,888 Treasury stock purchases (5,300 shares) -- -- (148,400) (148,400) Exercise of stock options and related tax benefit (2,648 shares issued from Treasury) -- -- 61,397 65,456 Issuances of shares -- -- -- 187,500 Payment of note receivable from stockholder -- -- -- 6,447 Warrant costs related to customer purchases -- -- -- 23,004 ----------- ----------- ----------- ----------- BALANCE, SEPTEMBER 30, 1999 $ 135,511 $ 83,436 $ (179,834) $ 1,964,066 =========== =========== =========== ===========
See notes to consolidated financial statements. 5 6 GENERAL INSTRUMENT CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited - In thousands)
NINE MONTHS ENDED SEPTEMBER 30, ----------------------------- 1999 1998 ---------- --------- Operating Activities: Net income $ 99,297 $ 9,480 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 65,654 60,146 Warrant costs related to customer purchases 23,004 18,121 Gain on sales of short-term investments (19,285) (11,429) Losses from asset sales and write-downs, net 12,454 8,858 Loss from equity investment 17,240 22,793 Changes in assets and liabilities: Accounts receivable (2,028) 17,856 Inventories 45,381 12,676 Prepaid expenses and other current assets 4,722 360 Deferred income taxes 2,317 (43,771) Non-current assets 3,594 1,225 Accounts payable and other accrued liabilities 54,542 50,739 Other non-current liabilities (1,101) (1,074) Other (628) (899) --------- --------- Net cash provided by operating activities 305,163 145,081 --------- --------- INVESTING ACTIVITIES: Additions to property, plant and equipment (45,215) (58,963) Investments and other assets (66,823) (7,995) Proceeds from sales of short-term investments 19,916 11,429 --------- --------- Net cash used in investing activities (92,122) (55,529) --------- --------- FINANCING ACTIVITIES: Proceeds from stock option exercises 40,700 55,844 Proceeds from issuance of shares 187,500 -- Purchase of treasury shares (148,400) (64,584) Payment of note receivable from stockholder 6,447 -- --------- --------- Net cash provided by (used in) financing activities 86,247 (8,740) --------- --------- Change in cash and cash equivalents 299,288 80,812 Cash and cash equivalents, beginning of period 148,675 35,225 --------- --------- Cash and cash equivalents, end of period $ 447,963 $ 116,037 ========= =========
See notes to consolidated financial statements. 6 7 GENERAL INSTRUMENT CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (IN THOUSANDS, UNLESS OTHERWISE NOTED) 1. COMPANY BACKGROUND General Instrument Corporation ("General Instrument" or the "Company"), formerly NextLevel Systems, Inc., is a leading worldwide provider of integrated and interactive broadband access solutions and, with its strategic partners and customers, is advancing the convergence of the Internet, telecommunications and video entertainment industries. The Company is the world's leading supplier of digital and analog set-top terminals and systems for wired and wireless cable television networks, as well as hybrid fiber/coaxial network transmission systems used by cable television operators, and is a provider of digital satellite television systems for programmers, direct-to-home ("DTH") satellite networks and private networks for business communications. Through its limited partnership interest in Next Level Communications L.P. (the "Partnership") and its interest in the Partnership's successor, Next Level Communication, Inc., (see Notes 10 and 14), the Company provides next-generation broadband access solutions for local telephone companies with the NLevel3(R) Switched Digital Access System ("NLevel3"). The Company was formerly the Communications Business of the former General Instrument Corporation (the "Distributing Company"). In a transaction that was consummated on July 28, 1997, the Distributing Company (i) transferred all the assets and liabilities, at the Distributing Company's historical cost, relating to the manufacture and sale of broadband communications products used in the cable television, satellite, and telecommunications industries to the Company (then a wholly-owned subsidiary of the Distributing Company) and all the assets and liabilities relating to the manufacture and sale of coaxial, fiber optic and other electric cable used in the cable television, satellite and other industries to its wholly-owned subsidiary CommScope, Inc. ("CommScope"), at the Distributing Company's historical cost, and (ii) distributed all of its outstanding shares of capital stock of each of the Company and CommScope to its stockholders on a pro rata basis as a dividend. Approximately 147.3 million shares of the Company's common stock, par value $.01 per share (the "Common Stock"), based on a ratio of one for one, were distributed to the Distributing Company's stockholders of record on July 25, 1997 (the "Communications Distribution"). On July 28, 1997, approximately 49.1 million shares of CommScope common stock, based on a ratio of one for three, were distributed to the Company's stockholders of record on that date (the "CommScope Distribution" and, together with the Communications Distribution, the "Distribution"). On July 28, 1997, the Company and CommScope began operating as independent entities with publicly traded common stock, and the Distributing Company retained no ownership interest in either the Company or CommScope. Additionally, immediately following the Communications Distribution, the Distributing Company was renamed General Semiconductor, Inc. ("General Semiconductor") and effected a one for four reverse stock split. In September, 1999, the Company entered into a definitive agreement of merger with Motorola, Inc. and its wholly-owned subsidiary, Lucerne Acquisition Corp. Under the merger agreement, which is subject to customary regulatory and stockholder approvals, each share of the Company would be exchanged for 0.575 shares of Motorola, Inc. 2. BASIS OF PRESENTATION The accompanying interim consolidated financial statements reflect the results of operations, financial position, changes in stockholders' equity and cash flows of the Company. The consolidated balance sheet as of September 30, 1999, the consolidated statements of operations for the three and nine months ended September 30, 1999 and 1998, the consolidated statement of stockholders' equity for the nine months ended September 30, 1999 and the consolidated statements of cash flows for the nine months ended September 30, 1999 and 1998 of the Company are unaudited and reflect all adjustments of a normal, recurring nature (except for those charges disclosed in Notes 7, 8 and 10) which are, in the opinion of management, necessary for a fair presentation of the interim period financial statements. The results of operations for the interim period are not necessarily indicative of the results of operations to be expected for the full year. The statements should be read in conjunction with the accounting policies and notes to the consolidated financial statements included in the Company's 1998 Annual Report on Form 10-K. 7 8 GENERAL INSTRUMENT CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (IN THOUSANDS, UNLESS OTHERWISE NOTED) 3. INVENTORIES Inventories consist of:
SEPTEMBER 30, 1999 DECEMBER 31, 1998 ------------------ ----------------- Raw materials $124,045 $103,807 Work in process 24,605 19,236 Finished goods 81,320 158,408 -------- -------- $229,970 $281,451 ======== ========
4. INVESTMENTS At September 30, 1999 and December 31, 1998, all of the Company's marketable equity securities were classified as available-for-sale. Proceeds from the sales of available-for-sale securities for the three and nine months ended September 30, 1999 were $7 million and $20 million, respectively. The related realized gains for the three and nine months ended September 30, 1999 were $7 million and $19 million, respectively. Proceeds and the related realized gains from the sales of available-for-sale securities for the three and nine months ended September 30, 1998 were $7 million and $11 million, respectively. Realized gains were determined using the securities' cost. At September 30, 1999, $184 million of these securities are included in short-term investments, and the remaining balance is included in investments and other assets. At December 31, 1999, all securities were reflected in short-term investments.
SEPTEMBER 30, 1999 DECEMBER 31, 1998 ------------------------------------ ----------------------------------- GROSS GROSS FAIR UNREALIZED COST FAIR UNREALIZED COST VALUE GAINS BASIS VALUE GAINS BASIS ------------------------------------ ----------------------------------- Marketable Equity Securities $193,961 $134,627 $ 59,334 $4,865 $ 3,865 $ 1,000 ==================================== ===================================
5. COMMITMENTS AND CONTINGENCIES A securities class action is presently pending in the United States District Court for the Northern District of Illinois, Eastern Division, In Re General Instrument Corporation Securities Litigation. This action, which consolidates numerous class action complaints filed in various courts between October 10 and October 27, 1995, is brought by plaintiffs, on their own behalf and as representatives of a class of purchasers of the Distributing Company's common stock during the period March 21, 1995 through October 18, 1995. The complaint alleges that the Distributing Company and certain of its officers and directors, as well as Forstmann Little & Co. and certain related entities, violated the federal securities laws, namely, Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), prior to the Distribution, by allegedly making false and misleading statements and failing to disclose material facts about the Distributing Company's planned shipments in 1995 of its CFT2200 and Digicipher(R) products. Also pending in the same court, under the same name, is a derivative action brought on behalf of the Distributing Company. The derivative action alleges that, prior to the Distribution, the members of the Distributing Company's Board of Directors, several of its officers and Forstmann Little & Co. and related entities have breached their fiduciary duties by reason of the matter complained of in the class action and certain defendants' alleged use of material non-public information to sell shares of the Distributing Company's stock for personal gain. Both actions seek unspecified damages and attorneys' fees and costs. The court granted the defendants' motion to dismiss the original complaints in both of these actions, but allowed the plaintiffs in each action an opportunity to file amended complaints. Amended complaints were filed on November 7, 1997. The defendants answered the amended consolidated complaint in the class actions, denying liability, and filed a renewed motion to dismiss the derivative action. On September 22, 1998, defendants' motion to dismiss the derivative action was denied. In November 1998, the defendants filed an answer to the derivative action, denying liability. On January 21, 1999, the plaintiffs in the class actions filed their motion for class certification, including the defendants' opposition. No ruling has been made on the class certification issue. The Company intends to vigorously contest these actions. An action entitled BKP Partners, L.P. v. General Instrument Corp. was brought in February 1996 by certain holders of preferred stock of Next Level Communications ("NLC"), which merged into a subsidiary of the Distributing Company in September 1995. The action was originally filed in the Northern District of California and was subsequently transferred to 8 9 GENERAL INSTRUMENT CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (IN THOUSANDS, UNLESS OTHERWISE NOTED) the Northern District of Illinois. The plaintiffs allege that the defendants violated federal securities laws by making misrepresentations and omissions and breached fiduciary duties to NLC in connection with the acquisition of NLC by the Distributing Company. Plaintiffs seek, among other things, unspecified compensatory and punitive damages and attorneys' fees and costs. On September 23, 1997, the district court dismissed the complaint, without prejudice, and the plaintiffs were given until November 7, 1997 to amend their complaint. On November 7, 1997, plaintiffs served the defendants with an amended complaint, which contains allegations substantially similar to those in the original complaint. The defendants filed a motion to dismiss parts of the amended complaint and answered the balance of the amended complaint, denying liability. On September 22, 1998, the district court dismissed with prejudice the portion of the complaint alleging violations of Section 14(a) of the Exchange Act, and denied the remainder of the defendants' motion to dismiss. In November, 1998, the defendants filed an answer to the remaining parts of the amended complaint, denying liability. The Company intends to vigorously contest this action. In connection with the Distribution, the Company has agreed to indemnify General Semiconductor with respect to its obligations, if any, arising out of or in connection with the matters discussed in the preceding two paragraphs. On February 19, 1998, a consolidated securities class action complaint entitled In Re Nextlevel Systems, Inc. Securities Litigation was filed in the United States District Court for the Northern District of Illinois, Eastern Division, naming the Company and certain former officers and directors as defendants. The complaint was filed on behalf of stockholders who purchased or otherwise acquired stock of the Company between July 25, 1997 and October 15, 1997. The complaint alleged that the defendants violated Sections 11 and 15 of the Securities Act of 1933, as amended (the "Securities Act"), and Sections 10(b) and 20(a) of the Exchange Act and Rule 10b-5 thereunder by making false and misleading statements about the Company's business, finances and future prospects. The complaint seeks damages in an unspecified amount. On April 9, 1998, the plaintiffs voluntarily dismissed their Securities Act claims. On May 5, 1998, the defendants moved to dismiss the remaining counts of the complaint. That motion was denied on March 31, 1999 and defendants' answer was filed on June 25, 1999. On July 30, 1999, defendants filed a motion seeking reconsideration of the denial of their motion to dismiss. The Company intends to vigorously contest this action. On March 5, 1998, an action entitled DSC Communications Corporation and DSC Technologies Corporation v. Next Level Communications L.P., KK Manager, L.L.C., General Instrument Corporation and Spencer Trask & Co., Inc. was filed in the Superior Court of the State of Delaware in and for New Castle County (the "Delaware Action"). In that action, DSC Communications Corporation and DSC Technologies Corporation (collectively, "DSC") alleged that in connection with the formation of the Partnership and the transfer to it of NLC's switched digital video technology, the Partnership and KK Manager, L.L.C. misappropriated DSC's trade secrets; that the Company improperly disclosed trade secrets when it conveyed such technology to the Partnership; and that Spencer Trask & Co., Inc. conspired to misappropriate DSC's trade secrets. The plaintiffs sought actual damages for the defendants' purported unjust enrichment, disgorgement of consideration, exemplary damages and attorney's fees, all in unspecified amounts. In April 1998, the Company and the other defendants filed an action in the United States District Court for the Eastern District of Texas, requesting that the federal court preliminarily and permanently enjoin DSC from prosecuting the Delaware Action because by pursuing such action, DSC effectively was trying to circumvent and relitigate the Texas federal court's November 1997 judgment in a previous lawsuit involving DSC, pursuant to which NLC had paid over $140 million. On May 14, 1998, the Texas court granted a preliminary injunction preventing DSC from proceeding with the Delaware Action. That injunction order was appealed to the United States Court of Appeals for the Fifth Circuit. On June 21, 1999, the Fifth Circuit affirmed the Texas federal court's grant of the preliminary injunction. On July 15, 1999, the Texas federal court granted the Delaware defendants' motion for summary judgment and issued its final judgment permanently enjoining DSC from prosecuting and continuing the Delaware Action. In May 1997, StarSight Telecast, Inc. ("StarSight") filed a Demand for Arbitration against the Company alleging that the Company breached the terms of a license agreement with StarSight by (a) developing a competing product that wrongfully incorporates StarSight's technology and inventions claimed within a certain StarSight patent, (b) failing to promote and market the StarSight product as required by the license agreement, and (c) wrongfully using StarSight's technical information, confidential information and StarSight's graphical user interface in breach of the license agreement. StarSight sought injunctive relief as well as damages. The first part of a bifurcated arbitration proceeding, relating to the Company's advanced analog products, began on March 22, 1999 before an arbitration panel of the American Arbitration Association in San Francisco, California. Oral arguments to the panel by the Company and StarSight were concluded on May 23, 1999. On October 4, 1999, the arbitration panel released an interim decision with respect to advanced analog products only. The arbitration panel found that the Company had breached the license agreement and had misappropriated certain StarSight trade secrets relating to electronic program guides. The arbitration panel rejected StarSight's interpretation of its patents and also 9 10 GENERAL INSTRUMENT CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (IN THOUSANDS, UNLESS OTHERWISE NOTED) found that the Company did not commercialize products that incorporate those patents. The panel further denied StarSight's request for an injunction. The arbitration panel found that StarSight is entitled to compensatory and punitive damages. The amount of such damages will be finally determined by the arbitrators based on damage calculations submitted by the parties. The Company estimates that compensatory damages will be in the range of $25 to $36 million. An additional 50% of such amount will be added as punitive damages, plus attorneys fees and costs. General Instrument has not determined whether it will oppose confirmation of the damage award. A separate phase of the arbitration relating to the use of electronic program guides on digital cable set-top terminals and satellite receivers is not anticipated to be scheduled until the second quarter of 2000. Unlike its advanced analog products, the Company does not sell a Company electronic program guide with its digital cable set-top terminals. The Company denies StarSight's allegations in the second phase and will continue to vigorously contest this action. On November 30, 1998, an action entitled Gemstar Development Corporation and Index Systems, Inc. v. General Instrument Corporation was filed in the United States District Court for the Northern District of California. The complaint alleges infringement by the Company of two U.S. patents allegedly covering electronic program guides. The complaint seeks unspecified damages and an injunction. After filing this action, the plaintiffs sought to consolidate discovery for this action with other program guide related patent infringement actions pending against Pioneer Electronics Corp., Scientific-Atlanta, Inc., and Prevue Networks, Inc. On April 26, 1999, the Judicial Panel on Multidistrict Litigation ordered the transfer of this action to the Northern District of Georgia for consolidated pretrial proceedings with the Pioneer Electronics Corp. and Scientific-Atlanta, Inc. actions. Scheduling and other preliminary discovery matters are currently awaiting an order from the Court. The Company denies that it infringes the subject patents and intends to vigorously defend this action. 6. LONG-TERM DEBT In July 1997, the Company entered into a bank credit agreement (the "Credit Agreement") which provides a $600 million unsecured revolving credit facility and matures on December 31, 2002. The Credit Agreement permits the Company to choose between two interest rate options: an Adjusted Base Rate (as defined in the Credit Agreement), which is based on the highest of (i) the rate of interest publicly announced by The Chase Manhattan Bank as its prime rate, (ii) 1% per annum above the secondary market rate for three-month certificates of deposit and (iii) the federal funds effective rate from time to time plus 0.5%, and a Eurodollar rate (LIBOR) plus a margin which varies based on certain performance criteria. The Company is also able to set interest rates through a competitive bid procedure. In addition, the Credit Agreement requires the Company to pay a facility fee on the total loan commitment. The Credit Agreement contains financial and operating covenants, including limitations on guarantee obligations, liens and sale of assets, and requires the maintenance of certain financial ratios. Significant financial ratios include (i) maintenance of consolidated net worth above $600 million adjusted for 50% of cumulative positive quarterly net income subsequent to June 30, 1997; (ii) maintenance of an interest coverage ratio based on EBITDA in comparison to net interest expense of greater than 5 to 1; and (iii) maintenance of a leverage ratio comparing total indebtedness to EBITDA of less than 3 to 1. In addition, under the Credit Agreement, certain changes in control of the Company, including the merger with Motorola, Inc., would result in an event of default, and the lenders under the Credit Agreement could declare all outstanding borrowings under the Credit Agreement immediately due and payable. None of the restrictions contained in the Credit Agreement is expected to have a significant effect on the Company's ability to operate, and as of September 30, 1999, the Company was in compliance with all financial and operating covenants under the Credit Agreement. At September 30, 1999, the Company had available credit of $500 million under the Credit Agreement. The Company had approximately $106 million of letters of credit outstanding at September 30, 1999, but has entered into an agreement that would reduce that amount by $75 million. 7. RESTRUCTURINGS In the fourth quarter of 1997, with the change in senior management, the Company undertook an effort to assess the future viability of its satellite business. As the satellite business had been in a state of decline, management of the Company made a decision to streamline the cost structure of its San Diego-based satellite business by reducing this unit's headcount by 225. In conjunction with the assessment of the satellite business, the Company also made a strategic decision with respect to its worldwide consolidated manufacturing operations that resulted in the closure of its Puerto Rico satellite TV manufacturing facility, which manufactured receivers used in the private network, commercial and consumer satellite markets for the reception of analog and digital television signals, and reduced headcount by 1,100. The Company also decided to close its corporate office and move from Chicago, Illinois to Horsham, Pennsylvania, which was completed during the first quarter of 1998. Costs associated with the closure of facilities ("Facility Costs") include vacated long-term leases which are payable 10 11 GENERAL INSTRUMENT CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (IN THOUSANDS, UNLESS OTHERWISE NOTED) through the end of the lease terms which extend through the year 2008. As a result of the above actions, the Company recorded a pre-tax charge of $36 million during the fourth quarter of 1997. As part of the restructuring plan, the Company recorded an additional $16 million of pre-tax charges in the first quarter of 1998 which primarily included $8 million for severance and other employee separation costs, $3 million of facility exit costs, including the early termination of a leased facility which the Company decided to close in the quarter ended March 31, 1998, and $5 million related to the write-down of fixed assets to their estimated fair values. Of these charges, $9 million were recorded as cost of sales, $6 million as selling, general and administrative ("SG&A") expense and $1 million as research and development ("R&D") expense. On April 29, 1999, PRIMESTAR, Inc. ("PRIMESTAR") announced that it had completed the previously announced sale of its direct broadcast satellite ("DBS") medium-power business and assets to Hughes Electronics Corporation ("Hughes"). Sales to PRIMESTAR accounted for 11% of the Company's sales in 1998. The Company currently expects future PRIMESTAR purchases of medium-power equipment from the Company to be insignificant. Further, as a result of the previously announced purchase by Hughes of PRIMESTAR's rights to acquire certain high-power satellite assets, the Company does not expect to supply any high-power equipment to PRIMESTAR. In the first quarter of 1999, in connection with the announcement of the PRIMESTAR developments, the Company evaluated its overhead structure and took steps to further consolidate its San Diego, California and Horsham, Pennsylvania operations, including reducing headcount by approximately 200. The Company recorded a pre-tax charge of approximately $15 million during the first quarter of 1999 which primarily included $6 million for severance costs, $6 million for the write-down of PRIMESTAR related inventory to its lower of cost or market, $2 million for the write-down of fixed assets used to manufacture PRIMESTAR products to their estimated fair values and $1 million of facility costs. Of these charges, $8 million were recorded as cost of sales and $7 million were recorded as SG&A expense. The following tabular reconciliation summarizes the restructuring activity from January 1, 1998 through September 30, 1999:
BALANCE AT 1998 BALANCE AT 1999 BALANCE AT ---------------------- --------------------- JANUARY 1, AMOUNTS DECEMBER 31, AMOUNTS SEPTEMBER 30, 1998 ADDITIONS UTILIZED 1998 ADDITIONS UTILIZED 1999 ----------- ---------- ----------- ------------- ---------- ---------- --------------- (in millions) Inventory (1) $ -- $ -- $ -- $ -- $ 6.1 $(3.8) $ 2.3 Property, Plant & Equipment (1) 7.8 4.6 (12.4) -- 2.2 -- 2.2 Facility Costs 10.5 3.3 (10.0) 3.8 0.8 (1.1) 3.5 Severance 19.9 7.6 (26.7) 0.8 5.7 (4.5) 2.0 ===== ===== ===== ===== ===== ===== ===== Total $38.2 $15.5 $(49.1) $ 4.6 $14.8 $(9.4) $10.0 ===== ===== ===== ===== ===== ===== =====
(1) These charges represent a direct reduction to the inventory and property, plant and equipment balances to reflect the identified impaired assets at their lower of cost or market and fair values, respectively. The amounts utilized reflect the disposition of such identified impaired assets. 8. OTHER CHARGES AND LITIGATION COSTS The Company incurred certain other pre-tax charges during the first quarter of 1998 primarily related to management's decision to close a satellite manufacturing facility due to reduced demand for the products manufactured by that facility. Concurrent with this decision, the Company determined that the carrying value of the inventory would not be recoverable and, accordingly, the Company wrote down the inventory to its lower of cost or market. In addition, the Company incurred moving costs associated with relocating certain fixed assets to other facilities, shutdown expenses and legal fees. The above charges totaled $25 million, of which $18 million are included in cost of sales and $7 million are included in SG&A expense. In addition, the Company incurred $8 million of charges, which are included in "other expense-net," related to costs incurred by the Partnership, which the Company accounts for under the equity method. Such costs are primarily related to a $5 million litigation settlement and compensation expense related to key executives of an acquired company. 11 12 The following tabular reconciliation summarizes the other charge activity discussed above:
BALANCE AT 1998 BALANCE AT 1999 BALANCE AT ------------------------ ------------ JANUARY 1, AMOUNTS DECEMBER 31, AMOUNTS SEPTEMBER 30, 1998 ADDITIONS UTILIZED 1998 UTILIZED 1999 ------------ ----------- ------------ ------------- ------------ --------------- (in millions) Inventory (1) $43.3 $15.0 $(43.3) $15.0 $(4.5) $10.5 Property, Plant & Equipment (1) 8.4 -- (1.1) 7.3 (7.3) -- Professional Fees & Other Costs 3.2 10.1 (13.3) -- -- -- Partnership Related -- Costs -- 8.4 - (8.4) -- -- -- ----- ----- ----- ----- ----- ----- Total $54.9 $33.5 $(66.1 ) $22.3 $(11.8) $10.5 ===== ===== ===== ===== ===== =====
(1) These charges represent a direct reduction to the inventory and property, plant and equipment balances to reflect these assets at their lower of cost or market and fair values, respectively. The amounts utilized reflect the disposition of such identified assets. During the three months ended September 30, 1999, the Company recorded a $43 million charge related to the American Arbitration Association panel's interim decision in the breach of contract dispute between the Company and StarSight Telecast, Inc. The arbitrators found that the Company had breached a license agreement and misappropriated certain StarSight trade secrets relating to electronic program guides and that StarSight is entitled to compensatory and punitive damages. The amount of such damages will be finally determined by the arbitrators after further submissions are made by the parties. The Company estimates that compensatory damages will be in the range of $25 to $36 million. An additional 50% of such amount will be added as punitive damages, plus attorneys fees and costs. See Note 5. 9. OTHER INCOME (EXPENSE) - NET Other income (expense)-net for the three and nine months ended September 30, 1999 primarily includes $7 million and $19 million, respectively, related to gains on the sales of short-term investments offset by $6 million and $17 million, respectively, related to the Company's share of the Partnership losses. Other income (expense)-net for the three and nine months ended September 30, 1998 primarily reflects $5 million and $23 million, respectively, related to the Company's share of the Partnership losses, including the Company's share of a $5 million litigation settlement and compensation expense related to key executives of an acquired company for the nine months ended September 30, 1998, offset by $7 million and $11 million, respectively, related to gains on the sales of short-term investments and $5 million for the nine months ended September 30, 1998 related to proceeds received from the settlement of an insurance claim. 10. THE NEXT LEVEL COMMUNICATIONS BUSINESS In January 1998, the Company transferred at historical cost the net assets, the underlying NLC technology, and the management and workforce of NLC to a newly formed limited partnership (the "Partnership") in exchange for approximately an 89% limited partnership interest (subject to additional dilution). Such transaction was accounted for at historical cost. The limited partnership interest is included in "investments and other assets" in the accompanying consolidated balance sheet at September 30, 1999. The operating general partner, which was formed by Spencer Trask & Co. ("Spencer Trask"), an unrelated third party, acquired approximately an 11% interest in the Partnership and has the potential to acquire up to an additional 11% in the future. The Company does not have the option to acquire the operating general partner's interest in the Partnership. Net assets transferred to the Partnership at formation of $45 million primarily included property, plant and equipment, inventories and accounts receivable partially offset by accounts payable and accrued expenses. In addition, in January 1998, the Company advanced $75 million to the Partnership in exchange for an 8% debt instrument (the "Note"), and the Note contains normal creditor security rights, including a prohibition against incurring amounts of indebtedness for borrowed money in excess of $10 million. Since the repayment of the Note was solely dependent upon the results of the Partnership's research and development activities and the commercial success of its product 12 13 GENERAL INSTRUMENT CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (IN THOUSANDS, UNLESS OTHERWISE NOTED) development, the Company recorded a charge to R&D expense during the quarter ended March 31, 1998 to fully reserve for the Note concurrent with the funding. The proceeds of the Note are being utilized to fund the R&D activities of the Partnership to develop the aforementioned telecommunication technology for widespread commercial deployment. During 1998, the Company agreed to make additional equity investments in the Partnership, aggregating $50 million, beginning in November 1998, to fund the Partnership's growth and assist the Partnership in meeting its forecasted working capital requirements. The Company completed these equity investments in the second quarter of 1999. The Company accounts for its interest in the Partnership as an investment under the equity method of accounting. Further, the Company's share of the Partnership's losses related to future R&D activities, up to a maximum of $75 million, are being offset against the $75 million reserve discussed above. For the three and nine months ended September 30, 1999, the Company's share of the Partnership's losses was $6 million and $17 million, respectively, (net of the Company's share of R&D expenses of $11 million and $32 million, respectively). For the three and nine months ended September 30, 1998, the Company's share of the Partnership's losses was $5 million and $23 million, respectively, (net of the Company's share of R&D expenses of $11 million and $31 million, respectively). The Company has eliminated its interest income from the Note against its share of the Partnership's related interest expense on the Note. The Company's net equity investment in the Partnership was $53 million at September 30, 1999. The following summarized financial information is provided for the Partnership for the three and nine months ended September 30, 1999 and 1998:
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30, --------------------------------------- --------------------------------------- 1999 1998 1999 1998 ----------------- ------------------ ------------------ ------------------ Net sales $ 14,240 $ 14,601 $ 32,430 $ 21,208 Gross profit (loss) 1,411 (497) 2,461 (568) Loss before income taxes (20,751) (18,161) (59,948) (60,282) Net cash used in operating activities (20,259) (24,596) (44,378) (63,017)
In November, 1999, in connection with the initial public offering of Next Level Communications, Inc., the corporate successor to the Partnership, the Company contributed the Note and accrued interest thereon, in exchange for additional ownership interest in Next Level Communications, Inc. See Note 14. 11. RELATED PARTY TRANSACTIONS A wholly-owned subsidiary of AT&T is a greater than 10% stockholder of the Company. AT&T is also a significant customer of the Company. Sales to AT&T (Tele-Communications, Inc prior to its merger with AT&T) represented 30% and 31% of total Company sales for the nine months ended September 30, 1999 and the year ended December 31, 1998, respectively. Management believes the transactions with AT&T are at arms length and are under terms no less favorable to the Company than those with other customers. At September 30, 1999 and December 31, 1998 accounts receivable from AT&T totaled $17 million and $81 million, respectively. 13 14 GENERAL INSTRUMENT CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (IN THOUSANDS, UNLESS OTHERWISE NOTED) 12. SEGMENT INFORMATION Selected information regarding the Company's reportable segments follows:
SATELLITE BROADBAND AND BROADCAST NETWORKS NETWORK TOTAL SYSTEMS SYSTEMS UNALLOCATED COMPANY ------------- ------------ ------------- ----------- THREE MONTHS ENDED SEPTEMBER 30, 1999 - ------------------------------------- Net sales $ 490,687 $ 53,576 $ -- $ 544,263 Operating income 71,267 7,918 (50,298)(b) 28,887 Other income - net 547 Interest income - net 4,038 Income before income taxes 33,472 Segment assets (a) 665,291 121,777 16,606(c) 803,674 THREE MONTHS ENDED SEPTEMBER 30, 1998 - ------------------------------------- Net sales $ 413,658 $ 104,538 $ -- $ 518,196 Operating income 67,531 12,144 (18,838)(b) 60,837 Other income - net 1,291 Interest income - net 1,389 Income before income taxes 63,517 Segment assets (a) 593,271 197,788 18,888 (c) 809,947 NINE MONTHS ENDED SEPTEMBER 30, 1999 - ------------------------------------- Net sales $ 1,396,873 $ 193,481 $ -- $ 1,590,354 Operating income 200,243 25,465 (81,587)(b) 144,121 Other expense - net (607) Interest income - net 12,108 Income before income taxes 155,622 NINE MONTHS ENDED SEPTEMBER 30, 1998 - ------------------------------------- Net sales $ 1,104,273 $ 319,348 $ -- $ 1,423,621 Operating income 161,575 29,810 (163,499)(b) 27,886 Other expense - net (8,513) Interest income - net 125 Income before income taxes 19,498
- ------------------- (a) Segment assets include accounts receivable, inventories and property, plant and equipment. Other balance sheet items are not allocated to the segments. (b) Primarily reflects unallocated amounts, including (i) goodwill amortization of $4 million and $11 million for the three and nine months ended September 30, 1999, respectively, and $4 million and $11 million for the three and nine months ended September 30, 1998, respectively, (ii) litigation costs of $43 million for the three and nine months ended September 30, 1999 (see Note 8) and (iii) restructuring and other charges of $15 million for the nine months ended September 30, 1999 and $115 million for the nine months ended September 30, 1998, (see Notes 7 and 8). The remaining reconciling amounts reflect unallocated selling, general and administrative expenses and other overhead costs. (c) Primarily reflects unallocated accounts receivable of $6 million and $21 million at September 30, 1999 and 1998, respectively, and certain unallocated property, plant and equipment balances of $16 million at September 30, 1999 and 1998, offset by write-downs related to restructuring and other charges not allocated to the segments for internal management reporting purposes. 14 15 GENERAL INSTRUMENT CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (IN THOUSANDS, UNLESS OTHERWISE NOTED) 13. OTHER INFORMATION Earnings (Loss) Per Share. The calculation of diluted weighted-average shares outstanding included the dilutive effects of stock options and warrants of 4,271 shares and 12,391 shares, respectively, for the three months ended September 30, 1999 and the dilutive effects of stock options and warrants of 4,124 shares and 11,409 shares, respectively, for the nine months ended September 30, 1999. The calculation of diluted weighted-average shares outstanding included the dilutive effects of stock options and warrants of 2,806 shares and 7,330 shares, respectively, for the three months ended September 30, 1998 and the dilutive effects of stock options and warrants of 2,380 shares and 6,105 shares, respectively, for the nine months ended September 30, 1998. License Amortization. Intangible assets consist primarily of a license, which is being amortized over its 20-year term based on the expected revenue stream. The revenue earned from the license is solely dependent on the Company's deployment of digital terminals and such deployment is expected to rise significantly during the 20-year term. The Company believes the expected revenue stream is a reliable measure of the future benefit of the license both in the aggregate and in terms of the periods to which such benefit will be realized. Accordingly, the Company believes this method of amortization is a more appropriate method than straight-line. At each reporting date, the Company's method of amortization requires the determination of a fraction, the numerator of which is the actual revenues for the period and the denominator of which is the expected revenues from the license during its 20-year term. Under the Company's method, amortization for the three and nine months ended September 30, 1999 was approximately $0.8 million and $2.5 million, respectively, and accumulated amortization as of September 30, 1999 was approximately $3.2 million. Comprehensive Income (Loss). Total comprehensive income was $64 million and $180 million for the three and nine months ended September 30, 1999, respectively. For the three and nine months ended September 30, 1998, total comprehensive income was $26 million and total comprehensive loss was $7 million, respectively. New Accounting Pronouncements Not Yet Adopted. Statement of Financial Accounting Standards ("SFAS") No. 133 "Accounting for Derivative Instruments and Hedging Activities" was issued in June 1998 and, as amended by SFAS No. 137 "Accounting for Derivative Instruments and Hedging Activities -- Deferral of the Effective Date of SFAS Statement No. 133" in June 1999, is effective for fiscal years beginning after June 15, 2000. SFAS No. 133 requires that all derivative instruments be measured at fair value and recognized in the balance sheet as either assets or liabilities. The Company is currently evaluating the impact this pronouncement will have on its consolidated financial statements. 14. SUBSEQUENT EVENT On November 9, 1999, Next Level Communications, Inc. ("NLCI") priced its initial public offering of 8,500,000 shares of common stock. NLCI is the corporate successor to the Partnership, of which a General Instrument subsidiary was the limited partner. In connection with this offering, the Partnership and the Company's wholly owned subsidiary, the limited partner, were merged into NLCI and the Company contributed the Note (see Note 10) and accrued interest thereon to NLCI in exchange for 64,103,724 shares of common stock of NLCI. This represents approximately 80% of the shares outstanding immediately after the offering (approximately 64% on a fully diluted basis) after giving effect to the exercise of the underwriters' over-allotment option. The Company has deposited all of its shares into a voting trust that limits its voting power to 49% of all outstanding shares of common stock; accordingly, the Company will continue to account for its ownership interest as an investment under the equity method of accounting. It is anticipated that the voting trust will terminate immediately upon the completion of the pending merger with Motorola, Inc. 15 16 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS NET SALES Net sales for the three months ended September 30, 1999 were $544 million, an increase of $26 million, or 5%, over net sales of $518 million for the three months ended September 30, 1998. Net sales for the nine months ended September 30, 1999 were $1,590 million compared to $1,424 million for the nine months ended September 30, 1998, an increase of $166 million, or 12%. The increases in net sales for the three and nine month periods reflect higher sales of digital cable systems, transmission and high speed data products, partially offset by lower sales of analog cable and satellite products. Digital and analog products represented 60% and 40%, respectively, of total sales for the nine months ended September 30, 1999 and 54% and 46%, respectively, of total sales for the nine months ended September 30, 1998. Worldwide broadband sales (consisting of digital and analog cable and wireless television systems, transmission network systems and high speed data products) of $491 million and $1,397 million for the three and nine months ended September 30, 1999, respectively, increased $77 million, or 19%, and $293 million, or 27%, respectively, from the comparable 1998 periods, primarily as a result of increased U.S. sales volume of digital cable terminals and headends, transmission product sales and high speed data product sales, partially offset by lower sales of analog cable systems. These sales reflect the commitment of cable television operators to deploy interactive digital systems in order to offer advanced entertainment, interactive services and Internet access to their customers. During the three months ended September 30, 1999 and 1998, broadband sales in the U.S. were 86% and 88%, respectively, combined U.S. and Canadian sales were 90% and 89%, respectively, and all other international sales were 10% and 11%, respectively, of total worldwide broadband sales. For the nine months ended September 30, 1999 and 1998, broadband sales in the U.S. were 85%, combined U.S. and Canadian sales were 89% and 86%, respectively, and all other international sales were 11% and 14%, respectively, of total worldwide broadband sales. The decrease in international sales from 1998 was experienced primarily in the Latin American and European regions and international sales are not expected to return to historical levels in the near-term. Worldwide satellite sales of $54 million and $193 million for the three and nine months ended September 30, 1999, respectively, decreased $51 million, or 49%, and $126 million, or 39%, respectively, from the comparable 1998 period, primarily as a result of lower sales to PRIMESTAR, Inc. ("PRIMESTAR"). On April 29, 1999, PRIMESTAR announced that it had completed the previously announced sale of its direct broadcast satellite ("DBS") medium-power business and assets to Hughes Electronics Corporation ("Hughes"). The Company currently expects future PRIMESTAR purchases of medium-power equipment from the Company to be insignificant. Further, as a result of the previously announced purchase by Hughes of PRIMESTAR's rights to acquire certain high-power satellite assets, the Company does not expect to supply any high-power equipment to PRIMESTAR. During the three months ended September 30, 1999 and 1998, satellite sales in the U.S. were 40% and 84%, respectively, combined U.S. and Canadian sales were 90% and 99%, respectively, and all other international sales were 10% and 1%, respectively, of total worldwide satellite sales. For the nine months ended September 30, 1999 and 1998, satellite sales in the U.S. were 61% and 91%, respectively, combined U.S. and Canadian sales were 89% and 98%, respectively, and all other international sales were 11% and 2%, respectively, of total worldwide satellite sales. The increase in international satellite sales during 1999 was experienced primarily in the Latin American region. AT&T (TCI prior to its merger with AT&T) accounted for approximately 30% of the Company's consolidated net sales for the nine months ended September 30, 1999. For the year ended December 31, 1998, TCI and PRIMESTAR represented approximately 31% and 11%, respectively, of total Company sales. GROSS PROFIT Gross profit was $158 million and $454 million for the three and nine months ended September 30, 1999, respectively, compared to $153 million and $387 million for the three and nine months ended September 30, 1998, respectively. Gross profit was 29% of sales for the three and nine months ended September 30, 1999, respectively, compared to 30% and 27% of sales for the comparable 1998 periods. Gross profit for the nine months ended September 30, 1999 included a $6 million gain, recorded in the second quarter of 1999, related to the favorable resolution of certain duty matters and $8 million of restructuring charges (see Note 7 and "Restructurings" below) recorded in the first quarter of 1999, primarily related to the write-down of PRIMESTAR related inventory to its lower of cost or market and the write-down of fixed assets used to manufacture PRIMESTAR products to their estimated fair values. Gross profit for the nine months ended September 30, 16 17 1998 included $9 million of restructuring charges (see Note 7 and "Restructurings" below) and $18 million of other charges (see Note 8 and "Other Charges" below) recorded in the first quarter of 1998, primarily related to severance and other employee separation costs, costs associated with the closure of various facilities, the write-down of fixed assets to their estimated fair values and the write-down of inventories to their lower of cost or market. SELLING, GENERAL AND ADMINISTRATIVE Selling, general & administrative ("SG&A") expense was $41 million and $132 million for the three and nine months ended September 30, 1999, respectively, compared to $46 million and $148 million for the three and nine months ended September 30, 1998, respectively. SG&A expense decreased as a percentage of sales to 8% for the three and nine months ended September 30, 1999, respectively, from 9% and 10% for the three and nine months ended September 30, 1998, respectively. SG&A for the nine months ended September 30, 1999 included $7 million of restructuring charges (see Note 7 and "Restructurings" below) recorded in the first quarter of 1999, primarily related to severance costs recorded in connection with the announcement of the PRIMESTAR developments. These restructuring activities have driven the reductions of ongoing SG&A expense. SG&A for the nine months ended September 30, 1998 included $6 million of restructuring charges (see Note 7 and "Restructurings" below) and $7 million of other charges (see Note 8 and "Other Charges" below) recorded in the first quarter of 1998, primarily related to severance and other employee separation costs, costs associated with the closure of various facilities, including moving costs and costs associated with changing the Company's corporate name. LITIGATION COSTS During the three months ended September 30, 1999, the Company recorded a $43 million charge related to the American Arbitration Association panel's interim decision in the breach of contract dispute between the Company and StarSight Telecast, Inc. The arbitrators found that the Company had breached a license agreement and misappropriated certain StarSight trade secrets relating to electronic program guides and that StarSight is entitled to compensatory and punitive damages. The amount of such damages will be finally determined by the arbitrators after further submissions are made by the parties. The Company estimates that compensatory damages will be in the range of $25 to $36 million. An additional 50% of such amount will be added as punitive damages, plus attorneys fees and costs. In the event this award is ultimately confirmed by a court, the Company would be able to satisfy the judgment without any material impact on its financial condition or future operations (see Note 5). RESEARCH AND DEVELOPMENT Research and development ("R&D") expense was $42 million and $125 million for the three and nine months ended September 30, 1999, respectively, compared to $42 million and $200 million, respectively, for the comparable 1998 periods. R&D expense for the nine months ended September 30, 1998 included a $75 million charge to fully reserve the Partnership Note (see Note 10). Proceeds of the Partnership Note are being utilized by the Partnership to fund research and development activities to develop, for widespread commercial deployment, the next-generation telecommunications technology for the delivery of telephony, video, and data from the telephone company central office to the home. The Company's R&D spending in 1999 is focused on new product opportunities, including advanced digital services, high-speed internet and data systems, and next generation transmission network systems. In addition, the Company is incurring R&D expense to develop analog and digital products for international markets, reduce costs and expand the features of its digital cable and satellite systems. OTHER INCOME (EXPENSE)--NET For the three and nine months ended September 30, 1999, other income-net was $1 million and other expense-net was $1 million, respectively. For the three and nine months ended September 30, 1998 other income-net was $1 million and other expense-net was $9 million, respectively. Other expense decreased in the nine months ended September 30, 1999 from the comparable 1998 period primarily due to a reduction in the Partnership's losses (see Note 10) and additional gains on the sales of short-term investments. Other income (expense)-net for the three and nine months ended September 30, 1999 primarily includes $7 million and $19 million, respectively, related to gains on the sales of short-term investments offset by $6 million and $17 million, respectively, related to the Company's share of the Partnership losses. Other income (expense)-net for the three and nine months ended September 30, 1998 primarily reflects $5 million and $23 million, respectively, related to the Company's share of the Partnership losses, including the Company's share of a $5 million litigation settlement and compensation expense related to key executives of an acquired company for the nine months ended September 30. 1998, offset by $7 million and $11 million, respectively, related to gains on the sales of short-term investments and $5 million for the nine months ended September 30, 1998 related to proceeds received from the settlement of an insurance claim. 17 18 INTEREST INCOME--NET Net interest income was $4 million and $12 million for the three and nine months ended September 30, 1999, respectively, compared to $1 million and $0.1 million for the three and nine months ended September 30, 1998, respectively. The increases in interest income reflect the higher average cash balances and debt free position during the three and nine months ended September 30, 1999. INCOME TAXES The Company recorded a provision for income taxes of $11 million and $56 million for the three and nine months ended September 30, 1999, respectively, and a provision for income taxes of $24 million and $10 million, respectively, for the comparable 1998 periods. Excluding any restructuring and other charges and litigation costs recorded during these periods, the effective tax rate was approximately 37% and 38% for the nine months ended September 30, 1999 and 1998, respectively. RESTRUCTURINGS In the fourth quarter of 1997, with the change in senior management, the Company undertook an effort to assess the future viability of its satellite business. As the satellite business had been in a state of decline, management of the Company made a decision to streamline the cost structure of its San Diego-based satellite business by reducing this unit's headcount by 225. In conjunction with the assessment of the satellite business, the Company also made a strategic decision with respect to its worldwide consolidated manufacturing operations that resulted in the closure of its Puerto Rico satellite TV manufacturing facility, which manufactured receivers used in the private network, commercial and consumer satellite markets for the reception of analog and digital television signals, and reduced headcount by 1,100. The Company also decided to close its corporate office and move from Chicago, Illinois to Horsham, Pennsylvania, which was completed during the first quarter of 1998. Costs associated with the closure of facilities include vacated long-term leases which are payable through the end of the lease terms which extend through the year 2008. As a result of the above actions, the Company recorded a pre-tax charge of $36 million during the fourth quarter of 1997 (see Note 7). These restructuring costs provided cost savings in certain satellite production processes; however, declining demand for certain satellite products has substantially offset the cost reductions. As part of the restructuring plan, the Company recorded an additional $16 million of pre-tax charges in the first quarter of 1998 which primarily included $8 million for severance and other employee separation costs, $3 million of facility exit costs, including the early termination of a leased facility which the Company decided to close in the quarter ended March 31, 1998, and $5 million related to the write-down of fixed assets to their estimated fair values (see Note 7). Of these charges, $9 million were recorded as cost of sales, $6 million as SG&A expense and $1 million as R&D expense. In the first quarter of 1999, in connection with the announcement of the PRIMESTAR developments, the Company evaluated its overhead structure and has taken steps to further consolidate its San Diego, California and Horsham, Pennsylvania operations, including reducing headcount by approximately 200. The Company recorded a pre-tax charge of approximately $15 million during the first quarter of 1999 which primarily included $6 million for severance costs, $6 million for the write-down of PRIMESTAR related inventory to its lower of cost or market, $2 million for the write-down of fixed assets used to manufacture PRIMESTAR products to their estimated fair values and $1 million of facility costs (see Note 7). Of these charges, $8 million were recorded as cost of sales and $7 million were recorded as SG&A expense. OTHER CHARGES The Company incurred certain other pre-tax charges during the first quarter of 1998 primarily related to management's decision to close a satellite manufacturing facility due to reduced demand for the products manufactured by that facility. Concurrent with this decision, the Company determined that the carrying value of the inventory would not be recoverable and, accordingly, the Company wrote down the inventory to its lower of cost or market. In addition, the Company incurred moving costs associated with relocating certain fixed assets to other facilities, shutdown expenses and legal fees. The above charges totaled $25 million, of which $18 million are included in cost of sales and $7 million are included in SG&A expense. In addition, the Company incurred $8 million of charges, which are included in "other expense-net," related to costs incurred by the Partnership, which the Company accounts for under the equity method. Such costs are primarily related to a $5 million litigation settlement and compensation expense related to key executives of an acquired company (see Note 8). 18 19 LIQUIDITY AND CAPITAL RESOURCES For the nine months ended September 30, 1999 and 1998, cash provided by operations was $305 million and $145 million, respectively. Cash provided by operations primarily reflects net income excluding non-cash charges and improved working capital levels in both periods. At September 30, 1999, working capital (current assets less current liabilities) was $774 million compared to $437 million at December 31, 1998. The Company believes that working capital levels are appropriate to support the growth of the business; however, there can be no assurance that future industry-specific developments or general economic trends will not alter the Company's working capital requirements. As part of its overall treasury program, the Company will, from time to time, sell certain receivable balances to financial institutions to manage credit risk and/or working capital levels. During the nine months ended September 30, 1999 and 1998, the Company invested $45 million and $59 million, respectively, in equipment and facilities. The Company expects to continue to expand its capacity to meet increased current and anticipated future demands for digital products, with capital expenditures for the year expected to approximate $65 million. The Company's R&D expenditures were $125 million and $200 million (including the $75 million funding related to the Partnership's R&D activities) during the nine months ended September 30, 1999 and 1998, respectively. The Company expects total R&D expenditures to approximate $170 million for the year ending December 31, 1999. The Company has a bank credit agreement (the "Credit Agreement") which provides a $600 million unsecured revolving credit facility and matures on December 31, 2002. The Credit Agreement permits the Company to choose between two competitive interest rate options. The Credit Agreement contains financial and operating covenants, including limitations on guarantee obligations, liens and the sale of assets, and requires the maintenance of certain financial ratios. Significant financial ratios include (i) maintenance of consolidated net worth above $600 million adjusted for 50% of cumulative positive quarterly net income subsequent to June 30, 1997; (ii) maintenance of an interest coverage ratio based on EBITDA in comparison to net interest expense of greater than 5 to 1; and (iii) maintenance of a leverage ratio comparing total indebtedness to EBITDA of less than 3 to 1. None of the restrictions contained in the Credit Agreement is expected to have a significant effect on the Company's ability to operate. Under the Credit Agreement, certain changes in the control of the Company, including the merger with Motorola, Inc., would result in an event of default, and the lenders under the Credit Agreement could declare all outstanding borrowings under the Credit Agreement immediately due and payable. If the Company is unsuccessful in getting the lenders under the Credit Agreement to waive the event of default upon the completion of the proposed merger with Motorola, Inc., the Company believes that is has sufficient potential alternatives, including cash and cash equivalents, working capital and/or credit facilities provided through Motorola, Inc., to meet its future cash requirements. As of September 30, 1999, the Company was in compliance with all financial and operating covenants contained in the Credit Agreement and had available credit of $500 million. The Company's management assesses its liquidity in terms of its overall ability to obtain cash to support its ongoing business levels and to fund its growth objectives. The Company's principal sources of liquidity both on a short-term and long-term basis are cash flows provided by operations together with other financing arrangements. The Company believes that based upon its analysis of its consolidated financial position and its expected operating cash flows from future operations, along with available funding under the Credit Agreement or other financing alternatives subsequent to the proposed merger with Motorola, Inc., cash flows will be adequate to fund operations, research and development and capital expenditures. There can be no assurance, however, that future industry-specific developments or general economic trends will not adversely affect the Company's operations or its ability to meet its cash requirements. NEW TECHNOLOGIES The Company operates in a dynamic and competitive environment, in which its success will be dependent upon numerous factors, including its ability to continue to develop appropriate technologies and successfully implement applications based on those technologies. In this regard, the Company has made significant investments to develop advanced systems and equipment for the cable and satellite television, Internet/data delivery and local telephone access markets. Additionally, the future success of the Company will be dependent on the ability of the cable and satellite television operators to successfully market the services provided by the Company's advanced digital terminals to their customers. Furthermore, as a result of the higher costs of initial production, digital products presently being shipped carry lower margins than the Company's mature analog products. Management of the Company expects cable television operators in the United States and abroad to continue to purchase analog products to upgrade their basic networks and to develop, using U.S. architecture and systems, international markets 19 20 where cable penetration is low and demand for entertainment programming is growing. However, management expects that demand in North America for its analog cable products will continue to decline. As the Company continues to introduce new products and technologies and such technologies gain market acceptance, there can be no assurance that sales of products based on new technologies will not affect the Company's product sales mix and/or will not have an adverse impact on sales of certain of the Company's other products. For example, sales of analog cable products have been impacted by a shift to digital deployment in North America. INTERNATIONAL MARKETS Management of the Company believes that additional growth for the Company will come from international markets, although the Company's international sales decreased during 1998 and have remained at these levels during 1999. There can be no assurance that international sales will increase to historical levels in the near future. EFFECT OF INFLATION The Company continually attempts to minimize any effect of inflation on earnings by controlling its operating costs and selling prices. During the past few years, the rate of inflation has been low and has not had a material impact on the Company's results of operations. READINESS FOR YEAR 2000 The Company is preparing for the impact of the arrival of the Year 2000 on its business, as well as on the businesses of its customers, suppliers and business partners. The "Year 2000 Issue" is a term used to describe the problems created by systems that are unable to accurately interpret dates after December 31, 1999. These problems are derived predominantly from the fact that many software programs have historically categorized the "year" in a two-digit format. The Year 2000 Issue creates potential risks for the Company, including potential problems in the Company's products as well as in the Information Technology ("IT") and non-IT systems that the Company uses in its business operations. The Company may also be exposed to risks from third parties with whom the Company interacts who fail to adequately address their own Year 2000 Issues. The Company's State of Readiness While the Company's Year 2000 efforts have been underway for several years, the Company centralized its focus on addressing the Year 2000 Issue in 1998 by forming a Year 2000 cross-functional project team of senior managers, chaired by the Company's Vice President of Information Technology who reports directly to the Company's Chief Executive Officer on this issue. The Audit Committee of the Board of Directors is advised periodically on the status of the Company's Year 2000 compliance program. The Year 2000 project team has developed a phased approach to identifying and remediating Year 2000 Issues, with many of these phases overlapping with one another or conducted simultaneously. The first phase was to develop a corporate-wide, uniform strategy for addressing the Year 2000 Issue and to assess the Company's current state of Year 2000 readiness. This included a review of all IT and non-IT systems, including Company products and internal operating systems for potential Year 2000 Issues. The Company completed this phase prior to the end of 1998. In addition, during this phase the Company developed its Year 2000 Policy Statement which was released to the Company's customers, suppliers and business partners. The second phase of the Company's Year 2000 compliance program (begun simultaneously with the first phase) was to define a Year 2000 "Compliance" standard and to develop uniform test plans and test methodologies, building on work already done by one of the Company's engineering groups. The Company developed a comprehensive Year 2000 test plan and test methodologies for the testing of its products, as well as third-party products. The Company has adopted the following six compliance categories for its products: "Compliant," "Compliant with Upgrade," "Compliant with Minor Issues," "Not Compliant or End of Life Product," "Testing yet to be Completed" and "Testing not Required." The creation of these six categories has assisted the Company in communicating with its customers, suppliers and business partners regarding the Year 2000 status of the Company's products. 20 21 To aid in communication with the Company's customers, suppliers and business partners, the Company developed an Internet web site that identifies the current Year 2000 status for each of the Company's products in accordance with the Company's Year 2000 compliance standard. The web site, which is updated periodically, also identifies available upgrades, as well as the contemplated completion date of testing and remediation for such products. In addition, the Company has provided detailed, customer-specific inventory information to major customers on a product-by-product basis in order to further assist such customers with their own Year 2000 compliance programs. In furtherance of providing information about its Year 2000 testing and remediation program, the Company has disclosed its test plan and methodologies to certain of its customers, strategic vendors and business partners. The Company is also participating in industry-wide joint system testing efforts and has participated in industry-wide forums with the Federal Communications Commission in order to facilitate awareness in the industry of Year 2000 Issues. The Company has also undertaken a review of its internal IT and non-IT systems to identify potential Year 2000 Issues. In 1996, the Company began the process of implementing a uniform worldwide business and accounting information system to improve internal reporting processes. The internal IT systems replaced include order entry systems, procurement and inventory management systems, and the Company's general financial systems. Based upon representations from the manufacturer and the Company's own internal testing, the Company believes that this uniform information system is Year 2000 compliant. The Company also has identified, replaced and/or upgraded legacy business systems that were not Year 2000 compliant and were not part of the uniform worldwide business and accounting information system. In conjunction with the Company's review of internal IT systems, the Company engaged an outside consulting firm with Year 2000 consulting experience to perform an assessment of the Company's processes and test methodologies and to benchmark such plans and methodologies against the practices of other companies. Based on these benchmark comparisons, certain recommendations were made related to the test plans. The Company is currently addressing these recommendations. With respect to non-IT systems, the Company is actively analyzing its in-line manufacturing equipment in order to assess and remediate any Year 2000 issues. To date, no material problems have been discovered, and the Company will continue to review, test and remediate (if necessary) such equipment. The Company has also evaluated its other critical non-IT facility and internal systems with date sensitive operating controls for Year 2000 Issues. While the Company believes that most of these systems will function without substantial Year 2000 compliance problems, the Company will continue to review, test and remediate (if necessary) such systems. The third phase of the Company's Year 2000 compliance program is the actual testing and remediation (if necessary) of the Company's IT products and systems. The Company has prioritized its testing and remediation work, focusing on products which the Company believes are more likely to be impacted by Year 2000 Issues. The Company has completed the testing and remediation (as necessary) of substantially all of its products in accordance with its adopted test plans and methodologies (except for end of life products). As of September 30, 1999, the Company estimates that it has completed approximately 98% of the Year 2000 readiness analysis required for its Advanced Network Systems, Digital Network Systems and Transmission Network Systems products. As of September 30, 1999, the Company estimates that it has completed approximately 95% of the Year 2000 readiness analysis for its Satellite and Broadcast Network Systems products. For certain of the Company's remaining products, testing and remediation (if necessary) is currently anticipated to be completed during the fourth quarter of 1999. The Company has completed testing and remediation of substantially all of its IT and non IT internal systems. The Company is presently evaluating each of its principal suppliers, service providers and other business partners to determine each of such party's Year 2000 status. The Company has developed a questionnaire and a Year 2000 certification for use with such third parties, and, as of September 30, 1999, the Company had contacted approximately 300 vendors about their Year 2000 compliance, including many of the vendors that the Company has identified as critical vendors. The Company is currently focused on obtaining Year 2000 Certifications or assurances from approximately 50 of these suppliers. The Company is currently developing appropriate contingency plans regarding these critical vendors, where formal Year 2000 certification has not been attained. The Company anticipates that this evaluation, along with the development and implementation of vendor contingency plans, will be on-going through the remainder of 1999. To date, no significant problems have been discovered. The Company is working jointly with customers, strategic vendors and business partners to identify and resolve any Year 2000 issues that may impact the Company. However, there can be no assurance that the companies with which the Company does business will achieve a Year 2000 conversion in a timely fashion, or that such failure to convert by another company will not have a material adverse effect on the Company. 21 22 The Costs to Address the Company's Year 2000 Issues The total cost associated with the Company's Year 2000 remediation is not expected to be material to the Company's financial condition or results of operations. The estimated total cost of the Company's Year 2000 remediation is not expected to exceed $5 million. Through September 30, 1999, the Company has spent approximately $3 million in connection with Year 2000 Issues. The cost of implementing the uniform worldwide business and accounting information system has not been included in this figure since the replacement of the previous systems was not accelerated due to Year 2000 Issues. All Year 2000 expenditures are made from the respective departments' budgets. The percentage of the IT budget during 1998 used for Year 2000 remediation was less than 3% and is expected to represent less than 3% of the IT budget for 1999. No IT projects have been deferred due to Year 2000 efforts. The Risks of the Company's Year 2000 Issues There can be no assurance that the Company will be completely successful in its efforts to address Year 2000 Issues. If some of the Company's products are not Year 2000 compliant, the Company could suffer lost sales or other negative consequences, including, but not limited to, diversion of resources, damage to the Company's reputation, increased service and warranty costs and litigation, any of which could materially adversely affect the Company's business operations or financial statements. The Company is also dependent on third parties such as its customers, suppliers, service providers and other business partners. If these or other third parties fail to adequately address Year 2000 Issues, the Company could experience a negative impact on its business operations or financial statements. For example, the failure of certain of the Company's principal suppliers to have Year 2000 compliant internal systems could impact the Company's ability to manufacture and/or ship its products or to maintain adequate inventory levels for production. The Company's Contingency Plans The Company is evaluating the need for certain contingency plans to address situations that may result if the Company or any of the third parties upon which the Company is dependent is unable to achieve Year 2000 readiness. For example, the Company has developed plans and procedures for its customer service division to assist customers with the transition through the Year 2000. Part of this plan includes processes and procedures recently used by the Company in connection with a program to upgrade a substantial number of analog addressable controllers to solve a date rollover issue prior to the year 1999. The Company is also evaluating the need for increasing inventory levels of key components of its manufactured products. Since the Company's Year 2000 compliance program is ongoing, its ultimate scope, as well as the consideration of additional contingency plans, will continue to be evaluated as new information becomes available. Year 2000 Forward-Looking Statements The foregoing Year 2000 discussion contains "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements, including without limitation, anticipated costs and the dates by which the Company expects to complete certain actions, are based on management's best current estimates, which were derived utilizing numerous assumptions about future events, including the continued availability of certain resources, representations received from third parties and other factors. However, there can be no guarantee that these estimates will be achieved, and actual results could differ materially from those anticipated. Specific factors that might cause such material differences include, but are not limited to, the ability to identify and remediate all relevant IT and non-IT systems, results of Year 2000 testing, adequate resolution of Year 2000 Issues by businesses and other third parties who are service providers, suppliers or customers of the Company, unanticipated system costs, the adequacy of and ability to develop and implement contingency plans and similar uncertainties. The "forward-looking statements" made in the foregoing Year 2000 discussion speak only as of the date on which such statements are made, and the Company undertakes no obligation to update any forward-looking statement to reflect events or circumstances after the date on which such statement is made or to reflect the occurrence of unanticipated events. FORWARD-LOOKING INFORMATION The Private Securities Litigation Reform Act of 1995 provides a "safe harbor" for forward-looking statements. This Management's Discussion and Analysis of Financial Condition and Results of Operations and other sections of this Form 10-Q may include forward-looking statements concerning, among other things, the Company's prospects, developments and business strategies. These forward-looking statements are identified by their use of such terms and phrases as "intends," 22 23 "intend," "intended," "goal," "estimate," "estimates," "expects," "expect," "expected," "project," "projects," "projected," "projections," "plans," "anticipates," "anticipated," "should," "designed to," "foreseeable future," "believe," "believes," "subject to" and "scheduled." These forward-looking statements are subject to certain uncertainties and other factors that could cause actual results to differ materially from such statements. These risks include, but are not limited to, factors relating to the proposed merger with Motorola, Inc., uncertainties relating to general political and economic conditions, uncertainties relating to government and regulatory policies, uncertainties relating to customer plans and commitments, the Company's dependence on the cable television industry and cable television capital spending, Year 2000 readiness, the pricing and availability of equipment, materials and inventories, technological developments, the competitive environment in which the Company operates, changes in the financial markets relating to the Company's capital structure and cost of capital, the uncertainties inherent in international operations and foreign currency fluctuations and authoritative generally accepted accounting principles or policy changes from such standard-setting bodies as the Financial Accounting Standards Board and the Securities and Exchange Commission. Reference is made to Exhibit 99 in this Form 10-Q for a further discussion of such factors. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date the statement was made. The Company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. 23 24 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK A significant portion of the Company's products are manufactured or assembled in Taiwan and Mexico. These foreign operations are subject to market risk changes with respect to currency exchange rate fluctuations, which could impact the Company's consolidated financial statements. The Company monitors its underlying exchange rate exposures on an ongoing basis and continues to implement selective hedging strategies to reduce the market risks from changes in exchange rates. On a selective basis, the Company enters into contracts to limit the currency exposure of monetary assets and liabilities, contractual and other firm commitments denominated in foreign currencies and the currency exposure of anticipated, but not yet committed, transactions expected to be denominated in foreign currencies. The use of these derivative financial instruments allows the Company to reduce its overall exposure to exchange rate movements since the gains and losses on these contracts substantially offset losses and gains on the assets, liabilities and transactions being hedged. Foreign currency exchange contracts are sensitive to changes in exchange rates. As of September 30, 1999, a hypothetical 10% fluctuation in the exchange rate of foreign currencies applicable to the Company, principally the new Taiwan dollar, would result in a net $3 million gain or loss on the contracts the Company has outstanding, which would offset the related net loss or gain on the assets, liabilities and transactions being hedged. 24 25 PART II OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS A securities class action is presently pending in the United States District Court for the Northern District of Illinois, Eastern Division, In Re General Instrument Corporation Securities Litigation. This action, which consolidates numerous class action complaints filed in various courts between October 10 and October 27, 1995, is brought by plaintiffs, on their own behalf and as representatives of a class of purchasers of the Distributing Company's common stock during the period March 21, 1995 through October 18, 1995. The complaint alleges that the Distributing Company and certain of its officers and directors, as well as Forstmann Little & Co. and certain related entities, violated the federal securities laws, namely, Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), prior to the Distribution, by allegedly making false and misleading statements and failing to disclose material facts about the Distributing Company's planned shipments in 1995 of its CFT2200 and Digicipher(R) products. Also pending in the same court, under the same name, is a derivative action brought on behalf of the Distributing Company. The derivative action alleges that, prior to the Distribution, the members of the Distributing Company's Board of Directors, several of its officers and Forstmann Little & Co. and related entities have breached their fiduciary duties by reason of the matter complained of in the class action and certain defendants' alleged use of material non-public information to sell shares of the Distributing Company's stock for personal gain. Both actions seek unspecified damages and attorneys' fees and costs. The court granted the defendants' motion to dismiss the original complaints in both of these actions, but allowed the plaintiffs in each action an opportunity to file amended complaints. Amended complaints were filed on November 7, 1997. The defendants answered the amended consolidated complaint in the class actions, denying liability, and filed a renewed motion to dismiss the derivative action. On September 22, 1998, defendants' motion to dismiss the derivative action was denied. In November 1998, the defendants filed an answer to the derivative action, denying liability. On January 21, 1999, the plaintiffs in the class actions filed their motion for class certification, including the defendants' opposition. No ruling has been made on the class certification issue. The Company intends to vigorously contest these actions. An action entitled BKP Partners, L.P. v. General Instrument Corp. was brought in February 1996 by certain holders of preferred stock of Next Level Communications ("NLC"), which merged into a subsidiary of the Distributing Company in September 1995. The action was originally filed in the Northern District of California and was subsequently transferred to the Northern District of Illinois. The plaintiffs allege that the defendants violated federal securities laws by making misrepresentations and omissions and breached fiduciary duties to NLC in connection with the acquisition of NLC by the Distributing Company. Plaintiffs seek, among other things, unspecified compensatory and punitive damages and attorneys' fees and costs. On September 23, 1997, the district court dismissed the complaint, without prejudice, and the plaintiffs were given until November 7, 1997 to amend their complaint. On November 7, 1997, plaintiffs served the defendants with an amended complaint, which contains allegations substantially similar to those in the original complaint. The defendants filed a motion to dismiss parts of the amended complaint and answered the balance of the amended complaint, denying liability. On September 22, 1998, the district court dismissed with prejudice the portion of the complaint alleging violations of Section 14(a) of the Exchange Act, and denied the remainder of the defendants' motion to dismiss. In November, 1998, the defendants filed an answer to the remaining parts of the amended complaint, denying liability. The Company intends to vigorously contest this action. In connection with the Distribution, the Company has agreed to indemnify General Semiconductor with respect to its obligations, if any, arising out of or in connection with the matters discussed in the preceding two paragraphs. On February 19, 1998, a consolidated securities class action complaint entitled In Re Nextlevel Systems, Inc. Securities Litigation was filed in the United States District Court for the Northern District of Illinois, Eastern Division, naming the Company and certain former officers and directors as defendants. The complaint was filed on behalf of stockholders who purchased or otherwise acquired stock of the Company between July 25, 1997 and October 15, 1997. The complaint alleged that the defendants violated Sections 11 and 15 of the Securities Act of 1933, as amended (the "Securities Act"), and Sections 10(b) and 20(a) of the Exchange Act and Rule 10b-5 thereunder by making false and misleading statements about the Company's business, finances and future prospects. The complaint seeks damages in an unspecified amount. On April 9, 1998, the plaintiffs voluntarily dismissed their Securities Act claims. On May 5, 1998, the defendants moved to dismiss the remaining counts of the complaint. That motion was denied on March 31, 1999 and defendants' answer was filed on June 25, 1999. On July 30, 1999, defendants filed a motion seeking reconsideration of the denial of their motion to dismiss. The Company intends to vigorously contest this action. 25 26 On March 5, 1998, an action entitled DSC Communications Corporation and DSC Technologies Corporation v. Next Level Communications L.P., KK Manager, L.L.C., General Instrument Corporation and Spencer Trask & Co., Inc. was filed in the Superior Court of the State of Delaware in and for New Castle County (the "Delaware Action"). In that action, DSC Communications Corporation and DSC Technologies Corporation (collectively, "DSC") alleged that in connection with the formation of the Partnership and the transfer to it of NLC's switched digital video technology, the Partnership and KK Manager, L.L.C. misappropriated DSC's trade secrets; that the Company improperly disclosed trade secrets when it conveyed such technology to the Partnership; and that Spencer Trask & Co., Inc. conspired to misappropriate DSC's trade secrets. The plaintiffs sought actual damages for the defendants' purported unjust enrichment, disgorgement of consideration, exemplary damages and attorney's fees, all in unspecified amounts. In April 1998, the Company and the other defendants filed an action in the United States District Court for the Eastern District of Texas, requesting that the federal court preliminarily and permanently enjoin DSC from prosecuting the Delaware Action because by pursuing such action, DSC effectively was trying to circumvent and relitigate the Texas federal court's November 1997 judgment in a previous lawsuit involving DSC, pursuant to which NLC had paid over $140 million. On May 14, 1998, the Texas court granted a preliminary injunction preventing DSC from proceeding with the Delaware Action. That injunction order was appealed to the United States Court of Appeals for the Fifth Circuit. On June 21, 1999, the Fifth Circuit affirmed the Texas federal court's grant of the preliminary injunction. On July 15, 1999, the Texas federal court granted the Delaware defendants' motion for summary judgment and issued its final judgment permanently enjoining DSC from prosecuting and continuing the Delaware Action. In May 1997, StarSight Telecast, Inc. ("StarSight") filed a Demand for Arbitration against the Company alleging that the Company breached the terms of a license agreement with StarSight by (a) developing a competing product that wrongfully incorporates StarSight's technology and inventions claimed within a certain StarSight patent, (b) failing to promote and market the StarSight product as required by the license agreement, and (c) wrongfully using StarSight's technical information, confidential information and StarSight's graphical user interface in breach of the license agreement. StarSight sought injunctive relief as well as damages. The first part of a bifurcated arbitration proceeding, relating to the Company's advanced analog products, began on March 22, 1999 before an arbitration panel of the American Arbitration Association in San Francisco, California. Oral arguments to the panel by the Company and StarSight were concluded on May 23, 1999. On October 4, 1999, the arbitration panel released an interim decision with respect to advanced analog products only. The arbitration panel found that the Company had breached the license agreement and had misappropriated certain StarSight trade secrets relating to electronic program guides. The arbitration panel rejected StarSight's interpretation of its patents and also found that the Company did not commercialize products that incorporate those patents. The panel further denied StarSight's request for an injunction. The arbitration panel found that StarSight is entitled to compensatory and punitive damages. The amount of such damages will be finally determined by the arbitrators based on damage calculations submitted by the parties. The Company estimates that compensatory damages will be in the range of $25 to $36 million. An additional 50% of such amount will be added as punitive damages, plus attorneys fees and costs. General Instrument has not determined whether it will oppose confirmation of the damage award. A separate phase of the arbitration relating to the use of electronic program guides on digital cable set-top terminals and satellite receivers is not anticipated to be scheduled until the second quarter of 2000. Unlike its advanced analog products, the Company does not sell a Company electronic program guide with its digital cable set-top terminals. The Company denies StarSight's allegations in the second phase and will continue to vigorously contest this action. On November 30, 1998, an action entitled Gemstar Development Corporation and Index Systems, Inc. v. General Instrument Corporation was filed in the United States District Court for the Northern District of California. The complaint alleges infringement by the Company of two U.S. patents allegedly covering electronic program guides. The complaint seeks unspecified damages and an injunction. After filing this action, the plaintiffs sought to consolidate discovery for this action with other program guide related patent infringement actions pending against Pioneer Electronics Corp., Scientific-Atlanta, Inc., and Prevue Networks, Inc. On April 26, 1999, the Judicial Panel on Multidistrict Litigation ordered the transfer of this action to the Northern District of Georgia for consolidated pretrial proceedings with the Pioneer Electronics Corp. and Scientific-Atlanta, Inc. actions. Scheduling and other preliminary discovery matters are currently awaiting an order from the Court. The Company denies that it infringes the subject patents and intends to vigorously defend this action. 26 27 ITEM 5. OTHER INFORMATION On November 9, 1999, Next Level Communications, Inc. priced its initial public offering of 8,500,000 shares of common stock. Next Level Communications, Inc. is the corporate successor to Next Level Communications L.P., of which a General Instrument subsidiary was the limited partner. In connection with this offering, Next Level Communications L.P. and the limited partner were merged into Next Level Communications, Inc. and General Instrument received 64,103,724 shares of common stock of Next Level Communications, Inc. This represents approximately 80% of the shares outstanding immediately after the offering (approximately 64% on a fully diluted basis) after giving effect to the exercise of the underwriters' over-allotment option. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits Exhibit 27 Financial Data Schedule Exhibit 99 Forward-Looking Information (b) Reports on Form 8-K The Company filed a Current Report on Form 8-K dated August 27, 1999, reporting in Item 5 of such report that Next Level Communications, Inc. filed a registration statement with the Securities and Exchange Commission for a proposed initial public offering of the common stock of Next Level Communications, Inc. The Company filed a Current Report on Form 8-K dated September 17, 1999, reporting in Item 5 of such report that on September 14, 1999, the Company entered into a definitive Agreement and Plan of Merger with Motorola, Inc. and its wholly-owned subsidiary, Lucerne Acquisition Corp. The Company filed a Current Report on Form 8-K dated September 23, 1999, disclosing in Item 5 of such report certain Slide Presentation Materials used by the Company's management in several investor conferences that were held on September 15, 1999 and September 16, 1999 following the announcement of the signing of an Agreement and Plan of Merger with Motorola, Inc. and its wholly-owned subsidiary, Lucerne Acquisition Corp. The Company filed a Current Report on Form 8-K dated October 7, 1999, reporting in Item 5 of such report that an American Arbitration Association panel released an interim decision in the breach of contract dispute between the Company and StarSight Telecast, Inc., a unit of Gemstar International Group, Ltd. 27 28 SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. GENERAL INSTRUMENT CORPORATION /s/ Marc E. Rothman ----------- ------------------- Marc E. Rothman Vice President, Financial Planning & Controller (Signing both in his capacity as Vice President on behalf of the Registrant and as chief accounting officer of the Registrant) November 12, 1999 - ------------------------- Date 28 29 INDEX TO EXHIBITS EXHIBIT DESCRIPTION - ------- ----------- Exhibit 27 Financial Data Schedule Exhibit 99 Forward-Looking Information 29 EX-27 2 FINANCIAL DATA SCHEDULE WARNING: THE EDGAR SYSTEM ENCOUNTERED ERROR(S) WHILE PROCESSING THIS SCHEDULE.
5 THE SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE FINANCIAL STATEMENTS OF GENERAL INSTRUMENT CORPORATION AS OF AND FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1999 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS 1,000 9-MOS JAN-01-99 SEP-30-99 447,963 183,761 349,015 (6,948) 229,970 1,257,357 544,388 (312,751) 2,546,594 483,464 0 0 0 1,809 1,962,257 2,546,594 1,590,354 1,590,354 1,135,895 1,135,895 0 0 12,108 155,622 (56,325) 99,297 0 0 0 99,297 0.57 0.52
EX-99 3 FORWARD LOOKING INFORMATION 1 EXHIBIT 99 GENERAL INSTRUMENT CORPORATION EXHIBIT 99 -- FORWARD-LOOKING INFORMATION The Private Securities Litigation Reform Act of 1995 provides a "safe harbor" for forward-looking statements. The Company's Form 10-K, the Company's Annual Report to Stockholders, any Form 10-Q or Form 8-K of the Company, or any other oral or written statements made by or on behalf of the Company, may include forward-looking statements which reflect the Company's current views with respect to future events and financial performance. These forward-looking statements are identified by their use of such terms and phrases as "intends," "intend," "intended," "goal," "estimate," "estimates," "expects," "expect," "expected," "project," "projects," "projected," "projections," "plans," "anticipates," "anticipated," "should," "designed to," "foreseeable future," "believe," "believes," and "scheduled" and similar expressions. These forward-looking statements are subject to certain uncertainties and other factors that could cause actual results to differ materially from such statements. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date the statement was made. The Company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. The actual results of the Company may differ significantly from the results discussed in forward-looking statements. Factors that might cause such a difference include, but are not limited to, factors relating to the proposed merger with Motorola, Inc., uncertainties relating to general political, economic and competitive conditions in the United States and other markets where the Company operates; uncertainties relating to government and regulatory policies; uncertainties relating to customer plans and commitments; the Company's dependence on the cable television industry and cable television capital spending; Year 2000 readiness; the pricing and availability of equipment, materials and inventories; technological developments; the competitive environment in which the Company operates; changes in the financial markets relating to the Company's capital structure and cost of capital; the uncertainties inherent in international operations and foreign currency fluctuations; authoritative generally accepted accounting principles or policy changes from such standard-setting bodies as the Financial Accounting Standards Board and the Securities Exchange Commission; and the factors as set forth below. FACTORS RELATING TO THE MERGER WITH MOTOROLA The Company has entered into a merger agreement with Motorola, Inc. whereby shares of the Company's common stock will be converted into shares of Motorola common stock. However, no assurances can be given as to whether or when the merger will be completed. The merger will combine two companies that have previously operated independently. The Company expects to realize strategic and other benefits as a result of the merger, including, among other things, the integration of key technologies necessary to bring converged voice, video and data networking to consumers and the accelerated roll-out of advanced services over hybrid fiber coax networks. However, the Company cannot predict with certainty whether, or to what extent, it will realize these benefits. The following are factors that may prevent the Company from realizing these benefits: - a substantial demand for interactive broadband access solutions utilizing hybrid fiber coax networks may not continue to develop as much or as rapidly as expected; - alterations may be necessary in sales and marketing campaigns in order to gain marketplace acceptance of the strategy of providing converged interactive voice, video, data and Internet access solutions over cable networks, including in particular the Company's product solutions in this environment; - development and deployment of next-generation network equipment may require more technical support than Motorola and the Company currently have employed or contracted; 2 - changes in technology may increase the number of competitors that Motorola faces after the merger or may require significant capital expenditures to provide competitive services; - other manufacturers that compete with Motorola that currently market networks compatible with General Instrument products may not continue to do so; and - an increase in the number of competitors serving these markets may make it more difficult to attract and retain necessary personnel or to obtain and retain customers; Any of these factors could cause actual results to differ materially from the Company's expectations. The Company also expects to realize certain cost savings and other financial and operating benefits as a result of the merger. However, the Company cannot predict with certainty whether these cost savings and benefits will occur, or the extent to which they actually will be achieved. There are a large number of systems that may be integrated, including management information, purchasing, accounting and finance, sales, billing, payroll and benefits and regulatory compliance. The integration of General Instrument and the multimedia group business of Motorola's Internet and Networking Group will also require significant attention from management. The diversion of management attention and any difficulties associated with integrating General Instrument into Motorola could have a material adverse effect on the revenues, the levels of expenses and the operating results of Motorola after the merger and the value of Motorola shares. The number of Motorola shares to be received in the merger for each General Instrument share is fixed. Therefore, because the market price of Motorola shares is subject to fluctuation, the value at the time of the merger of the Motorola shares to be received by General Instrument stockholders will depend on the market price of Motorola shares at that time. There can be no assurance as to the value of Motorola shares at that time. The market price of Motorola shares has been, and may continue to be, volatile. In addition to conditions that affect the market for stocks of high technology companies generally, factors such as new product announcements by Motorola or its competitors, quarterly fluctuations in Motorola's operating results and challenges associated with integration of businesses may have a significant impact on the market price of Motorola shares. These conditions could cause the price of Motorola shares to fluctuate substantially over short periods. FACTORS RELATING TO THE DISTRIBUTION In a transaction that was consummated on July 28, 1997, the former General Instrument Corporation (the "Distributing Company") (i) transferred all the assets and liabilities relating to the manufacture and sale of broadband communications products used in the cable television, satellite, and telecommunications industries to the Company (which was then named "NextLevel Systems, Inc." and was a wholly-owned subsidiary of the Distributing Company) and transferred all the assets and liabilities relating to the manufacture and sale of coaxial, fiber optic and other electric cable used in the cable television, satellite and other industries to its wholly-owned subsidiary CommScope, Inc. ("CommScope") and (ii) then distributed all of the outstanding shares of capital stock of each of the Company and CommScope to its stockholders on a pro rata basis as a dividend (the "Distribution"). Immediately following the Distribution, the Distributing Company changed its corporate name to "General Semiconductor, Inc." ("General Semiconductor"). Effective February 2, 1998, the Company changed its corporate name from "NextLevel Systems, Inc." to "General Instrument Corporation." The Distribution Agreement, dated as of June 12, 1997, among the Company, CommScope and the Distributing Company (the "Distribution Agreement") and certain other agreements executed in connection with the Distribution (collectively, the "Ancillary Agreements") allocate among the Company, CommScope, and General Semiconductor and their respective subsidiaries responsibility for various indebtedness, liabilities and obligations. It is possible that a court would disregard this contractual 3 allocation of indebtedness, liabilities and obligations among the parties and require the Company or its subsidiaries to assume responsibility for obligations allocated to another party, particularly if such other party were to refuse or was unable to pay or perform any of its allocated obligations. Pursuant to the Distribution Agreement and certain of the Ancillary Agreements, the Company has agreed to indemnify the other parties (and certain related persons) from and after consummation of the Distribution with respect to certain indebtedness, liabilities and obligations, which indemnification obligations could be significant. Although the Distributing Company has received a favorable ruling from the Internal Revenue Service, if the Distribution were not to qualify as a tax free spin-off (either because of the nature of the Distribution or because of events occurring after the Distribution) under Section 355 of the Internal Revenue Code of 1986, as amended, then, in general, a corporate tax would be payable by the consolidated group of which the Distributing Company was the common parent based upon the difference between the fair market value of the stock distributed and the Distributing Company's adjusted basis in such stock. The corporate level tax would be payable by General Semiconductor and could substantially exceed the net worth of General Semiconductor. However, under certain circumstances, the Company and CommScope have agreed to indemnify General Semiconductor for such tax liability. In addition, under the consolidated return rules, each member of the consolidated group (including the Company and CommScope) is severally liable for such tax liability. DEPENDENCE OF THE COMPANY ON THE CABLE TELEVISION INDUSTRY AND CABLE TELEVISION CAPITAL SPENDING The majority of the Company's revenues come from sales of systems and equipment to the cable television industry. Demand for these products depends primarily on capital spending by cable television system operators for constructing, rebuilding or upgrading their systems. The amount of this capital spending, and, therefore the Company's sales and profitability, may be affected by a variety of factors, including general economic conditions, the continuing trend of cable system consolidation within the industry, the financial condition of domestic cable television system operators and their access to financing, competition from direct-to-home ("DTH"), satellite, wireless television providers and telephone companies offering video programming, technological developments that impact the deployment of equipment and new legislation and regulations affecting the equipment used by cable television system operators and their customers. There can be no assurance that cable television capital spending will increase from historical levels or that existing levels of cable television capital spending will be maintained. Although the domestic cable television industry is comprised of thousands of cable systems, a small number of large cable television multiple systems operators ("MSOs") own a majority of cable television systems. As a result, a relatively small number of customers has historically accounted for a large portion of the Company's revenues, and this trend is expected to continue. Sales to the Company's single largest customer represented 30% and 31% Company sales for the nine months ended September 30, 1999 and the year ended December 31, 1998, respectively. For the same periods, the Company's top five MSO customers accounted for 52% and 54%, respectively, of the Company's total sales. Because a small number of MSOs account for a majority of the Company's revenues, the Company's future success will depend on its ability to develop and maintain relationships with these companies. The loss of business from a significant MSO could have a material adverse effect on the business of the Company. Because significant consolidation is occurring among cable television operators, the risk to the Company from the concentration of its customer base is increasing. THE IMPACT OF REGULATION AND GOVERNMENT ACTION In recent years, cable television capital spending has been affected by new legislation and regulation, on the federal, state and local level, and many aspects of such regulation are currently the subject of judicial proceedings and administrative or legislative proposals. During 1993 and 1994, the Federal Communications Commission (the "FCC") adopted rules under the Cable Television Consumer Protection and Competition Act of 1992 (the "1992 Cable Act"), regulating rates that cable television operators may 4 charge for lower tiers of service and generally not regulating the rates for higher tiers of service. In 1996, the Telecommunications Act of 1996 (the "Telecom Act") was enacted to eliminate certain governmental barriers to competition among local and long distance telephone, cable television, broadcasting and wireless services. The FCC is continuing its implementation of the Telecom Act which, when fully implemented, may significantly impact the communications industry and alter federal, state and local laws and regulations regarding the provision of cable and telephony services. Among other things, the Telecom Act eliminates substantially all restrictions on the entry of telephone companies and certain public utilities into the cable television business. Telephone companies may now enter the cable television business as traditional cable operators, as common carrier conduits for programming supplied by others, as operators of wireless distribution systems, or as hybrid common carrier/cable operator providers of programming on so-called "open video systems." The economic impact of the 1992 Cable Act, the Telecom Act and the rules thereunder on the cable television industry and the Company is still uncertain. On June 24, 1998, the FCC released a Report and Order entitled In the Matter of Implementation of Section 304 of the Telecommunications Act of 1996 - Commercial Availability of Navigation Devices (the "Retail Sales Order"), which promulgates rules providing for the commercial availability of navigation devices, including set-top devices and other consumer equipment, used to receive video signals and other services from multichannel video programming distributors ("MVPDs"), including cable television system operators. The Retail Sales Order mandates that (i) subscribers have a right to attach any compatible navigation device to an MVPD system regardless of its source and (ii) service providers are prohibited from taking actions which would prevent navigation devices that do not perform conditional access functions from being made available by retailers, manufacturers, or other affiliated vendors. To accomplish subscribers' right to attach, the FCC has ordered that (i) MVPDs must provide technical information concerning interface parameters necessary to permit navigation devices to operate with their systems; (ii) MVPDs must separate out security functions from non-security functions by July 1, 2000; and (iii) after January 1, 2005, MVPDs may not provide new navigation devices for sale, lease or use that perform both conditional access functions and other functions in a single integrated device. Unless modified or overturned, the Retail Sales Order will require set-top device manufacturers, such as the Company, to develop a separate security module to be available for sale to other manufacturers who want to build set-top devices, as well as ultimately prevent the Company from offering set-top devices in which the security and non-security functions are integrated. In addition, the Retail Sales Order may require the Company to offer its set-top devices through retail distribution channels, an area in which the Company has limited experience. The competitive impact of the Retail Sales Order is still uncertain, and there can be no assurance that the Company will be able to compete successfully with other consumer electronics manufacturers interested in manufacturing set-top devices, many of which have greater resources and retail sales experience than the Company. There can be no assurance that future legislation, regulations or government action will not have a material adverse effect on the operations and financial condition of the Company. TELECOMMUNICATIONS INDUSTRY COMPETITION AND TECHNOLOGICAL CHANGES AFFECTING THE COMPANY The Company will be significantly affected by the competition among cable television system operators, satellite television providers and telephone companies to provide video, voice and data/Internet services. In particular, although cable television operators have historically provided television services to the majority of U.S. households, DTH satellite television has attracted a growing number of subscribers and the regional telephone companies have begun to offer competing cable and wireless cable services. This competitive environment is characterized by rapid technological changes, particularly with respect to developments in digital compression and broadband access technology. The Company believes that, as a result of its development of new products based on emerging technologies and the diversity of its product offerings, it is well positioned to supply each of the cable, satellite and telephone markets. The future success of the Company, however, will be dependent on its ability to market and deploy these new products successfully and to continue to develop and timely exploit 5 new technologies and market opportunities both in the United States and internationally. There can be no assurance that the Company will be able to continue to successfully introduce new products and technologies, that it will be able to deploy them successfully on a large-scale basis or that its technologies and products will achieve significant market acceptance. The future success of the Company will also be dependent on the ability of cable and satellite television operators to successfully market the services provided by the Company's advanced digital terminals to their customers. Further, there can be no assurance that the development of products using new technologies or the increased deployment of new products will not have an adverse impact on sales by the Company of certain of its other products. For example, sales of analog cable products have been impacted by a shift to digital deployment in North America. INTELLECTUAL PROPERTY Because the Company's products are based on complex, rapidly-developing technologies, the Company has been, and could in the future be, made a party to litigation regarding intellectual property matters. The Company has from time to time been notified of allegations that it may be infringing certain patents and other intellectual property rights of others. The adverse resolution of any third party infringement claim could subject the Company to substantial liabilities and could require the Company to refrain from manufacturing or selling certain products. In addition, the costs incurred in intellectual property litigation can be substantial, regardless of the outcome. It may be necessary or desirable in the future to obtain licenses relating to one or more products or relating to current or future technologies, and there can be no assurance that the Company will be able to obtain these licenses or other rights or obtain such licenses or rights on commercially reasonable terms. COMPETITION The Company's products compete with those of a substantial number of foreign and domestic companies, some with greater resources, financial or otherwise, than the Company, and the rapid technological changes occurring in the Company's markets are expected to lead to the entry of new competitors. The Company's ability to anticipate technological changes and to introduce enhanced products on a timely basis will be a significant factor in the Company's ability to expand and remain competitive. Existing competitors' actions and new entrants may have an adverse impact on the Company's sales and profitability. For a discussion of competitive factors in regards to retail consumer electronic manufacturers see "The Impact of Regulation and Government Action". The Company believes that it enjoys a strong competitive position because of its large installed cable television equipment base, its strong relationships with the major cable television system operators, its technological leadership and new product development capabilities, and the likely need for compatibility of new technologies with currently installed systems. However, the focus by several industry groups and the Federal government on uniform standards for interoperability of devices will likely increase competition for the Company's products by enabling competitors to develop systems compatible with, or that are alternatives to, the Company's products. INTERNATIONAL OPERATIONS; FOREIGN CURRENCY RISKS U.S. broadband system designs and equipment are being employed in international markets, where cable television penetration is low. In addition, the Company is developing new products to address international market opportunities. However, the impact of the economic crises in Asia and Latin America has significantly affected the Company's results in these markets. There can be no assurance that international markets will rebound to historical levels or that such markets will continue to develop or that the Company will receive additional contracts to supply systems and equipment in international markets. International exports of certain of the Company's products require export licenses issued by the U.S. Department of Commerce prior to shipment in accordance with export control regulations. The Company has made a voluntary disclosure to the U.S Department of Commerce with respect to several violations by the Company of these export control regulations. While the Company does not expect these violations to have a material adverse effect on the Company's operations or financial condition, there can be no assurance that these violations will not result in the imposition of sanctions or restrictions on the Company. 6 A significant portion of the Company's products are manufactured or assembled in Taiwan and Mexico. In addition, the Company's operations are expanding into new international markets. These foreign operations are subject to the usual risks inherent in situating operations abroad, including risks with respect to currency exchange rates, economic and political destabilization, restrictive actions by foreign governments, nationalizations, the laws and policies of the United States affecting trade, foreign investment and loans, and foreign tax laws. The Company's cost-competitive status relative to other competitors could be adversely affected if the New Taiwan dollar, Mexican peso or another relevant currency appreciates relative to the U.S. dollar because this appreciation will make the Company's products manufactured and assembled in Taiwan or Mexico more expensive when priced in U.S. Dollars. YEAR 2000 READINESS The Company is preparing for the impact of the arrival of the Year 2000 on its business, as well as on the businesses of its customers, suppliers and business partners. The "Year 2000 Issue" is a term used to describe the problems created by systems that are unable to accurately interpret dates after December 31, 1999. These problems are derived predominantly from the fact that many software programs have historically categorized the "year" in a two-digit format. The Year 2000 Issue creates potential risks for the Company, including potential problems in the Company's products as well as in the Information Technology ("IT") and non-IT systems that the Company uses in its business operations. The Company may also be exposed to risks from third parties with whom the Company interacts who fail to adequately address their own Year 2000 issues. There can be no assurance that the Company will be successful in its efforts to address all of its Year 2000 issues. If some of the Company's products are not Year 2000 compliant, the Company could suffer lost sales or other negative consequences, including, but not limited to, diversion of resources, damage to the Company's reputation, increased service and warranty costs and litigation, any of which could materially adversely affect the Company's business operations or financial condition. The Company is also dependent on third parties such as its customers, suppliers, service providers and other business partners. If these or other third parties fail to adequately address Year 2000 Issues, the Company could experience a negative impact on its business operations or financial condition. For example, the failure of certain of the Company's principal suppliers to have Year 2000 compliant internal systems could impact the Company's ability to manufacture and/or ship its products or to maintain adequate inventory levels for production. The Company's Year 2000 statements, including without limitation, anticipated costs and the dates by which the Company expects to complete certain actions, are based on management's best current estimates, which were derived utilizing numerous assumptions about future events, including the continued availability of certain resources, representations received from third parties and other factors. However, there can be no guarantee that these estimates will be achieved, and actual results could differ materially from those anticipated. Specific factors that might cause such material differences include, but are not limited to, the ability to identify and remediate all relevant IT and non-IT systems, results of Year 2000 testing, adequate resolution of Year 2000 Issues by businesses and other third parties who are service providers, suppliers or customers of the Company, unanticipated system costs, the adequacy of and ability to develop and implement contingency plans and similar uncertainties. ENVIRONMENT The Company is subject to various federal, state, local and foreign laws and regulations governing the use, discharge and disposal of hazardous materials. The Company's manufacturing facilities are believed to be in substantial compliance with current laws and regulations. Compliance with current laws and regulations has not had and is not expected to have a material adverse effect on the Company's financial condition. 7 The Company's present and past facilities have been in operation for many years, and over that time in the course of those operations, such facilities have used substances which are or might be considered hazardous, and the Company has generated and disposed of wastes which are or might be considered hazardous. Therefore, it is possible that additional environmental issues may arise in the future, which the Company cannot now predict. -----END PRIVACY-ENHANCED MESSAGE-----