-----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, NPeRF6vXxKId5n1iJNb/fbDxg9hEAf70VbisOTjZV+QIZc3bkpLf8wt5r3TbKpGU rlAaI85WPRiMCMNeRupZqw== 0001047469-99-012832.txt : 19990402 0001047469-99-012832.hdr.sgml : 19990402 ACCESSION NUMBER: 0001047469-99-012832 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990331 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-K SEC ACT: SEC FILE NUMBER: 001-12925 FILM NUMBER: 99581795 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-K 1 FORM 10-K UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K (Mark One) /X/ Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the fiscal year ended December 31, 1998 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 incorporation or organization) (I.R.S. Employer 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) ---------------------------------------- Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of each exchange on which registered Common Stock, par value $.01 per share New York Stock Exchange Preferred Stock Purchase Rights New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act: NONE -------------------------- 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 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 / / No /X/ Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. /X/ The aggregate market value of the shares of Common Stock held by non-affiliates of the registrant was approximately $4.5 billion as of March 15, 1999 (based on the closing price for the Common Stock on the New York Stock Exchange on that date). For purposes of this computation, shares held by affiliates and by directors and officers of the registrant have been excluded. Such exclusion of shares held by directors and officers is not intended, nor shall it be deemed, to be an admission that such persons are affiliates of the registrant. As of March 15, 1999 there were 177,153,291 shares of the registrant's Common Stock, par value $0.01 per share, outstanding. DOCUMENTS INCORPORATED BY REFERENCE Portions of the registrant's Proxy Statement for the 1999 Annual Meeting of Stockholders, to be filed with the Securities and Exchange Commission, are incorporated by reference in Part III hereof. PART I ITEM 1. BUSINESS On July 25, 1997, the Company was spun off (the "Distribution") from its former parent company, General Instrument Corporation (the "Distributing Company"), under the name "NextLevel Systems, Inc.," through a distribution of the Company's common stock, par value $.01 per share (the "Common Stock"), to the stockholders of the Distributing Company. 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." Unless the context otherwise requires, references to the "Company" or "General Instrument" include General Instrument Corporation and its direct or indirect subsidiaries and the business of the Company as conducted by the Distributing Company prior to the Distribution. OVERVIEW The Company 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"), the Company provides next-generation broadband access solutions for local telephone companies with the Partnership's NLevel(3)-Registered Trademark-Switched Digital Access System ("NLevel(3)"). BUSINESS STRATEGY The Company's strategy is to use its technological leadership in providing secure broadband systems and equipment to enhance its leading position in its traditional markets while expanding into new markets. This strategy is based on the belief that (i) consumers in the United States and international markets will continue to demonstrate an increasing demand for new information and entertainment services, and (ii) content and service providers will continue to create new bandwidth-intensive video, voice and data applications. The Company's management believes that these factors will generate a continuing need for systems and equipment with greater capacity for all networks and architectures. Since December 1997, the Company has entered into several strategic relationships, including equity investments in the Company by large cable television multiple systems operators ("MSOs"), which are expected to provide a strong foundation for future business development and to reinforce the Company's position as a leading provider of the next generation of broadband communications equipment and systems. CABLE CUSTOMER EQUITY OWNERSHIP. The Company has issued warrants to purchase approximately 29 million shares of Common Stock to leading North American cable system operators. These warrants were issued in connection with definitive agreements to supply approximately 15 million digital set-top terminals to such operators. Included among the cable operators entitled to exercise the warrants upon the purchase of set-top terminals from the Company are Tele-Communications, Inc. ("TCI"), Time Warner Cable ("Time Warner"), MediaOne of Delaware, Inc. ("MediaOne"), Comcast Cable Communications, Inc. ("Comcast"), Cox Communications, Inc. ("Cox"), Adelphia Communications Corporation ("Adelphia"), Shaw Communications, Inc. ("Shaw"), Jones Intercable, Inc. ("Jones") and Charter Communications, Inc. ("Charter"). See "- Broadband Network Systems - Digital Network Systems" and Note 18 to the Consolidated Financial Statements. SET-TOP AUTHORIZATION SERVICES. The Company issued 21,356,000 shares of its Common Stock to an affiliate of TCI in connection with the Company's acquisition of the set-top authorization services business that controls the receipt of cable programming services delivered to subscribers by TCI's Headend In The Sky-Registered Trademark-. The Company now provides national authorization services throughout the United States to cable operators, many with relatively small individual systems that could not otherwise justify the initial capital investment required to launch a local digital headend computer control system. See "- Broadband Network Systems - Digital Network Systems" and Note 7 to the Consolidated Financial Statements SONY CORPORATION. The Company has entered into a strategic alliance with Sony Corporation of America ("Sony") to jointly develop digital television technologies for cable television devices and high definition television ("HDTV") products. In addition, the Company plans to incorporate Sony's Home Network architecture into its advanced digital set-top terminals. In connection with this strategic alliance, Sony purchased 7.5 million shares of Common Stock. MARKET OVERVIEW The Company has two reportable segments: Broadband Networks Systems (consisting of digital and analog cable and wireless television systems and transmission network systems) and Satellite and Broadcast Network Systems. For financial information about the Company's reportable segments and foreign and domestic operations see Note 21 to the Consolidated Financial Statements. Worldwide broadband networks systems sales increased $277 million, or 21%, to $1,569 million in 1998. For the years ended December 31, 1998 and 1997, broadband networks systems sales in the U.S. were 84% and 69%, respectively, combined U.S. and Canadian sales were 86% and 74%, respectively, and all other international sales were 14% and 26%, respectively, of total worldwide broadband networks systems sales. Worldwide broadband networks systems sales were $1,180 million in 1996, of which 33% related to international sales. Worldwide satellite and broadcast network systems sales of $418 million for the year ended December 31, 1998, decreased $44 million, or 10%, from the comparable 1997 period. For the years ended December 31, 1998 and 1997, satellite sales in the U.S. were 86% and 76%, respectively, combined U.S. and Canadian sales were 98% and 88%, respectively, and all other international sales were 2% and 12%, respectively, of total worldwide satellite sales. Worldwide satellite and broadcast network systems sales were $575 million in 1996, of which 12% related to international sales. BROADBAND NETWORKS SYSTEMS The Company's Broadband Networks product lines are organized as follows within the Broadband Networks Systems Segment: Digital Network Systems, Advanced Network Systems, Transmission Network Systems and IP Network Systems. DIGITAL NETWORK SYSTEMS. The Company is the world's leading supplier of secure interactive digital cable television delivery systems. The principal products are: (i) individual network elements, including consumer set-top terminals and various video, audio and data processing equipment used in cable operators' headends; (ii) computer equipment, software and services that secure programming content, download software applications to consumer set-top terminals, authorize individual subscriber services, enable network management and provide interfaces to cable operators' billing systems; and (iii) system integration services for the custom assembly and testing of Company and third-party hardware and software elements. North American cable operators began deploying commercial services using the Company's interactive digital delivery systems in 1996. As of December 31, 1998, the Company had shipped approximately 700 digital headend systems throughout North America, passing approximately 34 million homes and over 2.7 million digital cable and wireless set-top terminals. In addition, the Company's digital business is beginning to expand into regions beyond North America such as Europe, the Middle East, Asia/Pacific and Latin America. Digital compression technology typically allows cable operators to provide 6 to 12 times the number of programs per traditional channel slot than is possible using analog technology. Initial cable operator demand for the Company's digital products has resulted from: (i) the cable operators' ability to offer additional pay-per-view and other programming choices enabled by such digital compression technology; and (ii) the high quality of digital video/audio, electronic program guides and the potential to offer a wide range of new interactive applications. The Company's digital systems and set-top terminals enable Video-on-Demand ("VOD"), impulse Pay-Per-View, Internet access, e-mail, electronic yellow pages, home shopping, interactive games and educational services. The Company's digital products are designed with an open architecture so that new interactive software applications, being developed by third parties, can be downloaded over the cable network to set-top terminals already installed in consumer homes. All of the Company's digital cable set-top terminals utilize the digital transport stream and decode video compliant with the Motion Picture Experts Group 2 ("MPEG-2") international standard and demodulate Quadrature-Amplitute-Modulated signals compliant with International Telecommunications Union international standards. The Company's terminals and delivery systems also use standards-based interactive communications protocols and the Company's proprietary access 2 control technology marketed under the DigiCipher-Registered Trademark- II and MediaCipher-TM- brand names, as well as decode Dolby Digital-Registered Trademark- audio. As of December 31, 1998, the Company's digital terminal shipments have consisted of its DCT-1000, DCT-1200 and DCT-2000 model cable terminals and DWT-1000 model wireless terminals. All of these set-top products are two-way terminals capable of real-time, interactive operation using either a built-in RF return modem or optional telephone return modem. Additionally, all of these set-top products are compatible with the existing installed base of the Company's set-top products. Such compatability enhances security, reduces operating costs and improves bandwidth utilization. The Company expects to introduce new two-way interactive set-top terminal models during 1999. The DCT-5000+ model is a high-end terminal that will capitalize on a built-in Data-Over-Cable-Service/Interoperability Specification ("DOCSIS") compliant cable modem, Internet protocols and a unique triple tuner architecture to enable consumers to watch television, surf the World Wide Web and talk on a telephone simultaneously. The DVi-2000 and DVi-5000 models, which include Digital Video Broadcast Standard ("DVB") compliant technologies such as Musicam-Registered Trademark- audio decoding, target European and other international cable operators. The Company has entered into definitive agreements with leading North American cable operators to supply approximately 15 million digital set-top terminals, consistent with the cable industry's OpenCable initiative, over a three to five year period beginning in 1998, with an estimated value of $4.5 billion. The Company has issued warrants to purchase approximately 29 million shares of the Company's Common Stock to these cable operators in connection with such agreements. Included among these cable operators entitled to purchase set-top terminals from the Company are TCI, Time Warner, MediaOne, Comcast, Cox, Adelphia, Shaw, Jones, Charter, Suburban Cable Company, Intermedia Cable and Bresnan Communications Company, which cable operators have a collective subscriber base of over 46 million. In July 1998, the Company completed its acquisition from TCI's affiliates of certain physical assets and a license of associated intellectual property to enable it to provide the set-top authorization services that control the receipt of cable programming services delivered to subscribers by TCI's Headend In The Sky and other programmers. The Company issued 21,356,000 shares of its Common Stock to an affiliate of TCI in connection with this acquisition. The Company now provides national authorization services throughout the United States to MSOs, many with relatively small individual systems that could not otherwise justify the initial capital investment required to launch a local digital headend computer control system. The Company continues to supply its internally developed DAC-6000 model controller for local and regional authorization systems solutions for operators with larger individual system subscriber bases. ADVANCED NETWORK SYSTEMS. The Company is the world's leading provider of addressable analog set-top systems which enable cable operator control and subscriber access to a number of advanced entertainment services and features. The principal products include consumer set-top terminals and the associated central office headend computer and processing equipment. Use of these addressable systems enables operators to provide a suite of service offerings, including: pay-per-view, multiple tiers of programming services, and advanced video, audio and data entertainment services. Beginning in early 1995, the Company began shipping its latest generation Consumer Friendly Terminal system ("CFT"), the CFT2200 interactive advanced analog system, adding a new level of service offering to the prior analog platforms. The CFT2200 two-way interactive advanced analog terminal provides cable operators with the most complete set of services available today over an analog platform, including Internet access, interactive programming guides, CD-quality music, near video-on-demand ("NVOD"), supplemental sports and entertainment information and local information-on-demand. The Company shipped approximately 2.8 million and 3.2 million CFT advanced analog terminals for the years ended December 31, 1998 and December 31, 1997, respectively. The Company sells addressable analog set-top systems throughout the world, and is the market leader in North and South America, Europe, and Asia with the CFT advanced platform. The Company estimates that its market share in the U.S. analog addressable market has exceeded 50% for the last several years, both in the traditional and advanced product areas. While management expects that the Company's advanced analog cable products will continue to satisfy cable and wireless operator 3 demands worldwide for several years, due to the anticipated increased availability and use of digital cable products, the Company expects that demand in North America for its analog cable products will continue to decline. TRANSMISSION NETWORK SYSTEMS. The Company's transmission products provide end-to-end solutions that enable the transformation of the traditional cable television network into a two-way, fiber-rich, high speed voice/ video/data network. Transmission products include headend signal processing equipment, distribution amplifiers, fiber optic transmission equipment and passive components for wired television distribution systems. The Company's management expects cable television operators in the United States and abroad to continue to upgrade their basic networks and invest in new system capacity primarily to compete with other television programming sources, such as DTH, as well as to capitalize on the rapid growth in demand for new voice and data services, including high-speed Internet access. Further opportunities exist internationally where cable penetration is low and demand for both entertainment and high speed internet access is growing. IP NETWORK SYSTEMS. The Company's management believes Internet Protocol ("IP")-based high-speed data and telephony solutions over two-way cable networks present significant growth opportunities for the Company. To best capitalize on this market, the Company consolidated the management activities of its high-speed cable modem business with the emerging IP-based telephony business. The Company's family of Surfboard-Registered Trademark-high-speed cable modems are capable of delivering information through a cable television network at speeds significantly faster than a traditional telephony modem, while delivering instructions and other information upstream from the consumer over either the telephone lines in one-way systems or utilizing the cable network in two-way systems. The Company has been a leading proponent of two-way cable modem networks compliant with interoperable standards based upon DOCSIS and has entered into a working relationship with Cisco Systems, Inc. ("Cisco") to further the mass deployment of this technology. During 1998, the Company intensified its focus on local loop telephony solutions leveraging the standards-based DOCSIS network infrastructure. AT&T Corporation ("AT&T") has identified IP telephony as its solution of choice for providing local telephony service over cable networks. With its relationship with Cisco, the Company announced in January 1999 its intent to work with AT&T to develop and bring to market a seamless, end-to-end IP telephony solution. The Company is developing a broad portfolio of communication gateway products to enable IP telephony, including an option for the DCT 5000+, a variant of the Surfboard-Registered Trademark- high-speed data modem, and a point-of-entry mounted broadband telecommunications interface unit, or "BTI." SATELLITE AND BROADCAST NETWORK SYSTEMS. The Company is a provider of digital satellite television systems for programmers, DTH satellite network providers and private networks for business communications and distance learning. The Company offers a broad product line of digital compression and transmission systems including MPEG-2, DVB and Advanced Television Systems Committee compliant solutions. The Company also sees an emerging business opportunity for digital broadcast products related to the delivery of high definition and standard definition digital video signals by the cable and broadcast industries. The Company designs, manufactures and sells analog and digital satellite uplink and downlink products for commercial and consumer use. Using the Company's DigiCipher-Registered Trademark- II digital technology, commercial customers are able to compress their video, audio and data transmissions resulting in significant cost savings over traditional analog transmission. The Company also offers state-of-the-art network management and access control products and services that allow program packagers to efficiently and cost-effectively manage customer transactions and securely transmit their programming to only authorized end-users. The Company is the leading manufacturer of access control and scrambling and descrambling equipment used by television programmers for the satellite distribution of proprietary programming. The Company is also a leading supplier of digital satellite systems to private networks for business communications and distance learning. In 1998, in support of the government-mandated conversion to digital terrestrial television, the Company delivered its first commercial high definition television (HDTV) 4 encoding and decoding equipment to the CBS Television Network and Home Box Office (HBO), as well as local television stations in the U.S. The Company's analog satellite products are the exclusive systems for distributing encrypted C-band (large dish) satellite-delivered programming to cable television operators and large-diameter backyard satellite dish owners. Sales of analog consumer descramblers have declined, as expected, to minimal levels over the past two years and are expected to continue to decline because of the availability of competing digital satellite video services. The Company introduced its first digital descramblers for the backyard C-band market in 1997. This product, called 4DTV-Registered Trademark-, allows C-band dish owners to take advantage of the wealth of digital programming now being transmitted by satellite. There can be no assurance, however, as to the degree of market acceptance of this product. To date, significant quantities of 4DTV have not been shipped. The Company is currently the sole supplier of digital satellite receivers and digital satellite encoders to PRIMESTAR, Inc. ("PRIMESTAR"), representing approximately 11% of the Company's consolidated net sales for the year ended December 31, 1998. PRIMESTAR, the second largest provider of satellite television entertainment in the United States, currently operates a 160 channel medium-power direct broadcast satellite ("DBS") service. See Management's Discussion and Analysis of Financial Condition and Results of Operations and Note 21 to the Consolidated Financial Statements. On January 22, 1999, PRIMESTAR announced that it reached an agreement to sell its medium-power DBS business and assets as well as its rights to acquire high-power satellite assets to Hughes Electronics Corporation ("Hughes"). While the announcement stated that Hughes' DIRECTV expects to operate PRIMESTAR's medium-power business for a period of approximately two years, during which time it intends to transition PRIMESTAR subscribers to the high-power DIRECTV service, the Company is currently uncertain whether and to what extent PRIMESTAR will continue to order and purchase medium power-equipment from the Company. Further, the Company does not expect to supply any high-power equipment to PRIMESTAR. The announcement stated that if the proposed transaction with Hughes is not consummated for any reason, PRIMESTAR intends to continue its medium-power business. The loss of PRIMESTAR as a continuing customer of the Company will have a significant impact on the Company's satellite business. NEXT LEVEL COMMUNICATIONS L.P. The Partnership is a leading provider of next-generation integrated full service digital loop carrier ("DLC") and fiber-to-the-curb ("FTTC") systems that deliver telephony, video and data for local telephone companies, including Bell Atlantic Corporation ("Bell Atlantic") and U S West Communications ("U S West"). The Partnership's product, NLevel(3), is designed to permit the cost effective delivery of a suite of standard and advanced telephony services over twisted pair networks, including high-speed data/Internet, distance learning, video services as well as basic telephone services, to the home from a single access platform. In the fourth quarter of 1996, Next Level Communications ("NLC") entered into an agreement with a subsidiary of NYNEX Corporation, now Bell Atlantic, pursuant to which the Partnership will supply its NLevel(3) system for one million lines of telephone service in metropolitan New York City and Boston. Initial deployment for the greater Boston area began in the first quarter of 1997. Bell Atlantic also has options to extend its deployment of the NLevel(3) system to up to five million lines. In the third quarter of 1997, NLC entered into an agreement with U S West, pursuant to which the Partnership will supply its NLevel(3) system for 450,000 lines of broadband xDSL access. In addition, in July 1998, U S West selected the Partnership to supply DLC and FTTC systems for the delivery of broadband video, high-speed data/Internet, and basic telephone services. In January 1998, the Company transferred the business of NLC, including its net assets, principally technology, and its management and workforce to the Partnership in exchange for approximately an 89% limited partnership interest (subject to additional dilution). An entity controlled by Spencer Trask & Co., the operating general partner of the Partnership, acquired approximately an 11% interest in the Partnership and has the potential to acquire up to an additional 11% in the future. Pursuant to an agreement entered into in July 1998, the Company agreed to make an additional $50 million equity investment in the Partnership, which will increase its limited partnership interest to more than 90%. Through 5 December 31, 1998, the Company paid $16 million of the $50 million equity investment. The remainder of this investment will be paid during the first half of 1999. See Note 8 to the Consolidated Financial Statements. Pursuant to the partnership agreement, the operating general partner controls the Partnership and is responsible for developing the business plan and infrastructure necessary to position the Partnership as a stand-alone company. TECHNOLOGY AND LICENSING The management of the Company believes that it is in the unique position of currently producing the majority of the world's analog-addressable systems, while also leading the deployment of the digital technology that will eventually replace these systems. As a result, the Company will seek to build upon its core enabling technologies, digital compression, encryption and conditional access and control, in order to lead the transition of the market for broadband communications networks from analog to digital systems. The Company has licensed a number of semiconductor manufacturers to allow for broad deployment of the Company's MPEG-2 system. The Company has also licensed its DigiCipher-Registered Trademark- II/MPEG-2 technology to other equipment suppliers. The Company has also entered into other license agreements, both as licensor and licensee, covering certain products and processes with various companies. These license agreements require the payment of certain royalties which are not expected to be material to the Company's financial statements. RESEARCH AND DEVELOPMENT The Company intends to continue the current policy of actively pursuing the development of new technologies and applications. Research and development expenditures for the year ended December 31, 1998 were $244 million (including a $75 million charge to fully reserve the research and development advance made to the Partnership, see Note 8 to the Consolidated Financial Statements) compared to $208 million and $198 million for the years ended December 31, 1997 and 1996, respectively. The Company's management expects research and development expenditures to approximate $165 million in 1999. Research and development expenditures reflect the continued development of the Company's digital set-top terminals, broadband telephony, cable modems, advanced digital systems for cable and satellite television distribution and product development through strategic alliances. SALES AND DISTRIBUTION The Company's broadband communications products and services are marketed primarily to cable television operators and telephone companies. The Company's satellite communications products are marketed to satellite television programmers and providers as well as cable television operators. Demand for the Company's products will depend primarily on capital spending by cable television operators, satellite programmers and telephone companies for constructing, rebuilding or upgrading their systems. The amount of this capital spending and, therefore, a majority of the Company's sales and profitability, will be affected by a variety of factors, including general economic conditions, the continuing trend of consolidation within the cable industry, the financial condition of domestic cable television system operators and their access to financing, competition from DTH, satellite, wireless television providers and telephone companies offering video programming, technological developments and standardization efforts that impact the deployment of new equipment and new legislation and regulations affecting the equipment used by cable television system operators and their customers. While the Company's management believes that cable television capital spending is likely to increase as cable operators upgrade their basic networks and move from basic analog to advanced analog and digital systems, there can be no assurance that such increase from historical levels will occur or that existing levels will be maintained. Broadband and satellite communications systems are sold primarily through the efforts of sales personnel employed by the Company who are skilled in the technology of the particular system. Although the domestic cable television industry is comprised of thousands of cable systems, a small number of MSOs own a majority of cable television systems and account for a significant portion of the capital expenditures made by cable television system operators. The loss of business from a significant MSO could have a material adverse effect on the business of the Company. TCI, including its affiliates, accounted for 31% of the consolidated net sales of the Company for the year ended 6 December 31, 1998. See Note 19 to the Consolidated Financial Statements. PRIMESTAR accounted for 11% of the consolidated net sales of the Company for the year ended December 31, 1998. See Management's Discussion and Analysis of Financial Condition and Results of Operations and Note 21 to the Consolidated Financial Statements. PATENTS The Company's policy is to protect its proprietary position by, among other methods, filing U.S. and foreign patent applications to protect technology, inventions and improvements that the Company considers important to the development of its business. Although the Company's management believes that its patents provide a competitive advantage, the Company will rely equally on its proprietary knowledge and ongoing technological innovation to develop and maintain its competitive position. BACKLOG As of December 31, 1998 and December 31, 1997, the Company had a backlog of approximately $636 million and $484 million, respectively. Backlog includes only orders for products scheduled to be shipped within six months. Orders may be revised or canceled, either pursuant to their terms or as a result of negotiations; consequently, it is impossible to predict accurately the amount of backlog orders that will result in sales. COMPETITION The Company's products will 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 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. 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 MSOs, its technological leadership and new product development capabilities, and the likely need for compatibility of new technologies with currently installed systems. There can be no assurance, however, that competitors will not be able to develop systems compatible with, or that are alternatives to, the Company's proprietary technology or systems, or that the Company will be able to introduce new products and technologies on a timely basis. In addition, the Partnership is competing in the local telephone access equipment market with a number of well-established suppliers. There is no assurance that the Partnership will be successful in this market. RAW MATERIALS The Company purchases raw materials from many sources in the United States, as well as from sources in the Far East, Canada and Europe and its products include certain components that are currently available only from single sources. The Company has in effect inventory controls and other policies intended to minimize the effect of any interruption in the supply of these components. There is no single supplier the loss of which would have a continuing material adverse effect on the Company. 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 manufacturing facilities of the Company 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 results of operations and financial condition. EMPLOYEES As of March 1, 1999, approximately 7,800 people were employed by the Company. Of these employees, approximately 1,900, 2,400 and 3,200 were located at the U.S., Taiwan and Mexico facilities, respectively, with the balance located in Europe, Latin America and the Far East. As of March 1, 1999, approximately 500 of the Company's employees were covered by collective bargaining agreements. Of these employees, approximately 300 were located at the Mexican facilities and approximately 200 were located at facilities in Germany. The management of the Company believes that its relations with both its union and non-union employees are satisfactory. 7 ITEM 2. PROPERTIES The Company has manufacturing, warehouse, sales, research and development and administrative facilities worldwide which have an aggregate floor space of 1.8 million square feet. Of these facilities, aggregate floor space of approximately 1.1 million square feet is leased and the remainder is owned by the Company. The management of the Company does not believe that there is any material long-term excess capacity in the Company's facilities, although utilization is subject to change based on customer demand. The Company's primary manufacturing facilities are located in Taiwan and Mexico. The Company also has smaller manufacturing facilities in San Diego, California, Lewisville, Texas, and Bad Salzdetfurth, Germany. In addition, the Company leases office space for its sales, marketing and engineering personnel in the U.S., Europe, Asia, and Latin America. The Company's corporate headquarters are located in Horsham, Pennsylvania. The management of the Company believes that the Company's facilities and equipment generally are well maintained, in good operating condition and suitable for the Company's purposes and adequate for present operations. ITEM 3. 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-Registered Trademark- 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 the 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. 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 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 amended complaints, which contain 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 8 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 of 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. 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 $140 million. On May 14, 1998, the Texas court granted a preliminary injunction preventing DSC from proceeding with the Delaware Action. That injunction order is now on appeal to the United States Court of Appeal for the Fifth Circuit where it has been briefed and awaits determination. On July 6, 1998, the defendants filed a motion for summary judgment with the Texas court requesting a permanent injunction preventing DSC from proceeding with this litigation. As a result of the preliminary injunction, the Delaware Action has been stayed in its entirety. The Company intends to vigorously contest this 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 is seeking injunctive relief as well as damages (as specified below). The first part of a bifurcated arbitration proceeding began on March 22, 1999 before an arbitration panel of the American Arbitration Association in San Francisco, California. A separate hearing relating to certain of the Company's digital set top boxes and satellite products will be scheduled for a later date. On January 25, 1999, the Company received a copy of StarSight's Statement of Damages, as directed by the arbitration panel. This statement identifies purported damages arising from the sale by the Company of certain analog set top boxes containing a native electronic program guide. StarSight alleges that it is entitled to collect $90 million to $177 million in compensatory damages and an unspecified amount of punitive damages. 9 StarSight is seeking additional damages, including consequential damages, relating to the Company's digital set top boxes. The Company has denied StarSight's allegations and intends 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. The plaintiffs have sought to consolidate discovery for this action with similar actions pending against Pioneer Electronics Corp. and Scientific-Atlanta, Inc. The Company has responded to the plaintiffs' motion, currently pending before the Judicial Panel on Multidistrict Litigation (the "Judicial Panel"). On January 27, 1999, the court entered an order staying these proceedings until the Judicial Panel decides the plaintiffs' consolidation motion. The Company denies that it infringes the subject patents and intends to vigorously defend this action. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to a vote of the Company's security holders during the three months ended December 31, 1998. 10 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The Common Stock is listed and traded under the symbol GIC on the New York Stock Exchange. The Common Stock began trading on July 24, 1997, as a result of the Distribution. The Company did not pay dividends on its Common Stock during 1998. The Company's ability to pay cash dividends on its Common Stock is limited by certain covenants contained in a credit agreement to which the Company is a party.
Stock Price Ranges ------------------------ High Low ----------- ----------- 1997 Third quarter $ 21 1/2 $ 16 Fourth quarter $ 19 1/8 $ 12 5/8 1998 First quarter $ 22 $ 16 7/16 Second quarter $ 28 3/4 $ 19 3/4 Third quarter $ 29 1/2 $ 16 11/16 Fourth quarter $ 36 15/16 $ 17 1/2
As of March 23, 1999, the number of registered stockholders of record of the Company's Common Stock was 904. 11 ITEM 6. SELECTED FINANCIAL DATA FIVE YEAR SUMMARY
Year Ended December 31, ----------------------------------------------- (In millions, except per share data) 1998(a) 1997(b) 1996(c) 1995(d) 1994(e) ------- ------- ------- ------- ------- CONSOLIDATED STATEMENTS OF OPERATIONS DATA: Net sales $ 1,988 $ 1,764 $ 1,756 $ 1,533 $ 1,275 Cost of sales 1,431 1,336 1,350 1,080 878 Gross profit 557 428 406 453 397 Selling, general and administrative 194 215 174 138 103 Research and development 244 208 198 138 105 Purchased in-process technology -- -- -- 140 -- Amortization of excess of cost over fair value of net assets acquired 14 15 14 14 15 NLC litigation costs -- -- 141 -- -- Operating income (loss) 104 (10) (122) 22 175 Interest income (expense), net 1 (5) (26) (23) (27) Income (loss) before income taxes and cumulative effect of changes in accounting principles 94 (10) (149) (2) 149 Net income (loss) $ 55 $ (16) $ (96) $ 4 $ 121 Earnings per share - basic $ 0.35 Earnings per share - diluted $ 0.33 Pro forma loss per share - basic and diluted (f) $ (0.11) $ (0.65) December 31, ----------------------------------------------- 1998 1997 1996 1995 1994 ------- ------- ------- ------- ------- CONSOLIDATED BALANCE SHEET DATA: Total assets $ 2,188 $ 1,675 $ 1,630 $ 1,354 $ 1,199 Other non-current liabilities 68 66 188 75 78 Stockholders' equity 1,650 1,215 1,051 926 764
- -------------------------- (a) Includes charges of $124 million ($79 million net-of-tax) reflecting restructuring and other charges primarily including costs related to the closure of various facilities, including the Company's satellite TV manufacturing facility in Puerto Rico, severance and other employee separation costs, the write-down of fixed assets to their estimated fair values and inventory to its lower of cost or market, as well as a $75 million charge to fully reserve for the R&D advance made to the Partnership (see Notes 5, 6 and 8 to the consolidated financial statements contained in Item 8). (b) Includes charges of $110 million ($79 million net-of-tax) reflecting restructuring and other charges primarily including costs related to the closure of various facilities, including the Company's satellite TV manufacturing facility in Puerto Rico, severance and other employee separation costs, the write-down of inventory to its lower of cost or market, the write-down of fixed assets to their estimated fair values and costs related to dividing the Distributing Company's Taiwan operations between the Company and General Semiconductor, Inc. (see Notes 1, 5 and 6). (c) Includes charges of $226 million ($145 million net-of-tax) reflecting Next Level Communications ("NLC") litigation costs, restructuring charges and other charges primarily related to the transition to the Company's next-generation digital products and the write-down of inventory to its lower of cost or market (see Notes 5, 6 and 16). (d) Includes a charge of $140 million ($90 million net-of-tax) for purchased in-process technology in connection with the acquisition of NLC (see Note 8). (e) Includes an income tax benefit of $31 million, as a result of a reduction in a valuation allowance related to domestic deferred income tax assets. (f) Prior to the Distributions (see Note 1), the Company did not have its own capital structure; accordingly, pro forma per share information has only been presented for the years ended December 31, 1997 and 1996. The pro forma loss per share was calculated by dividing the net loss by the pro forma weighted-average number of shares outstanding. The pro forma weighted-average number of shares outstanding used for 1996 equaled the number of common shares issued on the date of the Distributions, and for 1997, included the number of common shares issued on the date of the Distributions plus the actual share activity during the period subsequent to the Distributions. 12 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW OF BUSINESS 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 was formerly the Communications Business of the former General Instrument Corporation (the "Distributing Company"). In July 1997, the Distributing Company distributed all of its outstanding shares of capital stock of the Company to its stockholders, and the Company then began operating as a publicly traded independent entity. The Company's consolidated financial statements and notes to the consolidated financial statements ("Notes"), included elsewhere in this Form 10-K, should be read as an integral part of the following financial review. COMPARISON OF RESULTS OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 1998 WITH THE YEAR ENDED DECEMBER 31, 1997 NET SALES. Net sales for the year ended December 31, 1998 were $1,988 million compared to $1,764 million for the year ended December 31, 1997. Net sales in 1998 when compared to 1997 reflect higher sales of digital cable systems, partially offset by lower sales of analog cable systems and a decline in international sales. Analog and digital products represented 44% and 56%, respectively, of total sales in 1998 compared to 58% and 42%, respectively, of total sales in 1997. Worldwide broadband sales (consisting of digital and analog cable and wireless television systems and transmission network systems) increased $277 million, or 21%, to $1,569 million in 1998 primarily as a result of increased U.S. sales volumes of digital cable terminals and headends, partially offset by lower sales of analog cable systems. These sales reflect the increasing commitment of U.S. cable television operators to deploy interactive digital systems in order to offer advanced entertainment, interactive services and Internet access to their customers. For the years ended December 31, 1998 and 1997, broadband sales in the U.S. were 84% and 69%, respectively, combined U.S. and Canadian sales were 86% and 74%, respectively, and all other international sales were 14% and 26%, respectively, of total worldwide broadband sales. Worldwide satellite sales of $418 million for the year ended December 31, 1998 decreased $44 million, or 10%, from the comparable 1997 period primarily as a result of lower private and commercial network sales in international markets. For the years ended December 31, 1998 and 1997, satellite sales in the U.S. were 86% and 76%, respectively, combined U.S. and Canadian sales were 98% and 88%, respectively, and all other international sales were 2% and 12%, respectively, of total worldwide satellite sales. The decrease in broadband and satellite international sales during 1998 was experienced in all international regions. The largest decreases in sales were experienced in the Asia/Pacific and Latin American regions, and there can be no assurance that international sales will return to 1997 levels in the near term. On January 22, 1999, PRIMESTAR, Inc. ("PRIMESTAR") announced that it reached an agreement to sell its direct broadcast satellite ("DBS") medium-power business and assets as well as its rights to acquire high-power satellite assets to Hughes Electronics Corporation ("Hughes"). Sales to PRIMESTAR accounted for 11% of the Company's sales in 1998. The Company is currently uncertain whether and to what extent PRIMESTAR will continue to order and purchase medium-power equipment from the Company. Further, the Company does not expect to supply any high-power equipment to PRIMESTAR. See "Developments Related to PRIMESTAR" below. GROSS PROFIT. Gross profit increased $129 million, or 30%, to $557 million in 1998 from $428 million in 1997 and was 28% of sales in 1998 compared to 24% in 1997. Gross profit for the year ended December 31, 1998 was reduced by $9 million of restructuring charges (see Note 5 and "Restructurings" below) and $18 million of other charges (see Note 6 and "Other Charges" below) recorded in the first quarter of 1998, primarily related to severance and other employee 13 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. Gross profit for the year ended December 31, 1997 was reduced by $84 million of charges primarily related to the closure of the Company's Puerto Rico satellite manufacturing facility, employee costs related to dividing the Distributing Company's Taiwan operations between the Company and General Semiconductor, Inc. and the write-down of inventories to their lower of cost or market (see Notes 1, 5 and 6). Gross profit increases primarily reflect increased sales levels as well as product cost reductions, driven primarily by chip integration and productivity improvements at the Company's Taiwan manufacturing facility. SELLING, GENERAL AND ADMINISTRATIVE. Selling, general and administrative ("SG&A") expense was $194 million in 1998 compared to $215 million in 1997 and was 10% of sales in 1998 compared to 12% in 1997. SG&A expense for the year ended December 31, 1998 included $6 million of restructuring charges (see Note 5 and "Restructurings" below) and $7 million of other charges (see Note 6 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. SG&A expense in 1997 included $28 million of charges related to severance and other employee separation costs, costs associated with the closure of various facilities and legal and other professional fees incurred in connection with the Distributions (see Notes 1, 5 and 6), partially offset by a $5 million credit related to the collection of certain receivables previously considered to be uncollectible. SG&A spending for 1997 also included SG&A expenses related to NLC. RESEARCH AND DEVELOPMENT. Research and development ("R&D") expense increased $36 million, or 17%, to $244 million in 1998 from $208 million in 1997 and was 12% of sales in 1998 and 1997. R&D expense for the year ended December 31, 1998 included a $75 million charge to fully reserve the Partnership Note (see Note 8). Proceeds of the Partnership Note are being utilized by the Partnership to fund research and development activities through 1999 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. Such widespread deployment is not expected until the latter part of 1999 or early in 2000; however, there can be no assurance that the development activities currently being undertaken will result in successful commercial deployment. R&D expense for the year ended December 31, 1997 included $9 million of charges primarily related to the write-down of certain assets used in R&D activities to their estimated fair values (see Notes 5 and 6). R&D spending in 1998 reflects the continued development of the Company's digital set-top terminals, broadband telephony, cable modems, advanced digital systems for cable and satellite television distribution and product development through strategic alliances. OTHER INCOME (EXPENSE) - NET. Other expense - net of $12 million for the year ended December 31, 1998 primarily included the Company's equity interest in the Partnership's loss (see Note 8), which includes the BBT litigation settlement (see Note 16) and compensation expense related to key executives of an acquired company, partially offset by gains on the sale of a portion of the Company's investment in Ciena Corporation and the settlement of an insurance claim. Other income of $6 million for the year ended December 31, 1997 predominantly reflects net investment gains, primarily from the sale of a portion of the Company's investment in Ciena Corporation. INTEREST INCOME (EXPENSE) - NET. Interest expense - net for the year ended December 31, 1997 includes an allocation of interest expense from the Distributing Company, which was allocated based upon the Company's net assets as a percentage of the total net assets of the Distributing Company for the period prior to the date of the Communications Distribution. Net interest expense allocated to the Company was $15 million for the year ended December 31, 1997. Subsequent to July 25, 1997, the date of the Communications Distribution, net interest represents actual net interest expense incurred by the Company. INCOME TAXES. Through the date of the Distributions, income taxes were determined as if the Company had filed separate tax returns under its then existing structure for the periods presented. The Company recorded provisions for income taxes of $38 million and $6 million for the years ended December 31, 1998 and 1997, respectively. Excluding the restructuring and other net charges recorded in 1998 and 1997, the effective tax rates were 38%. 14 DEVELOPMENTS RELATED TO PRIMESTAR. PRIMESTAR is the second largest provider of satellite television entertainment in the United States and currently operates a 160-channel medium-power DBS service. The Company is currently the sole supplier of digital satellite receivers and digital satellite encoders to PRIMESTAR. The announcement of the proposed acquisition of PRIMESTAR, described above, stated that if the proposed transaction with Hughes is not consummated for any reason, PRIMESTAR intends to continue its medium-power business. Prior to this announcement, the Company had estimated that 1999 revenues from the sale of equipment to PRIMESTAR would be approximately $100 million. The Company believes that, if the proposed acquisition is consummated, such revenues will be substantially reduced. While the Company expects to minimize the effect of the potential loss of revenue from PRIMESTAR through increased sales of its digital cable systems and reductions in overhead expenses, there can be no assurance that the Company will be successful in replacing this lost revenue. In February 1999, 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 expects to take a pre-tax charge during the first quarter of 1999 of approximately $15 million, for severance and facility consolidation costs. Approximately $10 million of this charge requires cash payments, which the Company expects to make during 1999. The employee reductions are expected to decrease ongoing SG&A expenses by approximately $25 million during 1999. The loss of PRIMESTAR as a continuing customer will have a significant impact on the Company's satellite business. However, absent the failure of PRIMESTAR to honor its contractual commitments with the Company, the Company believes that the loss of PRIMESTAR's business will not have a material adverse effect on the Company's financial condition or results of operations. RESTRUCTURINGS. In the first half of 1997, in connection with the Distributions, the Company recorded pre-tax charges to cost of sales of $18 million for employee costs, which included a curtailment and settlement loss of $4 million, related to dividing the Distributing Company's Taiwan operations between the Company and General Semiconductor. Further, the Company recorded a charge of $6 million to SG&A expense for legal and other professional fees incurred in connection with the Distributions. These charges did not result in the reduction of future costs; therefore, they have not had and are not expected to have a significant impact on the Company's results of operations and cash flows. 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 has not experienced reduced revenues as a result of the closure of this manufacturing facility since the products previously manufactured at this location are currently being manufactured by subcontractors in the U.S. and were sold by the Company during 1998. The Company also decided to close its corporate office and move from Chicago, Illinois to Horsham, Pennsylvania. The closure of the Chicago corporate office was completed during the first quarter of 1998. As a result of the above actions, the Company recorded a pre-tax charge of $36 million during the fourth quarter of 1997, which included $15 million for severance and other employee separation costs, $11 million for costs associated with the closure of the facilities and $10 million related to the write-off of fixed assets at these facilities. Of these charges, $21 million were recorded as cost of sales, $14 million as SG&A expense and $1 million as research and development expense. All of the fourth quarter severance and other employee separation costs were paid by the end 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 (see Note 5). These restructuring costs provided cost savings in certain satellite production processes; however, declining demand for certain satellite products has substantially offset the cost reductions. 15 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 SG&A and $1 million as research and development expense. As of December 31, 1998, approximately $1 million of the first quarter severance costs remain to be paid and will be paid during 1999 (see Note 5). In connection with the developments related to PRIMSTAR, in February 1999, 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 expects to take a pre-tax charge during the first quarter of 1999 of approximately $15 million, for severance and facility consolidation costs. OTHER CHARGES. In the fourth quarter of 1997, the Company recorded $61 million ($44 million net of tax) of other charges, partially offset by $11 million ($7 million net of tax) of other income, described below. In conjunction with the assessment of the satellite business, management concluded that future sales of certain satellite products would not be sufficient to recover the carrying value of related inventory. Accordingly, the Company recorded a $43 million charge to write-down inventory to its lower of cost or market. Concurrent with this inventory write-down, management reviewed the fixed assets and equipment related to production and testing associated with these products and concluded that their carrying value would no longer be recoverable since such assets would no longer be utilized and, accordingly, the Company wrote-down such assets by $10 million to their estimated scrap value, which management believes approximated fair value. These fixed assets were not being utilized as of December 31, 1997 and 1998. A portion of these fixed assets have been disposed of and the Company expects that the remaining assets will be disposed of during 1999. The Company incurred approximately $8 million of professional fees related to the assessment of the satellite business. Of the $61 million of charges, $45 million were recorded as cost of sales, $8 million were recorded as SG&A expense and $8 million were recorded as research and development expense. The $61 million of other charges were partially offset by $11 million of other income related to investment gains and income associated with the reversal of accrued interest related to the final NLC Litigation settlement on the date the court issued its final ruling. 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, shut down 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 income (expense)-net," related to costs incurred by the Partnership, which the Company accounts for under the equity method. Such costs are primarily related to the BBT litigation settlement (see Note 16) and compensation expense related to key executives of an acquired company (see Note 6). COMPARISON OF RESULTS OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 1997 WITH THE YEAR ENDED DECEMBER 31, 1996 NET SALES. Net sales for the year ended December 31, 1997 were $1,764 million compared to $1,756 million for the year ended December 31, 1996. Net sales in 1997 when compared to 1996 reflect higher sales of digital cable TV systems and interactive advanced analog TV systems, offset by lower sales of basic analog cable TV systems, cable transmission network systems, digital satellite receivers and private/commercial network satellite systems. Analog and digital products represented 58% and 42%, respectively, of total sales in 1997 compared to 67% and 33%, respectively, of total sales in 1996. 16 Worldwide broadband sales (consisting of digital and analog cable and wireless television systems and transmission network systems) increased $112 million, or 10%, to $1,293 million in 1997 primarily as a result of increased U.S. sales volumes of digital cable TV terminals and headends and CFT advanced analog cable TV terminals, partially offset by lower sales of basic analog cable and transmission network systems. These sales reflect the increasing commitment of U.S. cable television operators to deploy state-of-the-art digital and interactive advanced analog systems in order to offer advanced entertainment, interactive services and Internet access to their customers. International broadband sales increased $11 million, or 3%, to $403 million in 1997 and represented 31% of worldwide broadband sales in 1997 compared to 33% in 1996. Worldwide satellite sales of $462 million for the year ended December 31, 1997 decreased $113 million, or 20%, from 1996 primarily as a result of lower sales volumes of digital satellite receivers to PRIMESTAR. International satellite sales increased $41 million, or 59%, to $110 million in 1997, primarily as a result of higher Canadian sales. International satellite sales represented 24% of worldwide satellite sales in 1997 compared to 12% in 1996. NLC sales were $9 million in 1997. GROSS PROFIT. Gross profit increased $22 million, or 5%, to $428 million in 1997 from $406 million in 1996 and was 24% of sales in 1997 compared to 23% in 1996. Gross profit for the year ended December 31, 1997 was reduced by $84 million of charges primarily related to the closure of the Company's Puerto Rico satellite manufacturing facility, employee costs related to dividing the Distributing Company's Taiwan operations between the Company and General Semiconductor, Inc. and the write-down of inventories to their lower of cost or market (see Notes 1, 5 and 6). Gross profit for the year ended December 31, 1996 was reduced by $71 million of charges primarily related to the write-down of inventories to their lower of cost or market and the accrual of upgrade and product warranty liabilities in connection with the transition to the Company's next-generation digital products (see Note 6). The higher gross profit and gross profit margin in 1997 resulted from higher production volumes and ongoing cost reduction programs on digital and advanced analog products. SELLING, GENERAL AND ADMINISTRATIVE. SG&A expense was $215 million in 1997 compared to $174 million in 1996 and was 12% of sales in 1997 compared to 10% in 1996. SG&A expense for the year ended December 31, 1997 included $28 million of charges related to severance and other employee separation costs, costs associated with the closure of various facilities and legal and other professional fees incurred in connection with the Distributions (see Notes 1, 5 and 6), partially offset by a $5 million credit related to the collection of certain receivables previously considered to be uncollectible. SG&A expense in 1996 included $14 million of charges primarily related to employee separation costs due to the Distributing Company's plan to separate into three independent companies, the write-down of various fixed assets to their estimated fair values and the settlement of a litigation matter (see Notes 1, 5 and 6). SG&A base spending was also greater in 1997 than in 1996 as a result of increased marketing and field support for NLC's Nleve1(3)-Registered Trademark- telephony system and the Company's DVB-compliant digital satellite products and increased sales force, field support and marketing in international cable and satellite television markets. RESEARCH AND DEVELOPMENT. R&D expense increased $10 million, or 5%, to $208 million in 1997 from $198 million in 1996 and was 12% of sales in 1997 compared to 11% in 1996. R&D expense for the year ended December 31, 1997 included $9 million of charges primarily related to the write-down of fixed assets used in R&D activities to their estimated fair values (see Notes 5 and 6). R&D spending in 1997 reflects: the continued development of next-generation products, including high-speed data systems for cable and telephone networks, switched-digital access systems for fiber and twisted-pair networks, as well as the modification of existing products for international markets; the continued development of enhanced addressable analog terminals and advanced digital systems for cable and satellite television distribution; and product development and international expansion through strategic alliances. In addition, in 1997, the Company remained focused on reducing costs and enhancing the features of its digital cable and satellite television systems. The NLC business has expended approximately $50 million in research and development costs from the date of the Company's acquisition of the NLC business in 1995 through December 31, 1997. 17 OTHER INCOME (EXPENSE) - NET. Other income of $6 million for the year ended December 31, 1997 predominantly reflects investment gains, primarily from the sale of a portion of the Company's investment in Ciena Corporation. INTEREST INCOME (EXPENSE) - NET. Net interest expense represents an allocation of interest expense from the Distributing Company based upon the Company's net assets as a percentage of the total net assets of the Distributing Company through July 25, 1997, the date of the Distributions. Net interest expense allocated to the Company was $15 million for the year ended December 31, 1997 compared to $26 million in 1996. Subsequent to July 25, 1997, net interest income primarily represents actual interest earned on the Company's net cash balance and the net reversal of accrued interest subsequent to receiving a revised final judgment in the suit brought against NLC and the founders of NLC by DSC Communications Corporation and DSC Technologies Corporation (the "NLC Litigation"). On a pro forma basis, interest income was $6 million in 1997 compared to interest expense of $8 million in 1996 (see Note 4). INCOME TAXES. Through the date of the Distributions, income taxes were determined as if the Company had filed separate tax returns under its then existing structure for the periods presented. The Company recorded a provision for income taxes of $6 million and a benefit for income taxes of $53 million for the years ended December 31, 1997 and 1996, respectively. Excluding the restructuring and other net charges recorded in 1997 and 1996, the effective tax rates were 38% and 36%, respectively. The higher effective rate in 1997 resulted from a higher provision for state income taxes (see Note 14). RESTRUCTURINGS. In 1996, the Company recorded an $8 million charge to SG&A expense for the write-down of various assets to fair value. This charge consists principally of a $3 million write-down of a facility that the Company decided to vacate and a $4 million write-off of previously capitalized amounts related to a data processing systems project which the Company abandoned in 1996. These actions reduced depreciation expense associated with the assets written down. In the first half of 1997, in connection with the Distributions, the Company recorded pre-tax charges to cost of sales of $18 million for employee costs related to dividing the Distributing Company's Taiwan operations between the Company and General Semiconductor. Further the Company recorded a charge of $6 million to SG&A expense for legal and other professional fees incurred in connection with the Distributions. These charges do not result in the reduction of future costs; therefore, they have not had and are not expected to have a significant impact on the Company's results of operations and cash flows. Cash payments related to these charges were paid by the end of the first quarter of 1998. 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 reduced headcount by 1,100. This facility manufactured receivers used in the private network, commercial and consumer satellite markets for the reception of analog and digital television signals. The Company does not expect reduced revenues as a result of the closure of this manufacturing facility since the products previously manufactured at this location will be manufactured by subcontractors in the U.S. and will be sold by the Company during 1998. The Company also decided to close its corporate office and move from Chicago, Illinois to Horsham, Pennsylvania. The closure of the Chicago corporate office was completed during the first quarter of 1998. As a result of the above actions, the Company recorded a pre-tax charge of $36 million during the fourth quarter of 1997, which included $15 million for severance and other employee separation costs, $11 million for costs associated with the closure of the facilities and $10 million related to the write-off of fixed assets at these facilities. Of these charges, $21 million were recorded as cost of sales, $14 million as SG&A expense and $1 million as research and development expense. Through December 31, 1997, the Company made severance payments of $5 million to approximately 800 employees, and the remaining severance and other employee separation costs were paid by the end of 1998. Costs associated with the closure of facilities ("Facility Costs") include vacated long-term leases which are payable through the 18 end of the lease terms which extend through the year 2008 (see Note 5). These restructuring costs provided cost savings in certain satellite production processes; however, declining demand for certain satellite products has substantially offset the cost reductions. OTHER CHARGES. In the fourth quarter of 1996, the Company recorded $57 million ($35 million net of tax) of charges related to the Company's transition to next generation digital products and $20 million ($13 million net of tax) of other charges related to the write-down to the lower of cost or market, of inventory products the Company decided to discontinue and the settlement of a litigation matter. Of these charges, $71 million were recorded as cost of sales and related to the write-down of inventories to their estimated lower of cost or market and the accrual of contractual upgrade and product warranty liabilities in connection with the transition to the Company's next generation digital products. The remaining $6 million of charges were recorded as SG&A expense and related to the write-down of fixed assets to their estimated fair values and settlement of a litigation matter. All of the fourth quarter charges were utilized by the end of 1997. The following is a description of the $57 million of charges related to the Company's transition to next generation digital products: - - In the fourth quarter of 1996, the Company recorded a $47.9 million write-down of digital product inventory to its lower of cost or market as it became evident that the expected sales price, less costs to complete, would not be sufficient to recover the carrying value of the inventory. - - The initial sales of digital products occurred during the fourth quarter of 1996. At the time of the sale, the Company accrued warranty liability in accordance with its accounting policy in Note 3. However, during the fourth quarter of 1996, subsequent to the initial sale, the Company was required to rework the product to correct an unanticipated system issue. This rework resulted in an additional $1.6 million of warranty expense and was incurred prior to December 31, 1996. - - In addition, the Company recorded an additional $3.8 million warranty liability as it became evident in the fourth quarter of 1996 that the failure rates on certain satellite products would exceed the rate previously anticipated. At the time of the sale of this product, the Company accrued a warranty liability in accordance with its accounting policy in Note 3. - - Also, in December 1996, the Company contractually agreed to provide an upgrade at no charge related to its transition from the analog platform to digital products. The $3.4 million cost of this upgrade was accrued on the date the Company became contractually obligated to perform such upgrade. In the fourth quarter of 1997, the Company recorded $61 million ($44 million net of tax) of other charges offset by $11 million ($7 million net of tax) of other income, described below. In conjunction with the assessment of the satellite business, management concluded that future sales of certain satellite products would not be sufficient to recover the carrying value of related inventory. Accordingly, the Company recorded a $43 million charge to write-down inventory to its lower of cost or market. Concurrent with this inventory write-down, management reviewed the fixed assets and equipment related to production and testing associated with these products and concluded that their carrying value would no longer be recoverable since such assets would no longer be utilized and, accordingly, the Company wrote-down such assets by $10 million to their estimated scrap value, which management believes approximated fair value. These fixed assets were not being utilized as of December 31, 1997. A portion of these fixed assets have been disposed of and the Company expects that the remaining assets will be disposed of during 1999. The Company incurred approximately $8 million of professional fees related to the assessment of the satellite business. Of the $61 million of charges, $45 million were recorded as cost of sales, $8 million were recorded as SG&A expense and $8 million were recorded as research and development expense. The $61 million of other charges were partially offset by $11 million of other income related to investment gains and income associated with the reversal of accrued interest related to the final NLC Litigation settlement on the date the court issued its final ruling. 19 LIQUIDITY AND CAPITAL RESOURCES Prior to the Distributions, the Company participated in the Distributing Company's cash management program. To the extent the Company generated positive cash, such amounts were remitted to the Distributing Company. To the extent the Company experienced temporary cash needs for working capital purposes or capital expenditures, such funds were historically provided by the Distributing Company. At the date of the Distributions, $125 million of cash was transferred to the Company. For the years ended December 31, 1998 and 1997, cash provided by operations was $271 million and cash used in operations was $1 million, respectively. Cash provided by operations in 1998 primarily reflects cash generated from operations, partially offset by the R&D advance made to the Partnership and payments related to restructuring charges. Cash used in operations in 1997 primarily reflects the payment of the judgment in the NLC Litigation and the funding of NLC's operations, offset by cash generated by the operations of the broadband network systems business. At December 31, 1998, working capital was $437 million compared to $436 million at December 31, 1997. 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. During the years ended December 31, 1998 and 1997, the Company invested $92 million and $80 million, respectively, in equipment and facilities. In 1999, 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 $90 million. Additionally, during the years ended December 31, 1998 and 1997, the Company made investments of $34 million and $40 million, respectively. The Company's R&D expenditures were $244 million (including the $75 million charge for the R&D advance made to the Partnership) and $208 million for the years ended December 31, 1998 and 1997, respectively, and are expected to approximate $165 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 (excluding $116 million and $86 million of charges incurred in 1998 and 1997, respectively) in comparison to net interest expense of greater than 5 to 1; and (iii) maintenance of a leverage ratio comparing total indebtedness to EBITDA (excluding $116 million and $86 million of charges incurred in 1998 and 1997, respectively) 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. As of December 31, 1998, the Company was in compliance with all financial and operating covenants contained in the Credit Agreement and had available credit of $500 million. In January 1999, Sony Corporation purchased 7.5 million newly issued unregistered shares of Common Stock of the Company for $188 million. On September 9, 1998, the Company announced a share repurchase program authorizing the Company to repurchase up to 10 million shares of its outstanding Common Stock. Through December 31, 1998, the Company had repurchased a total of 6.3 million shares at a cost of $126.3 million. On July 17, 1998, the Company consummated a transaction with TCI, pursuant to which the Company acquired, in exchange for 21.4 million unregistered shares of the Company's Common Stock, certain assets, a license to certain intellectual property (which will enable the Company to conduct authorization services intended to provide the cable industry with a secure access control platform to support widespread deployment of digital terminals and related systems and applications) and a $50 million non-interest bearing note receivable. The net purchase price of $400 million was allocated primarily to the license acquired (see Note 7). 20 In January 1998, the Company transferred the net assets, principally technology, and the management and workforce of NLC to a newly formed limited partnership in exchange for approximately an 89% (subject to additional dilution) limited partnership interest. The technology transferred to the Partnership related to in-process research and development for the design and marketing of a highly innovative next-generation telecommunication broadband access system for the delivery of telephony, video and data from a telephone company central office to the home. Additionally, the Company advanced to the Partnership $75 million, utilizing available operating funds and borrowings under its Credit Agreement, in exchange for the Note. Since the repayment of the Note is solely dependent upon the results of the Partnership's research and development activities and the commercial success of its product development, the Company recorded a charge to fully reserve for the Note concurrent with the funding (see Note 8). 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. Through December 31, 1998, the Company has made $16 million of this $50 million investment. The Company expects to make the remaining equity investment during the first half of 1999. 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 and borrowings under the Credit Agreement. 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 (see Note 15), cash flows will be adequate to fund operations, research and development, capital expenditures, restructuring charges and investments. 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 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 in comparison to the prior year, and there can be no assurance that international sales will increase to 1997 levels in the near future. In order to support the Company's international product and marketing strategies, it is currently expected that the Company will add operations in foreign 21 markets in the following areas, among others: customer service, sales and expansion of manufacturing capacity at existing facilities. Although no assurance can be given, management expects that the expansion of international operations will not require significant increased levels of capital expenditures. 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. YEAR 2000 READINESS DISCLOSURE 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 for its IT and non-IT systems 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 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. To aid in communication with the Company's customers, suppliers and business partners, the Company has 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 22 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 being replaced include order entry systems, purchasing 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 plans to identify and replace and/or upgrade legacy business systems that are not Year 2000 compliant and are 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 test plans 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. In addition, the outside consulting firm is continuing to provide assistance in monitoring the Company's Year 2000 status and progress in areas such as: testing, internal and external communication and contingency planning. With respect to non-IT systems, the Company is actively analyzing its in-line manufacturing equipment in order to assess 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 is also evaluating 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 and non-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 the majority of its products in accordance with its adopted test plans and methodologies and is diligently working to complete testing and remediation (if necessary) of the remainder of its products (except for end of life products) by the end of the third quarter of 1999. As of March 1, 1999, the Company estimates that it has completed approximately 95% of the Year 2000 readiness analysis required for its Advanced Network Systems, Digital Network Systems and Transmission Network Systems products. As of March 1, 1999, the Company estimates that it has completed approximately 60% of the Year 2000 readiness analysis for its Satellite and Broadcast Network Systems products. For certain of the Company's satellite and broadcast products and the Company's national authorization center, testing and remediation (if necessary) is currently anticipated to be completed by the end of the third quarter of 1999. The Company has completed testing and remediation of substantially all of its IT and non IT internal systems, with the exception of certain minor systems which the Company expects to complete by the end of the third quarter of 1999. 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 March 1, 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 150 of these suppliers. The Company anticipates that this evaluation will be on-going through the remainder of 1999. 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. 23 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 March 1, 1999, the Company has spent approximately $2 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 is in the process of developing plans and procedures for its customer service division to assist customers with the transition through the Year 2000. Part of this plan will include 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" 24 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-K 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," "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, 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 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-K 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. ITEM 7A. 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 (see Notes 3 and 20 to the consolidated financial statements contained in Item 8). 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 December 31, 1998, a hypothetical 10% fluctuation in the exchange rate of foreign currencies applicable to the Company, principally the new Taiwan and Canadian dollars, would result in a net $4 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. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Reference is made to Item 14(a) for a list of financial statements filed as part of this Annual Report. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. 25 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT Information required by this Item is contained in the sections captioned "Management of the Company - Board of Directors of the Company," "Management of the Company - Executive Officers" and "Management of the Company - Section 16(a) Beneficial Ownership Reporting Compliance" included in the Proxy Statement for the Company's 1999 Annual Meeting of Stockholders (the "1999 Proxy Statement") and is incorporated herein by reference. ITEM 11. EXECUTIVE COMPENSATION Information required by this Item is contained in the sections captioned "Management of the Company - Executive Officer Compensation," "Management of the Company - Compensation of Directors," "Management of the Company - Stock Options," "Management of the Company - Pension Plan and SERP" and "Management of the Company - Severance Protection and Separation Agreements" in the 1999 Proxy Statement and is incorporated herein by reference. The sections captioned "Management of the Company - Compensation Committee Report on Compensation of Executive Officers" and "Performance Graph" in the 1999 Proxy Statement are not incorporated by reference herein. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT Information required by this Item is contained in the section captioned "Beneficial Ownership of Common Stock" in the 1999 Proxy Statement and is incorporated herein by reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Information required by this Item is contained in the section captioned "Management of the Company - Certain Relationships and Related Transactions" in the 1999 Proxy Statement and is incorporated herein by reference. 26 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
Page --------- (a) Documents Filed as Part of this Report: 1. FINANCIAL STATEMENTS. Independent Auditors' Report F-1 Consolidated Statements of Operations for the Years ended December 31, 1996, 1997, and 1998 F-2 Consolidated Balance Sheets as of December 31, 1997 and 1998 F-3 Consolidated Statements of Stockholders' Equity for the Years ended December 31, 1996, 1997, and 1998 F-4 Consolidated Statements of Cash Flows for the Years ended December 31, 1996, 1997, and 1998 F-5 Notes to Consolidated Financial Statements for the Years ended December 31, 1996, 1997, and 1998 F-6 2. FINANCIAL STATEMENT SCHEDULE. Independent Auditors' Report F-30 Schedule II - Valuation and Qualifying Accounts F-31 3. FINANCIAL STATEMENTS OF NEXT LEVEL COMMUNICATIONS L.P. (an unconsolidated majority owned investee) F-32 4. LIST OF EXHIBITS. See Index of Exhibits included on pages 29-30. (b) Reports on Form 8-K: None.
27 SIGNATURES Pursuant to the requirements of Section 13 or Section 15(d) 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 Date: March 31, 1999 By: /s/ EDWARD D. BREEN ------------------------------------------ Edward D. Breen CHAIRMAN OF THE BOARD AND CHIEF EXECUTIVE OFFICER Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Signature Title - ------------------------------------------------------------------------ -------------------------------------------------- /s/ EDWARD D. BREEN ------------------------------------------------ Chairman of the Board, President and Chief Edward D. Breen Executive Officer (Principal Executive Officer) /s/ ERIC M. PILLMORE ------------------------------------------------ Senior Vice President, Finance and Chief Financial Eric M. Pillmore Officer (Principal Financial Officer) /s/ MARC E. ROTHMAN ------------------------------------------------ Vice President, Financial Planning and Controller Marc E. Rothman (Principal Accounting Officer) /s/ JOHN SEELY BROWN ------------------------------------------------ Director John Seely Brown /s/ FRANK M. DRENDEL ------------------------------------------------ Director Frank M. Drendel /s/ LYNN FORESTER ------------------------------------------------ Director Lynn Forester /s/ THEODORE J. FORSTMANN ------------------------------------------------ Director Theodore J. Forstmann /s/ ALEX J. MANDL ------------------------------------------------ Director Alex J. Mandl /s/ DAN SCHAEFER ------------------------------------------------ Director Dan Schaefer Signature Date - ------------------------------------------------------------------------ ----------------------- /s/ EDWARD D. BREEN ------------------------------------------------ March 31, 1999 Edward D. Breen /s/ ERIC M. PILLMORE ------------------------------------------------ March 31, 1999 Eric M. Pillmore /s/ MARC E. ROTHMAN ------------------------------------------------ March 31, 1999 Marc E. Rothman /s/ JOHN SEELY BROWN ------------------------------------------------ March 31, 1999 John Seely Brown /s/ FRANK M. DRENDEL ------------------------------------------------ March 31, 1999 Frank M. Drendel /s/ LYNN FORESTER ------------------------------------------------ March 31, 1999 Lynn Forester /s/ THEODORE J. FORSTMANN ------------------------------------------------ March 31, 1999 Theodore J. Forstmann /s/ ALEX J. MANDL ------------------------------------------------ March 31, 1999 Alex J. Mandl /s/ DAN SCHAEFER ------------------------------------------------ March 31, 1999 Dan Schaefer
28 INDEX TO EXHIBITS
Exhibit Description 2.1* Agreement of Merger, dated as of July 25, 1997, between the Company and NextLevel Systems of Delaware, Inc. 3.1## Restated Certificate of Incorporation of the Company. 3.2## Certificate of Designation, Preferences and Rights of Series A Junior Participating Preferred Stock. 3.3## Amended and Restated By-Laws of the Company. 4.1*** Rights Agreement, dated as of June 12, 1997, between the Company and ChaseMellon Shareholder Services, L.L.C., as Rights Agent (the "Rights Agreement"), which includes, as Exhibit A thereto, the Certificate of Designation, Preferences and Rights of Series A Junior Participating Preferred Stock of the Company, as Exhibit B thereto, the Form of Right Certificate and as Exhibit C thereto, the Summary of Rights to Purchase Preferred Shares. 4.2**** Amendment, dated as of December 16, 1997, to the Rights Agreement. 4.3** Form of Warrant Issuance Agreement. 4.4### Specimen Form of the Company's Common Stock Certificate. 10.1* Employee Benefits Allocation Agreement, dated as of July 25, 1997, among the Company, CommScope, Inc. and General Semiconductor, Inc. 10.2* Debt and Cash Allocation Agreement, dated as of July 25, 1997, among the Company, CommScope, Inc. and General Semiconductor, Inc. 10.3* Insurance Agreement, dated as of July 25, 1997, among the Company, CommScope, Inc. and General Semiconductor, Inc. 10.4* Tax Sharing Agreement, dated as of July 25, 1997, among the Company, CommScope, Inc. and General Semiconductor, Inc. 10.5* Trademark License Agreement, dated as of July 25, 1997, among the Company, CommScope, Inc. and General Semiconductor, Inc. 10.6* Transition Services Agreement, dated as of July 25, 1997, between the Company and General Semiconductor, Inc. 10.7* Transition Services Agreement, dated as of July 25, 1997, between the Company and CommScope, Inc. 10.8* Credit Agreement, dated as of July 23, 1997, among the Company, Certain Banks, The Chase Manhattan Bank, as Administrative Agent, and The Chase Manhattan Bank, Bank of America National Trust and Savings Association, BankBoston, N.A., The Bank of Nova Scotia, Bank of Tokyo-Mitsubishi Trust Company, Caisse Nationale de Credit Agricole, CIBC Inc., Deutsche Bank, A.G., New York Branch and/or Cayman Islands Branch, The Fuji Bank Limited and NationsBank, N.A. as Co-Agents. 10.9# First Amendment, dated as of March 18, 1998, to the Credit Agreement, dated as of July 23, 1997, among the Company, certain banks, the Chase Manhattan Bank as Administrative Agent, and certain other banks as Co-Agents. 10.10## Asset Purchase Agreement among TCIVG-GIC, Inc., NDTC Technology, Inc. and the Company dated as of June 17, 1998. 10.11## License Agreement by and between NDTC Technology, Inc. and the Company dated as of July 17, 1998. 10.12 Stock Purchase Agreement by and between Sony Corporation of America and the Company dated November 30, 1998. 10.13*+ The Company's 1997 Long-Term Incentive Plan. 10.14*****+ Form of Severance Protection Agreement between the Company and certain executive officers. 10.15**+ The Company's Annual Incentive Plan.
29
Exhibit Description 10.16**+ The Company's Deferred Compensation Plan. 10.17**+ The Company's Supplemental Executive Retirement Plan. 21 Subsidiaries of the Company. 23 Consent of Deloitte & Touche LLP. 27 Financial Data Schedule. 99 Forward-Looking Information.
All other exhibits are not applicable. - -------------------------- * Incorporated herein by reference from the Company's Quarterly Report on Form 10-Q for the period ended June 30, 1997 (File No. 001-12925). ** Incorporated herein by reference from the Company's Annual Report on Form 10-K for the period ended December 31, 1997 (File No. 001-12925). *** Incorporated herein by reference from the Company's Registration Statement on Form 8-A, filed with the Commission on June 30, 1997 (File No. 001-12925). **** Incorporated herein by reference from the Company's Current Report on Form 8-K dated as of December 17, 1997 (File No. 001-12925). ***** Incorporated herein by reference from the Company's Quarterly Report on Form 10-Q for the period ended September 30, 1997 (File No. 001-12925). # Incorporated herein by reference from the Company's Quarterly Report on Form 10-Q for the period ended March 31, 1998 (File No. 001-12925). ## Incorporated herein by reference from the Company's Quarterly Report on Form 10-Q for the period ended June 30, 1998 (File No. 001-12925). ### Incorporated herein by reference from the Company's Quarterly Report on Form 10-Q for the period ended September 30, 1998 (File No. 001-12925). + Management contract or compensatory plan. 30 INDEPENDENT AUDITORS' REPORT To the Board of Directors and Stockholders of General Instrument Corporation: We have audited the accompanying consolidated balance sheets of General Instrument Corporation and its subsidiaries (formerly NextLevel Systems, Inc. and, prior thereto, the Communications Business of the former General Instrument Corporation) as of December 31, 1998 and 1997, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1998. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of General Instrument Corporation and its subsidiaries at December 31, 1998 and 1997, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1998 in conformity with generally accepted accounting principles. /s/ DELOITTE & TOUCHE LLP - ----------------------------- DELOITTE & TOUCHE LLP Parsippany, New Jersey February 9, 1999 F-1 GENERAL INSTRUMENT CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS
Year Ended December 31, ---------------------------------- (In thousands, except per share amounts) 1998 1997 ---------------- ---------------- NET SALES $ 1,987,825 $ 1,764,088 Cost of sales 1,431,327 1,336,482 ---------------- ---------------- GROSS PROFIT 556,498 427,606 ---------------- ---------------- OPERATING EXPENSES: Selling, general and administrative 193,637 215,404 Research and development 244,295 207,826 Amortization of excess of cost over fair value of net assets acquired 14,319 14,571 NLC litigation costs -- -- ---------------- ---------------- Total operating expenses 452,251 437,801 ---------------- ---------------- OPERATING INCOME (LOSS) 104,247 (10,195) Other income (expense) - net (including equity interest in Partnership losses of $25,089 for the year ended December 31, 1998) (11,815) 5,766 Interest income (expense) - net 1,217 (5,210) ---------------- ---------------- INCOME (LOSS) BEFORE INCOME TAXES 93,649 (9,639) (Provision) benefit for income taxes (38,199) (6,474) ---------------- ---------------- NET INCOME (LOSS) $ 55,450 $ (16,113) ---------------- ---------------- Pro Forma Loss Per Share - Basic and Diluted $ (0.11) ---------------- Pro Forma Weighted - Average Shares Outstanding 147,523 Earnings Per Share - Basic $ 0.35 ---------------- Earnings Per Share - Diluted $ 0.33 ---------------- Weighted - Average Shares Outstanding - Basic 159,547 Weighted - Average Shares Outstanding - Diluted 168,952 (In thousands, except per share amounts) 1996 ---------------- NET SALES $ 1,755,585 Cost of sales 1,349,815 ---------------- GROSS PROFIT 405,770 ---------------- OPERATING EXPENSES: Selling, general and administrative 174,432 Research and development 198,071 Amortization of excess of cost over fair value of net assets acquired 14,278 NLC litigation costs 141,000 ---------------- Total operating expenses 527,781 ---------------- OPERATING INCOME (LOSS) (122,011) Other income (expense) - net (including equity interest in Partnership losses of $25,089 for the year ended December 31, 1998) (1,427) Interest income (expense) - net (25,970) ---------------- INCOME (LOSS) BEFORE INCOME TAXES (149,408) (Provision) benefit for income taxes 53,098 ---------------- NET INCOME (LOSS) $ (96,310) ---------------- Pro Forma Loss Per Share - Basic and Diluted $ (0.65) ---------------- Pro Forma Weighted - Average Shares Outstanding 147,315 Earnings Per Share - Basic Earnings Per Share - Diluted Weighted - Average Shares Outstanding - Basic Weighted - Average Shares Outstanding - Diluted
See notes to consolidated financial statements. F-2 GENERAL INSTRUMENT CORPORATION CONSOLIDATED BALANCE SHEETS
December 31, ---------------- (In thousands, except share data) 1998 ---------------- ASSETS Cash and cash equivalents $ 148,675 Short-term investments 4,865 Accounts receivable, less allowance for doubtful accounts of $3,833 and $3,566, respectively (includes accounts receivable from related party of $81,075 at December 31, 1998) 340,039 Inventories 281,451 Deferred income taxes 100,274 Other current assets 15,399 ---------------- Total current assets 890,703 Property, plant and equipment, net 237,131 Intangibles, less accumulated amortization of $97,630 and $86,333, respectively 497,696 Excess of cost over fair value of net assets acquired, less accumulated amortization of $122,110 and $108,123, respectively 455,466 Deferred income taxes 1,999 Investments and other assets 104,765 ---------------- TOTAL ASSETS $ 2,187,760 ---------------- LIABILITIES AND STOCKHOLDERS' EQUITY Accounts payable $ 267,565 Other accrued liabilities 186,113 ---------------- Total current liabilities 453,678 Deferred income taxes 15,913 Other non-current liabilities 67,998 ---------------- Total liabilities 537,589 ---------------- Commitments and contingencies (See Notes 16 and 21) 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; 173,393,275 and 148,358,188 shares issued, respectively 1,734 Additional paid-in capital 1,742,824 Note receivable from stockholder (40,615) Retained earnings (accumulated deficit) 36,214 Accumulated other comprehensive income, net of taxes of $1,020 and $11,347, respectively 2,845 ---------------- 1,743,002 Less - Treasury Stock, at cost, 4,619,069 and 4,309 shares, respectively (92,831) ---------------- Total stockholders' equity 1,650,171 ---------------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 2,187,760 ---------------- (In thousands, except share data) 1997 ---------------- ASSETS Cash and cash equivalents $ 35,225 Short-term investments 30,346 Accounts receivable, less allowance for doubtful accounts of $3,833 and $3,566, respectively (includes accounts receivable from related party of $81,075 at December 31, 1998) 343,625 Inventories 288,078 Deferred income taxes 105,582 Other current assets 21,862 ---------------- Total current assets 824,718 Property, plant and equipment, net 236,821 Intangibles, less accumulated amortization of $97,630 and $86,333, respectively 82,546 Excess of cost over fair value of net assets acquired, less accumulated amortization of $122,110 and $108,123, respectively 471,186 Deferred income taxes 5,634 Investments and other assets 54,448 ---------------- TOTAL ASSETS $ 1,675,353 ---------------- LIABILITIES AND STOCKHOLDERS' EQUITY Accounts payable $ 200,817 Other accrued liabilities 188,250 ---------------- Total current liabilities 389,067 Deferred income taxes 5,745 Other non-current liabilities 65,730 ---------------- Total liabilities 460,542 ---------------- Commitments and contingencies (See Notes 16 and 21) 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; 173,393,275 and 148,358,188 shares issued, respectively 1,484 Additional paid-in capital 1,213,566 Note receivable from stockholder -- Retained earnings (accumulated deficit) (19,236) Accumulated other comprehensive income, net of taxes of $1,020 and $11,347, respectively 18,999 ---------------- 1,214,813 Less - Treasury Stock, at cost, 4,619,069 and 4,309 shares, respectively (2) ---------------- Total stockholders' equity 1,214,811 ---------------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 1,675,353 ----------------
See notes to consolidated financial statements. F-3 GENERAL INSTRUMENT CORPORATION CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Note Retained Common Stock Additional Receivable Earnings --------------------- Paid-In From (Accumulated (In thousands) Shares Amount Capital Stockholder Deficit) ---------- --------- ------------- ------------- ------------- BALANCE, JANUARY 1, 1996 -- $ -- $ -- $ -- $ -- Comprehensive loss Net loss -- -- -- -- -- Total comprehensive loss Transfers from the Distributing Company -- -- -- -- -- Other transactions with the Distributing Company -- -- -- -- -- ---------- --------- ------------- ------------- ------------- BALANCE, DECEMBER 31, 1996 -- -- -- -- -- Comprehensive income Net income (loss) -- -- -- -- (19,236) Other comprehensive income (loss), net-of-tax: Unrealized gains (losses) on available-for-sale securities, net of reclassification adjustment (see Note 10) -- -- -- -- -- Total comprehensive income Transfers from the Distributing Company -- -- -- -- -- Other transactions with the Distributing Company -- -- -- -- -- Spin-off from the Distributing Company 147,315 1,473 1,195,948 -- -- Exercise of stock options and related tax benefit 679 7 10,362 -- -- Stock issued in connection with a business acquisition 358 4 6,996 -- -- Other 6 -- 260 -- -- ---------- --------- ------------- ------------- ------------- BALANCE, DECEMBER 31, 1997 148,358 1,484 1,213,566 -- (19,236) Comprehensive income Net income -- -- -- -- 55,450 Other comprehensive income, net-of-tax: Unrealized losses on available-for-sale se- curities, net of reclassification adjustment (see Note 10) -- -- -- -- -- Total comprehensive income Treasury stock purchases (6,278 shares) -- -- -- -- -- Exercise of stock options and related tax benefit (5,342 shares, of which 1,663 shares were issued from Treasury) 3,679 37 64,501 -- -- Stock issued in connection with an acquisition 21,356 213 442,923 (43,320) -- Payment of note receivable from stockholder -- -- -- 2,705 -- Warrant costs related to customer purchases -- -- 21,834 -- -- ---------- --------- ------------- ------------- ------------- BALANCE, DECEMBER 31, 1998 173,393 $ 1,734 $ 1,742,824 $ (40,615) $ 36,214 ---------- --------- ------------- ------------- ------------- Accumulated Other Common Total Comprehensive Stock In Divisional Stockholders' (In thousands) Income Treasury Net Equity Equity --------------- ------------ -------------- ------------- BALANCE, JANUARY 1, 1996 $ -- $ -- $ 926,168 $ 926,168 Comprehensive loss Net loss -- -- (96,310) (96,310) ------------- Total comprehensive loss (96,310) Transfers from the Distributing Company -- -- 226,370 226,370 Other transactions with the Distributing Company -- -- (5,054) (5,054) --------------- ------------ -------------- ------------- BALANCE, DECEMBER 31, 1996 -- -- 1,051,174 1,051,174 Comprehensive income Net income (loss) -- -- 3,123 (16,113) Other comprehensive income (loss), net-of-tax: Unrealized gains (losses) on available-for-sale securities, net of reclassification adjustment (see Note 10) (2,577) -- 21,576 18,999 ------------- Total comprehensive income 2,886 Transfers from the Distributing Company -- -- 125,310 125,310 Other transactions with the Distributing Company -- -- 17,814 17,814 Spin-off from the Distributing Company 21,576 -- (1,218,997) -- Exercise of stock options and related tax benefit -- -- -- 10,369 Stock issued in connection with a business acquisition -- -- -- 7,000 Other -- (2) -- 258 --------------- ------------ -------------- ------------- BALANCE, DECEMBER 31, 1997 18,999 (2) -- 1,214,811 Comprehensive income Net income -- -- -- 55,450 Other comprehensive income, net-of-tax: Unrealized losses on available-for-sale se- curities, net of reclassification adjustment (see Note 10) (16,154) -- -- (16,154) ------------- Total comprehensive income 39,296 Treasury stock purchases (6,278 shares) -- (126,300) -- (126,300) Exercise of stock options and related tax benefit (5,342 shares, of which 1,663 shares were issued from Treasury) -- 33,471 -- 98,009 Stock issued in connection with an acquisition -- -- -- 399,816 Payment of note receivable from stockholder -- -- -- 2,705 Warrant costs related to customer purchases -- -- -- 21,834 --------------- ------------ -------------- ------------- BALANCE, DECEMBER 31, 1998 $ 2,845 $ (92,831) $ -- $ 1,650,171 --------------- ------------ -------------- -------------
See notes to consolidated financial statements. F-4 GENERAL INSTRUMENT CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended December 31, ------------------------------ (In thousands) 1998 1997 -------------- -------------- OPERATING ACTIVITIES: Net income (loss) $ 55,450 $ (16,113) Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: Depreciation and amortization 83,564 89,857 Warrant costs related to customer purchases 21,834 -- Gain on sale of short-term investment (11,429) (10,667) NLC litigation costs, net -- -- Losses from asset sales and write-downs, net 20,569 19,486 Loss from equity investment 25,089 -- Changes in assets and liabilities: Accounts receivable (4,738) 57,557 Inventories (4,773) (22,637) Prepaid expenses and other current assets 1,350 7,919 Deferred income taxes (278) 5,237 Non-current assets (2,504) 1,226 Accounts payable and other accrued liabilities 83,933 (11,245) NLC litigation payment -- (140,692) Other non-current liabilities 2,268 18,955 Other 454 617 -------------- -------------- Net cash provided by (used in) operating activities 270,789 (500) -------------- -------------- INVESTING ACTIVITIES: Additions to property, plant and equipment (91,760) (79,828) Investments in other assets (31,387) (32,770) Acquisitions, net of cash acquired (2,150) (6,980) Proceeds from sale of short-term investment 11,429 10,667 Proceeds from sale of assets -- 10,529 -------------- -------------- Net cash used in investing activities (113,868) (98,382) -------------- -------------- FINANCING ACTIVITIES: Transfers from Distributing Company -- 125,310 Proceeds from stock option exercises 80,124 9,363 Purchase of treasury shares (126,300) -- Payment of note receivable from stockholder 2,705 -- Other -- (566) -------------- -------------- Net cash provided by (used in) financing activities (43,471) 134,107 -------------- -------------- Change in cash and cash equivalents 113,450 35,225 Cash and cash equivalents, beginning of year 35,225 -- -------------- -------------- Cash and cash equivalents, end of year $ 148,675 $ 35,225 -------------- -------------- (In thousands) 1996 -------------- OPERATING ACTIVITIES: Net income (loss) $ (96,310) Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: Depreciation and amortization 84,500 Warrant costs related to customer purchases -- Gain on sale of short-term investment -- NLC litigation costs, net 91,650 Losses from asset sales and write-downs, net 11,974 Loss from equity investment -- Changes in assets and liabilities: Accounts receivable (160,550) Inventories (42,450) Prepaid expenses and other current assets (2,185) Deferred income taxes (3,978) Non-current assets 3,327 Accounts payable and other accrued liabilities 60,108 NLC litigation payment -- Other non-current liabilities (26,079) Other 3,347 -------------- Net cash provided by (used in) operating activities (76,646) -------------- INVESTING ACTIVITIES: Additions to property, plant and equipment (134,353) Investments in other assets (3,700) Acquisitions, net of cash acquired (11,671) Proceeds from sale of short-term investment -- Proceeds from sale of assets -- -------------- Net cash used in investing activities (149,724) -------------- FINANCING ACTIVITIES: Transfers from Distributing Company 226,370 Proceeds from stock option exercises -- Purchase of treasury shares -- Payment of note receivable from stockholder -- Other -- -------------- Net cash provided by (used in) financing activities 226,370 -------------- Change in cash and cash equivalents -- Cash and cash equivalents, beginning of year -- -------------- Cash and cash equivalents, end of year $ -- --------------
See notes to consolidated financial statements. F-5 GENERAL INSTRUMENT CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands, except per share data, 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") (see Note 8), the Company provides next-generation broadband access solutions for local telephone companies with the Partnership's NLevel(3)-Registered Trademark-Switched Digital Access System ("NLevel(3)"). 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 "Distributions"). 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. 2. BASIS OF PRESENTATION The consolidated financial statements include an allocation of certain assets, liabilities and general corporate expenses from the Distributing Company for the periods prior to the Distributions. In the opinion of management, general corporate administrative expenses have been allocated to the Company on a reasonable and consistent basis by management of the Distributing Company using estimates of the relative efforts provided to the Company by the Distributing Company. However, it is not practicable to determine the actual costs that would have been incurred if the Company operated on a stand-alone basis; accordingly, such allocations may not necessarily be indicative of the level of expenses which would have been incurred had the Company been operating as a separate stand-alone entity during the periods prior to the Distributions. Prior to the Distributions, the Company participated in the Distributing Company's cash management program, and the accompanying consolidated financial statements include an allocation of net interest expense from the Distributing Company for the periods prior to the Distributions. To the extent the Company generated positive cash, such amounts were remitted to the Distributing Company. To the extent the Company experienced temporary cash needs for working capital purposes or capital expenditures, such funds were historically provided by the Distributing Company. The net effect of these transactions is reflected in stockholders' equity. Net interest expense has been allocated based upon the Company's net assets as a percentage of the total net assets of the Distributing Company. The allocations were made consistently in each F-6 NOTES (Dollars in thousands, except per share data, unless otherwise noted) period, and management believes the allocations are reasonable. However, these interest costs would not necessarily be indicative of what the actual costs would have been had the Company operated as a separate, stand-alone entity. Subsequent to the Distributions, the Company is responsible for all cash management functions using its own resources or purchased services and is responsible for the costs associated with operating as a public company. Prior to the Distributions, the Company's financial results included the costs incurred under the Distributing Company's pension and postretirement benefit plans for employees and retirees of the Company. Subsequent to the Distributions, the Company's financial results include the costs incurred under the Company's own pension and postretirement benefit plans. The provision for income taxes for the periods prior to the Distributions was based on the Company's expected annual effective tax rate calculated assuming the Company had filed separate tax returns under its then existing structure. Subsequent to the Distributions, the provision for income taxes is based on the Company's actual results for that period. The financial information included herein, related to the periods prior to the Distributions, may not necessarily reflect the consolidated results of operations, financial position, changes in stockholders' equity and cash flows of the Company since the Company was not a separate stand-alone entity. 3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES PRINCIPLES OF CONSOLIDATION. The accompanying consolidated financial statements include the accounts of General Instrument and its wholly-owned subsidiaries. Investments in which the Company exercises significant influence, but which it does not control, are accounted for under the equity method of accounting. Investments in which the Company has less than a 20% ownership interest, and does not exercise significant influence, are accounted for at cost. All intercompany accounts and transactions have been eliminated. USE OF ESTIMATES. The preparation of the accompanying consolidated financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting periods. Actual results could differ from those estimates. REVENUE RECOGNITION. The Company recognizes revenue when products are shipped and services are performed. Revenues generated by services performed and the costs of those services are not material. PRODUCT WARRANTY. The Company warrants its products against defects and accrues estimated warranty expense at the time of sale. Actual warranty costs incurred are charged against the accrual when paid. CASH EQUIVALENTS. The Company considers all highly liquid debt instruments with a maturity of three months or less at the date of purchase to be cash equivalents. SHORT-TERM INVESTMENTS. Marketable equity securities held by the Company are classified as "available-for-sale" securities and reported at fair value. Any unrealized holding gains and losses, net of taxes, are excluded from operating results and are recognized as a separate component of stockholders' equity until realized. Fair value of the securities is determined based on market prices and realized gains and losses are determined using the securities' cost. The Company held no debt securities during any period presented. INVENTORIES. Inventories are stated at the lower of cost, determined on a first-in, first-out basis, or market. PROPERTY, PLANT AND EQUIPMENT. Property, plant and equipment are stated at cost. Provisions for depreciation are based on estimated useful lives of the assets using the straight-line method. Useful lives are 5 to 35 years for buildings and improvements; economic useful life or lease term, whichever is shorter, for leasehold improvements and 3 to 10 years for machinery and equipment. INTANGIBLE ASSETS. 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 F-7 NOTES (Dollars in thousands, except per share data, unless otherwise noted) actual revenues for the period and the denominator of which is the expected revenues from the license during its 20-year term (see Note 7). Intangible assets also include patents, which are being amortized on a straight-line basis over 5 to 17 years. Management believes that, as of December 31, 1998, the carrying values and remaining lives of such assets are appropriate. EXCESS OF COST OVER FAIR VALUE OF NET ASSETS ACQUIRED. The excess of cost over fair value of net assets acquired is being amortized on a straight-line basis over 30 to 40 years. Management continually reassesses the appropriateness of both the carrying value and remaining life of the excess of cost over fair value of net assets acquired by assessing recoverability based on forecasted operating cash flows, on an undiscounted basis, and other factors. Management believes that, as of December 31, 1998, the carrying value and remaining life of the excess of cost over fair value of net assets acquired are appropriate. LONG-LIVED ASSETS. Whenever events indicate that the carrying values of long-lived assets or identifiable intangibles, and the goodwill related to those assets, may not be recoverable, the Company evaluates the carrying values of such assets using future undiscounted cash flows. If the sum of the expected undiscounted future cash flows is less than the carrying amount of the asset, the Company will recognize an impairment loss equal to the difference between the fair value and carrying value of such asset. The Company recorded significant impairment losses during the periods presented (see Notes 5 and 6). Management believes that, as of December 31, 1998, the carrying values of such assets are appropriate. FOREIGN CURRENCY TRANSLATION. The Company has determined the U.S. dollar to be the functional currency of its foreign operations. Accordingly, gains and losses recognized as a result of translating foreign operations' monetary assets and liabilities from local currencies to U.S. dollars are reflected in the accompanying consolidated statements of operations. For periods prior to the Distributions, the Company had been considered in the Distributing Company's overall risk management strategy to reduce its exposure to adverse movements in foreign exchange rates. To limit foreign currency exposure on monetary assets and liabilities, the Distributing Company, on behalf of the Company, and subsequent to the Distributions, the Company entered into foreign currency forward exchange contracts on a month-to-month basis. BENEFIT PLANS. Prior to the Distributions, the Company participated in the Distributing Company's sponsored non-contributory, defined benefit pension plans covering substantially all employees of the Company. Subsequent to the Distributions, substantially all employees are covered by defined benefit pension plans of the Company. The benefits under the plans are based on years of service and compensation levels. Contributions to pension funds are made when actuarial computations prescribe such funding. INCOME TAXES. The Company's operating results for periods prior to the Distributions were included in the Distributing Company's consolidated U.S. and state income tax returns and in the tax returns of certain of the Distributing Company's foreign subsidiaries. Through the date of the Distributions, the provision for income taxes was based on the Company's expected annual effective tax rate calculated assuming the Company had filed separate tax returns under its then existing structure. Subsequent to the Distributions, the provision for income taxes is based on the Company's actual results for that period. Deferred income taxes reflect the future tax consequences of differences between the financial reporting and tax bases of assets and liabilities. Deferred income taxes have been provided for the income tax liability that would be incurred on the repatriation of undistributed earnings of the Company's foreign subsidiaries, except for locations where the Company has designated earnings to be permanently reinvested. EARNINGS PER SHARE AND PRO FORMA LOSS PER SHARE. On December 31, 1997, the Company adopted Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings per Share," which replaces primary and fully diluted earnings per share calculated under Accounting Principles Board Opinion ("APB") No. 15, "Earnings per Share," with basic and diluted earnings per share. Basic earnings per share is computed by dividing net income by the weighted-average number of common shares outstanding. Diluted earnings per share is computed by dividing net income by the weighted-average number of common and common equivalent shares outstanding adjusted for the dilutive effect of stock options and warrants (unless such common stock equivalents would be anti-dilutive), and the computation of diluted earnings per share assumes the exercise of stock options and warrants using F-8 NOTES (Dollars in thousands, except per share data, unless otherwise noted) the treasury stock method. For the year ended December 31, 1998 the calculation of diluted weighted-average shares outstanding included the dilutive effects of stock options and warrants of 2,575 and 6,830 shares, respectively. Prior to the Distributions, the Company did not have its own capital structure, and pro forma per share information has been presented for the years ended December 31, 1997 and 1996. The pro forma weighted-average number of shares outstanding used in the pro forma per share calculation for 1996 equaled the number of common shares issued on the date of the Distributions, and for 1997, included the number of common shares issued on the date of the Distributions plus the actual share activity during the period subsequent to the Distributions. Further, since the computation of diluted loss per share is anti-dilutive for the years ended December 31, 1997 and 1996, the amounts reported for pro forma basic and diluted loss per share are the same. RECLASSIFICATIONS. Certain prior year amounts have been reclassified to conform with the current year presentation. NEW ACCOUNTING PRONOUNCEMENTS NOT YET ADOPTED. In June 1998, SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," was issued and is effective for fiscal years beginning after June 15, 1999. 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. 4. PRO FORMA FINANCIAL INFORMATION (UNAUDITED) The unaudited pro forma consolidated statements of operations presented below were prepared to give effect to the Distributions as if they had occurred on January 1, 1996. The unaudited pro forma statements of operations set forth below do not purport to represent what the Company's operations actually would have been had the Distributions occurred on January 1, 1996 or to project the Company's operating results for any future period. The unaudited pro forma information has been prepared utilizing the historical consolidated statements of operations of the Company which were adjusted to reflect: (i) an additional $4 million and $7 million of selling, general and administrative ("SG&A") costs for the years ended December 31, 1997 and 1996, respectively, to eliminate the allocation of corporate expenses to CommScope and General Semiconductor, as such costs subsequent to the Distributions are no longer allocable and (ii) a net debt level of $100 million at the beginning of each period presented through July 25, 1997, the date of the Communications Distribution. Year Ended December 31, -------------------- 1997 1996 --------- --------- Net sales $1,764,088 $1,755,585 Cost of sales 1,336,482 1,349,815 --------- --------- Gross profit 427,606 405,770 --------- --------- Operating expenses: Selling, general and administrative 219,004 181,032 Research and development 207,826 198,071 Amortization of excess of cost over fair value of net assets acquired 14,571 14,278 NLC litigation costs -- 141,000 --------- --------- Total operating expenses 441,401 534,381 --------- --------- Operating loss (13,795) (128,611) Other income (expense), net 5,766 (1,427) Interest income (expense), net 5,631 (7,595) --------- --------- Loss before income taxes (2,398) (137,633) (Provision) benefit for income taxes (9,269) 48,989 --------- --------- Net loss $ (11,667) $ (88,644) --------- --------- Weighted-average shares outstanding 147,523 147,315 Loss per share - basic and diluted $ (0.08) $ (0.60)
5. RESTRUCTURINGS In December 1996, the Distributing Company committed to certain restructuring actions not related to the Distributions. These actions resulted in a charge of $8 million to SG&A expense for the write-down of various assets to fair value. This charge consists principally of a $3 million write-down of a facility that the Company decided to vacate and a $4 million write-off of previously capitalized amounts related to a data processing systems project which the Company abandoned in 1996. In the first half of 1997, in connection with the Distributions (see Note 1), the Company recorded pre-tax charges of $18 million to cost of sales for employee costs, which included a curtailment and settlement loss of $4 million (see Note 17), related to dividing the Distributing Company's Taiwan operations between the Company and General Semiconductor. Further, the Company recorded F-9 NOTES (Dollars in thousands, except per share data, unless otherwise noted) a charge of $6 million to SG&A expense for legal and other professional fees incurred in connection with the Distributions. 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 has not experienced reduced revenues as a result of the closure of this manufacturing facility since the products previously manufactured at this location are currently being manufactured by subcontractors in the U.S. and were sold by the Company during 1998. The Company also decided to close its corporate office and move from Chicago, Illinois to Horsham, Pennsylvania. The closure of the Chicago corporate office was completed during the first quarter of 1998. As a result of the above actions, the Company recorded a pre-tax charge of $36 million during the fourth quarter of 1997, which included $15 million for severance and other employee separation costs, $11 million for costs associated with the closure of the facilities and $10 million related to the write-off of fixed assets at these facilities. Of these charges, $21 million were recorded as cost of sales, $14 million as SG&A expense and $1 million as research and development expense. All of the fourth quarter severance and other employee separation costs were paid by the end of 1998. Costs associated with the closure of facilities ("Facility Costs") include vacated long-term leases which are payable through the end of the lease terms which extend through the year 2008. The $18 million and $21 million of restructuring charges described in the preceding two paragraphs were recorded to cost of sales during 1997 since they relate to the Taiwan and Puerto Rico manufacturing facilities. The costs of these facilities have historically been included in cost of sales; therefore, the restructuring charges related to these facilities have also been recorded in cost of sales. 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 SG&A and $1 million as research and development expense. The following tabular reconciliation summarizes the restructuring activity discussed above:
1996 1997 1998 -------------------- Balance -------------------- Balance -------------------- Amounts at Dec. 31, Amounts at Dec. 31, Amounts (in millions) Additions Utilized 1996 Additions Utilized 1997 Additions Utilized --------- --------- ----------- --------- --------- ------------ --------- --------- Property, Plant & Equipment (1) $4.2 $(3.3) $0.9 $10.4 $ (3.5) $ 7.8 $ 4.6 $(12.4) Facility Costs 3.0 -- 3.0 11.2 (3.7) 10.5 3.3 (10.0) Severance 0.4 (0.4) -- 32.7 (12.8) 19.9 7.6 (26.7) Professional Fees -- -- -- 6.0 (6.0) -- -- -- --------- --------- ----------- --------- --------- ------------ --------- --------- Total $7.6 $(3.7) $3.9 $60.3 $(26.0) $38.2 $15.5 $(49.1) --------- --------- ----------- --------- --------- ------------ --------- --------- Balance at Dec. 31, (in millions) 1998 ------------ Property, Plant & Equipment (1) $ -- Facility Costs 3.8 Severance 0.8 Professional Fees -- ------------ Total $4.6 ------------
(1) The amount provided represents a direct reduction to the property, plant and equipment balance to reflect the identified impaired assets at their fair value. The amounts utilized reflect the disposition of such identified impaired assets. 6. OTHER CHARGES In the fourth quarter of 1996, the Company recorded $57 million ($35 million net of tax) of charges related to the Company's transition to next generation digital products and $20 million ($13 million net of tax) of other charges related to the write-down to the lower of cost or market, of inventory products the Company decided to discontinue F-10 NOTES (Dollars in thousands, except per share data, unless otherwise noted) and the settlement of a litigation matter. Sales of the product the Company decided to discontinue were not material. Of these charges, $71 million were recorded as cost of sales and related to the write-down of inventories to their estimated lower of cost or market and the accrual of contractual upgrade and product warranty liabilities in connection with the transition to the Company's next generation digital products. The remaining $6 million of charges were recorded as SG&A expense and related to the write-down of fixed assets to their estimated fair values and settlement of a litigation matter. All of the fourth quarter charges were utilized by the end of 1997. The following is a description of the $57 million of charges related to the Company's transition to next generation digital products: - - In the fourth quarter of 1996, the Company recorded a $47.9 million write-down of digital product inventory to its lower of cost or market as it became evident that the expected sales price, less costs to complete, would not be sufficient to recover the carrying value of the inventory. - - The initial sales of digital products occurred during the fourth quarter of 1996. At the time of the sale, the Company accrued warranty liability in accordance with its accounting policy in Note 3. However, during the fourth quarter of 1996, subsequent to the initial sale, the Company was required to rework the product to correct an unanticipated system issue. This rework resulted in an additional $1.6 million of warranty expense and was incurred prior to December 31, 1996. - - In addition, the Company recorded an additional $3.8 million warranty liability as it became evident in the fourth quarter of 1996 that the failure rates on certain satellite products would exceed the rate previously anticipated. At the time of the sale of this product, the Company accrued a warranty liability in accordance with its accounting policy in Note 3. - - Also, in December 1996, the Company contractually agreed to provide an upgrade at no charge related to its transition from the analog platform to digital products. The $3.4 million cost of this upgrade was accrued on the date the Company became contractually obligated to perform such upgrade. In the fourth quarter of 1997, the Company recorded $61 million ($44 million net of tax) of other charges, partially offset by $11 million ($7 million net of tax) of other income, described below. In conjunction with the assessment of the satellite business, management concluded that future sales of certain satellite products would not be sufficient to recover the carrying value of related inventory. Accordingly, the Company recorded a $43 million charge to write-down inventory to its lower of cost or market. Concurrent with this inventory write-down, management reviewed the fixed assets and equipment related to production and testing associated with these products and concluded that their carrying value would no longer be recoverable since such assets would no longer be utilized and, accordingly, the Company wrote-down such assets by $10 million to their estimated scrap value, which management believes approximated fair value. These fixed assets were not being utilized as of December 31, 1998. A portion of these fixed assets have been disposed of and the Company expects that the remaining assets will be disposed of during 1999. The Company incurred approximately $8 million of professional fees related to the assessment of the satellite business. Of the $61 million of charges, $45 million were recorded as cost of sales, $8 million were recorded as SG&A expense and $8 million were recorded as research and development expense. The $61 million of other charges were partially offset by $11 million of other income related to investment gains and income associated with the reversal of accrued interest related to the final NLC Litigation settlement on the date the court issued its final ruling. 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, shut down 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 income (expense) - net," related to costs incurred by the Partnership, which the Company accounts for under the equity method. Such costs are primarily related to the BBT litigation settlement (see Note 16) and compensation expense related to key executives of an acquired company. F-11 NOTES (Dollars in thousands, except per share data, unless otherwise noted) The following tabular reconciliation summarizes the other charge activity discussed above:
1996 1997 1998 -------------------- Balance -------------------- Balance -------------------- Amounts at Dec. 31, Amounts at Dec. 31, Amounts (In millions) Additions Utilized 1996 Additions Utilized 1997 Additions Utilized --------- --------- ----------- --------- --------- ------------ --------- --------- Inventory(1) $64.4 $(4.2) $60.2 $42.6 $(59.5) $43.3 $15.0 $(43.3) Property, Plant & Equipment(1) 4.9 (1.7) 3.2 10.0 (4.8) 8.4 -- (1.1) Professional Fees & Other Costs 8.2 (7.1) 1.1 7.7 (5.6) 3.2 10.1 (13.3) Partnership Related Costs -- -- -- -- -- -- 8.4 (8.4) --------- --------- ----------- --------- --------- ------------ --------- --------- Total $77.5 $(13.0) $64.5 $60.3 $(69.9) $54.9 $33.5 $(66.1) --------- --------- ----------- --------- --------- ------------ --------- --------- Balance at Dec. 31, (In millions) 1998 ------------ Inventory(1) $15.0 Property, Plant & Equipment(1) 7.3 Professional Fees & Other Costs -- Partnership Related Costs -- ------------ Total $22.3 ------------
(1) These charges represent a direct reduction to the inventory and property, plant and equipment balances to reflect these assets at the lower of cost or market and fair values, respectively. The amounts utilized reflect the disposition of such identified assets. 7. ASSET PURCHASE On June 17, 1998, the Company entered into an Asset Purchase Agreement (the "Agreement") with two affiliates of Tele-Communications, Inc., TCIVG-GIC, Inc. ("TCIVG") and NDTC Technology, Inc. ("NDTC Technology" and, collectively with TCIVG, "TCI") pursuant to which the Company agreed to acquire from TCIVG, in exchange for 21.4 million unregistered shares of the Company's Common Stock, certain assets, a license to certain intellectual property from NDTC Technology which will enable the Company to conduct authorization services and future cash consideration as discussed below. The shares issued to TCI are restricted in that they are not registered and are not transferable to any unrelated party other than in the event of a change of control of the Company for a period of three years following their date of issuance. The Company's provision of services under the aforementioned license is intended to provide the cable industry with a secure access control platform to support widespread deployment of digital terminals and related systems and applications. On July 17, 1998, the transaction was consummated. The Agreement provides the Company with minimum revenue guarantees from TCI over the first nine years from the date of closing. The Company has contracted with NDTC Technology for certain support services during the first nine years following the date of closing, with renewable one-year terms. The Agreement gives the Company the right to license the technology for a period of 20 years. As mentioned above, the Agreement contains a provision for TCIVG to pay the Company $50 million over the first five years from the date of closing in equal monthly installments which represents a reduction of purchase price. The present value of the $50 million note receivable was recorded as a reduction of stockholders' equity. The net purchase price of $400 million was allocated to the license and the assets acquired based on their respective estimated fair values. The fair value of assets acquired includes property, plant and equipment of $2 million, deferred tax liabilities of $30 million and a license of $428 million. The Company computed the purchase price by multiplying the number of shares issued by the per share trading price of the stock reduced by a 10% discount to reflect the restrictions associated with the unregistered shares, and adjusted such resulting amount to reflect the $50 million reduction in purchase price discussed above. The Company is amortizing the cost of the license 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. Such deployment is expected to rise significantly during the 20-year license term as supported by industry data and the Company's contractual obligations with customers. The Company expects revenues resulting from such deployments, which are calculated based on estimated monthly fees times the estimated subscriber base, to rise from approximately $2.5 million in 1998 to approximately $44 million by 2002 to approximately $70 million by 2007 to approximately $80 million per annum during the last seven years of the 20-year license term. The Company F-12 NOTES (Dollars in thousands, except per share data, unless otherwise noted) 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. This method results in any variation from original estimates being recognized in the current period in a manner consistent with a units-of-production method of depreciation. Under the Company's method, amortization for the period from July 17, 1998 to December 31, 1998 was approximately $0.7 million. 8. THE PARTNERSHIP In January 1998, the Company transferred at historical cost the net assets of its Next Level Communications ("NLC") subsidiary purchased in 1995, the underlying NLC technology related to the design and marketing of a next-generation telecommunication broadband access system for the delivery of telephony, video and data from a telephone company central office to the home, and the management and workforce of NLC to the newly formed 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 December 31, 1998. The operating general partner, which was formed by Spencer Trask & Co., an unrelated third party, has 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 remaining interest in the Partnership. Net assets transferred to the Partnership of $45 million primarily included property, plant and equipment, inventories and accounts receivable partially offset by accounts payable and accrued expenses. The Company's net equity investment in the Partnership was $36 million at December 31, 1998. Pursuant to the Partnership agreement, the operating general partner controls the Partnership and is responsible for developing the business plan and infrastructure necessary to position the Partnership as a stand-alone company. The Company, as the limited partner, has certain protective rights, including the right to approve an alteration of the legal structure of the Partnership, the sale of the Partnership's principal assets, the sale of the Partnership and a change in the limited partner's financial interests in the Partnership. The Company can not remove the general partner, except for cause; however, it has the right to approve a change in the general partner. Since the operating general partner controls the day-to-day operations of the Partnership and has the ability to make decisions typical of a controlling party, including the execution of agreements on all material matters affecting the Partnership's business, the Partnership's operating results have not been consolidated with the operating results of the Company subsequent to the January 1998 transfer. The Company does not expect widespread commercial deployment of this technology until the latter part of 1999 or early in 2000, however, there can be no assurance that the development activities currently being undertaken will result in successful commercial deployment. 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 is solely dependent upon the results of the Partnership's research and development activities and the commercial success of its product development, the Company recorded a charge to research and development 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 research and development activities of the Partnership through 1999 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. Through December 31, 1998, the Company has made $16 million of this $50 million investment. The Company expects to make the remaining equity investment during the first half of 1999. F-13 NOTES (Dollars in thousands, except per share data, unless otherwise noted) The Company is accounting 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 research and development activities will be offset against the $75 million reserve discussed above. Also, the Company eliminates its interest income from the Note against the Partnership's related interest expense on the Note. For the year ended December 31, 1998, the Company's share of the Partnership's losses was $25 million, (net of the Company's share of research and development expenses and the interest income elimination). The following summarized financial information is provided for the Partnership as of and for the year ended December 31, 1998: Net sales $ 43,830 Gross profit 397 Loss before income taxes (81,731) Net cash used in operating activities (66,633) Current assets 69,829 Non-current assets 27,942 Current liabilities 31,265 Non-current liabilities 81,275
9. SHORT-TERM INVESTMENTS Short-term investments are comprised of marketable equity securities at December 31, 1998 and 1997, and all such securities were classified as "available-for-sale." Proceeds and the related realized gains from the sales of available-for-sale securities were $11 million during both 1998 and 1997. The Company held no such securities during 1996. Short-term investments, excluding cash equivalents, consisted of the following at December 31, 1998 and 1997: Gross Fair Unrealized Cost Marketable Equity Securities Value Gains Basis ---------- ---------- --------- December 31, 1998 $ 4,865 $ 3,865 $1,000 ---------- ---------- --------- December 31, 1997 $30,346 $30,346 $ -- ---------- ---------- ---------
- -------------------------------------------------------------------------------- 10. OTHER COMPREHENSIVE INCOME Effective January 1, 1998, the Company adopted SFAS No. 130, "Reporting Comprehensive Income." This statement requires that an enterprise report the change in its net assets during the period from non-owner sources. Since this statement only requires additional disclosures, it had no impact on the Company's consolidated financial position or cash flows. During 1998 and 1997, other comprehensive income (loss) comprised unrealized gains (losses) on available-for-sale securities. Below is a reconciliation of the gross unrealized holding gains (losses) arising during 1998 and 1997 and the net unrealized gains (losses), including reclassification adjustments and the related tax benefit (expense) of each:
Year Ended December 31, --------------------------------------------------------------- 1998 1997 ------------------------------------- ------------------------ Tax Tax Pre-tax (Expense) Net-of-tax Pre-tax (Expense) Amount or Benefit Amount Amount or Benefit ----------- ----------- ----------- ----------- ----------- Unrealized holding gains (losses) arising during the period $ (15,052) $ 5,870 $ (9,182) $ 41,013 $ (15,507) Less: reclassification adjustment for gains included in net income (11,429) 4,457 (6,972) (10,667) 4,160 ----------- ----------- ----------- ----------- ----------- Unrealized gains (losses) on available-for-sale securities, net $ (26,481) $ 10,327 $ (16,154) $ 30,346 $ (11,347) ----------- ----------- ----------- ----------- ----------- Net-of-tax Amount ----------- Unrealized holding gains (losses) arising during the period $ 25,506 Less: reclassification adjustment for gains included in net income (6,507) ----------- Unrealized gains (losses) on available-for-sale securities, net $ 18,999 -----------
F-14 Notes (Dollars in thousands, except per share data, unless otherwise noted) 11. INVENTORIES Inventories consist of: December 31, -------------------------- 1998 1997 ------------ ------------ Raw materials $ 103,807 $ 111,148 Work in process 19,236 19,676 Finished goods 158,408 157,254 ------------ ------------ $ 281,451 $ 288,078 ------------ ------------
12. PROPERTY, PLANT AND EQUIPMENT - NET Property, plant and equipment - net consist of: December 31, -------------------------- 1998 1997 ------------ ------------ Land and land improvements $ 17,683 $ 17,683 Buildings, improvements and leasehold improvements 33,051 37,443 Machinery and equipment 462,305 421,615 ------------ ------------ 513,039 476,741 Less accumulated depreciation (275,908) (239,920) ------------ ------------ $ 237,131 $ 236,821 ------------ ------------
13. OTHER ACCRUED LIABILITIES Other accrued liabilities consist of: December 31, -------------------------- 1998 1997 ------------ ------------ Salaries and compensation liabilities $ 41,286 $ 49,831 Payroll, state and local taxes 10,764 7,648 Product and warranty liabilities 56,666 54,594 Other 77,397 76,177 ------------ ------------ $ 186,113 $ 188,250 ------------ ------------
14. INCOME TAXES The domestic and foreign components of income (loss) before income taxes are as follows: Year Ended December 31, --------------------------------------- 1998 1997 1996 ----------- ------------ ------------ Domestic $ 81,881 $ (23,157) $ (189,487) Foreign 11,768 13,518 40,079 ----------- ------------ ------------ Total $ 93,649 $ (9,639) $ (149,408) ----------- ------------ ------------
The components of the provision (benefit) for income taxes are as follows: Year Ended December 31, ------------------------------------- 1998 1997 1996 ----------- ----------- ----------- Current: Federal $ 19,987 $ 7,583 $ (5,878) Foreign 8,939 3,905 4,312 State 9,550 3,800 1,796 ----------- ----------- ----------- 38,476 15,288 230 ----------- ----------- ----------- Deferred: Federal 7,932 (11,039) (52,635) Foreign (5,971) 926 1,269 State (2,238) 1,299 (1,962) ----------- ----------- ----------- (277) (8,814) (53,328) ----------- ----------- ----------- Provision (benefit) for income taxes $ 38,199 $ 6,474 $ (53,098) ----------- ----------- -----------
Actual current tax liabilities are lower than reflected above for the year ended December 31, 1998 by $17,602 for the stock option deduction benefits recorded as a credit to stockholders' equity. The provision for income taxes for the periods prior to the Distributions was based on the Company's expected annual effective tax rate calculated assuming the Company had filed separate tax returns under its then existing structure. Subsequent to the Distributions, the provision for income taxes is based on the Company's actual results for that period. The following table presents the principal reasons for the difference between the actual income tax provision (benefit) and the tax provision (benefit) computed by applying the U.S. federal statutory income tax rate to the loss before income taxes: Year Ended December 31, ---------------------------------- 1998 1997 1996 ---------- ---------- ---------- Federal income tax provision (benefit) at 35% $32,777 $(3,374) $(52,293) State income taxes - net 4,253 3,314 (108) Foreign operations (996) 1,153 (6,655) Non-deductible purchase accounting item 4,880 4,997 4,997 Other - net (2,715) 384 961 ---------- ---------- ---------- Provision (benefit) for income taxes $38,199 $6,474 $(53,098) ---------- ---------- ---------- Effective income tax rate 40.8% 67.2% (35.5%)
F-15 NOTES (Dollars in thousands, except per share data, unless otherwise noted) Deferred income taxes as recorded in the accompanying consolidated balance sheets are comprised of the following: December 31, ------------------------ 1998 1997 ----------- ----------- Deferred tax assets: Domestic net operating loss carryforwards (expiring in 2012) $ 18,892 $ 35,325 Tax credit carryforwards (expiring through 2018) 11,897 6,516 Accounts receivable and inventory reserves 33,312 33,732 Product and warranty liabilities 22,064 21,250 Employee benefits 28,996 26,784 Reserve on Partnership Note 11,010 -- Warrant costs related to customer purchases 8,515 -- Other accrued liabilities 15,686 12,354 Other 3,438 4,275 ----------- ----------- Gross deferred tax assets 153,810 140,236 ----------- ----------- Deferred tax liabilities: Fixed and intangible assets 65,063 17,673 Unrealized gain on short-term investments 1,020 11,347 Other 1,367 5,745 ----------- ----------- Gross deferred tax liabilities 67,450 34,765 ----------- ----------- Net deferred tax asset $ 86,360 $ 105,471 ----------- -----------
In July 1997, the Company, General Semiconductor and CommScope entered into a tax-sharing agreement that effectively provides that the Company will be responsible for the consolidated tax liability of the Distributing Company for all periods prior to the Distributions. At December 31, 1996, the federal and state income taxes which were currently payable or receivable were settled with the Distributing Company through divisional net equity. In addition, during the year ended December 31, 1996, the Distributing Company settled certain tax matters which decreased the Company's tax payable through divisional net equity to the Distributing Company and resulted in a credit of $5 million to goodwill, since these matters related to periods prior to the acquisition of the Distributing Company by affiliates of Forstmann Little & Co. Deferred taxes have not been provided on undistributed earnings of certain foreign operations of $14 million and $6 million in 1998 and 1997, respectively, as those earnings are considered to be permanently reinvested. Determining the tax liability that would arise if these earnings were remitted is not practicable. Income taxes received during 1998 and 1997 subsequent to the Distributions were $5 million and $2 million, respectively. Income taxes paid during 1998 were $15 million. 15. 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 will vary 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 the sale of assets, and requires the maintenance of certain financial ratios. In addition, under the Credit Agreement, certain changes in control of the Company 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 December 31, 1998 and 1997, the Company was in compliance with all financial and operating covenants under the Credit Agreement. At December 31, 1998 and 1997, the Company had not borrowed under the Credit Agreement and had available credit of $500 million and $513 million, respectively. Interest paid related to the Credit Agreement during 1998 and 1997 subsequent to the Distributions was $1 million and $5 million, respectively. F-16 NOTES (Dollars in thousands, except per share data, unless otherwise noted) 16. COMMITMENTS AND CONTINGENCIES The Company leases office space, manufacturing and warehouse facilities and transportation and other equipment under operating leases, which expire at various dates through the year 2009. Rent expense was $15 million, $16 million and $15 million in 1998, 1997 and 1996, respectively. The Company has two seven-year operating lease agreements for its domestic administrative facilities, and the total cost of the facilities covered by these agreements approximates $110 million. These leases provide for a substantial residual value guarantee (approximately 83% of the total cost) which is due upon termination of the lease and include purchase and renewal options. The Company can exercise its purchase option or the facilities can be sold to a third party. Upon termination of the leases, the Company expects the fair market value of the leased facilities to substantially reduce or eliminate the payment under the residual value guarantees. The table of future minimum operating lease payments below excludes any payments related to these guarantees. Total future minimum rentals to be received under noncancelable subleases as of December 31, 1998 are $9 million. Future minimum lease payments required under noncancelable operating leases as of December 31, 1998 are as follows: 1999 $9,769 2000 9,073 2001 8,649 2002 8,421 2003 5,932 Thereafter 8,643 --------- Total minimum lease payments $50,487 ---------
The Company had approximately $109 million and $87 million of letters of credit outstanding at December 31, 1998 and 1997, respectively. The Company is either a plaintiff or a defendant in several pending legal matters. In addition, 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 consolidated financial statements. In April 1995, DSC Communications Corporation and DSC Technologies Corporation (collectively, "DSC") brought suit against NLC and the founders of NLC (the "NLC Litigation"). In June 1996, a final judgment against NLC and the individual defendants was entered in favor of DSC and a pre-tax charge to earnings of $141 million was recorded. In October 1997, the trial court entered a revised final judgment, and in November 1997, the Company satisfied the judgment with a payment of $141 million. On May 5, 1998, the action entitled BroadBand Technologies, Inc. v. General Instrument Corp., pending in the United States District Court for the Eastern District of North Carolina, was dismissed with prejudice. In addition, on May 4, 1998, the action entitled Next Level Communications v. BroadBand Technologies, Inc., was dismissed with prejudice. These dismissals were entered pursuant to a settlement agreement under which, among other things, the Partnership has paid BroadBand Technologies ("BBT") $5 million and BBT and the Partnership have entered into a perpetual cross-license of patents applied for or issued currently or during the next five years. At the time of the formation of the Partnership (see Note 8), the Company, as limited partner, and Spencer Trask, as general partner, estimated that no liability existed with respect to the BBT litigation. Further, the Partnership indemnified the Company with respect to this litigation because such litigation was directly related and attributable to the technology transferred to the Partnership. 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 Distributions, by allegedly making false and misleading statements and failing to disclose material facts about the F-17 NOTES (Dollars in thousands, except per share data, unless otherwise noted) Distributing Company's planned shipments in 1995 of its CFT 2200 and Digicipher-Registered Trademark- 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 Distributions, 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 the 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. 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 amended complaints, which contain 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 Distributions, the Company has agreed to indemnify General Semiconductor, Inc. with respect of 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. 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 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 misappropriated DSC's trade F-18 NOTES (Dollars in thousands, except per share data, unless otherwise noted) secrets; that the Company improperly disclosed trade secrets when it conveyed such technology to the Partnership; and that Spencer Trask 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, described above, pursuant to which NLC had paid $141 million. On May 14, 1998, the Texas court granted a preliminary injunction preventing DSC from proceeding with the Delaware Action. That injunction order is now on appeal to the United States Court of Appeal for the Fifth Circuit where it has been briefed and awaits determination. On July 6, 1998, the defendants filed a motion for summary judgment with the Texas court requesting a permanent injunction preventing DSC from proceeding with this litigation. As a result of the preliminary injunction, the Delaware Action has been stayed in its entirety. The Company intends to vigorously contest this 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 is seeking injunctive relief as well as damages (as specified below). The arbitration proceeding is scheduled to begin March 22, 1999 before an arbitration panel of the American Arbitration Association in San Francisco, California. On January 25, 1999, the Company received a copy of StarSight's Statement of Damages, as directed by the arbitration panel. This statement identifies purported damages arising from the sale by the Company of certain analog set top boxes containing a native electronic program guide. StarSight alleges that it is entitled to collect $90 million to $177 million in compensatory damages and an unspecified amount of punitive damages. The Company has denied StarSight's allegations and intends 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. The plaintiffs have sought to consolidate discovery for this action with similar actions pending against Pioneer Electronics Corp. and Scientific - Atlanta, Inc. The Company has responded to the plaintiffs' motion, currently pending before the Judicial Panel on Multidistrict Litigation (the "Judicial Panel"). On January 27, 1999, the court entered an order staying these proceedings until the Judicial Panel decides the plaintiffs' consolidation motion. The Company denies that it infringes the subject patents and intends to vigorously defend this action. While the ultimate outcome of the matters described above cannot be determined, the Company intends to vigorously contest these actions and management does not believe that the final disposition of these matters will have a material adverse effect on the Company's consolidated financial statements. 17. EMPLOYEE BENEFIT PLANS PENSION AND OTHER POSTRETIREMENT PLANS. Prior to the Distributions, the Company participated in the Distributing Company's domestic and foreign pension plans, and the Company's consolidated financial statements reflect the costs experienced for its employees and retirees while included in the Distributing Company's plans. The Company, CommScope and General Semiconductor entered into an Employee Benefits Allocation Agreement, which provided that, effective as of the Distributions, the Company assumed responsibility for liabilities of the Distributing Company under the Distributing Company's employee benefit plans with respect to individuals who are employees or retirees of the Company. In connection with dividing the Distributing Company's Taiwan operations between F-19 NOTES (Dollars in thousands, except per share data, unless otherwise noted) the Company and General Semiconductor, a curtailment and settlement loss of $4 million was recorded by the Company. Following the Distributions, the Company established separate defined benefit plans for the employees and retirees of the Company. Assets included in trusts under qualified pension plans were divided after the Distributions between the trusts for the Distributing Company's qualified pension plans and the Company's qualified pension plans. Each such domestic plan received the legally required funding under the Employee Retirement Income Security Act of 1974 ("ERISA"), and foreign plans received funding as specified under the applicable statutory requirements. Prior to the Distributions, the Company participated in the Distributing Company's sponsored contributory health-care and life insurance benefits plan. Following the Distributions, the Company established a separate postretirement benefit plan for the employees and retirees of the Company (the "Plan"). The Plan is an unfunded contributory group medical plan for all full-time U.S. employees of the Company not covered by a collective bargaining agreement and who meet defined age and service requirements. The Company recognizes the cost of providing and maintaining postretirement benefits during employees' active service periods. The Plan is the primary provider of benefits for retirees up to age 65. After age 65, Medicare becomes the primary provider. Net periodic benefit cost of the Company for the years ended December 31, 1998 and 1997 consists of the following:
Pension Benefits Other Benefits ------------------------------------------------------ -------------------------- Year Ended December 31, Year Ended December 31, ------------------------------------------------------ -------------------------- 1998 1997 1998 1997 -------------------------- -------------------------- ------------ ------------ COMPONENTS OF NET PERIODIC Domestic Foreign Domestic Foreign BENEFIT COST ------------ ------------ ------------ ------------ Service cost $ 3,557 $ 1,719 $ 2,651 $ 1,713 $ 1,063 $ 824 Interest 2,881 1,347 2,443 1,612 591 531 Expected return on plan assets (2,081) (135) (1,755) (285) -- -- Net amortization and deferral (9) 367 (11) 578 (186) (181) Curtailment and settlement loss -- -- -- 4,282 -- -- ------------ ------------ ------------ ------------ ------------ ------------ Net periodic benefit cost $ 4,348 $ 3,298 $ 3,328 $ 7,900 $ 1,468 $ 1,174 ------------ ------------ ------------ ------------ ------------ ------------
The Company's share of the Distributing Company's consolidated net periodic benefit costs that has been recorded in the accompanying statement of operations in 1996 was $5 million for pension benefit costs and $0.8 million for other benefit costs. The net periodic benefit cost presented above for 1997 includes the Company's share of the Distributing Company's net periodic benefit cost for the period prior to the Distributions.
Pension Benefits Other Benefits ------------------------------------------------------ -------------------------- 1998 1997 1998 1997 -------------------------- -------------------------- ------------ ------------ CHANGE IN BENEFIT OBLIGATION Domestic Foreign Domestic Foreign ------------ ------------ ------------ ------------ Benefit obligation at beginning of year $ 37,986 $ 20,211 $ 32,558 $ 31,243 $ 8,528 $ 5,510 Service cost 3,557 1,719 2,651 1,713 1,063 824 Interest 2,881 1,347 2,443 1,612 591 531 Actuarial (gain) loss 6,890 534 1,021 (647) 642 1,967 Benefits paid (690) (1,946) (687) (174) (118) (304) Effect of curtailment -- -- -- (1,806) -- -- Settlement payments -- -- -- (11,307) -- -- Effect of foreign exchange -- 250 -- (423) -- -- ------------ ------------ ------------ ------------ ------------ ------------ Benefit obligation at end of year $ 50,624 $ 22,115 $ 37,986 $ 20,211 $ 10,706 $ 8,528 ------------ ------------ ------------ ------------ ------------ ------------
F-20 NOTES (Dollars in thousands, except per share data, unless otherwise noted)
Pension Benefits ------------------------------------------------------ 1998 1997 -------------------------- -------------------------- CHANGE IN PLAN ASSETS Domestic Foreign Domestic Foreign ------------ ------------ ------------ ------------ Fair value of plan assets at beginning of year $ 25,680 $ 912 $ 22,104 $ 8,752 Actual return on plan assets 3,374 53 4,263 -- Employer contributions 2,651 3,386 -- 1,751 Benefits paid (690) (1,937) (687) (10,704) Transfers from the Distributing Company -- -- -- 1,616 Effect of foreign exchange -- 65 -- (503) ------------ ------------ ------------ ------------ Fair value of plan assets at end of year $ 31,015 $ 2,479 $ 25,680 $ 912 ------------ ------------ ------------ ------------ Pension Benefits Other Benefits ------------------------------------------------------ -------------------------- December 31, December 31, ------------------------------------------------------ -------------------------- 1998 1997 1998 1997 -------------------------- -------------------------- ------------ ------------ RECONCILIATION OF FUNDED STATUS Domestic Foreign Domestic Foreign ------------ ------------ ------------ ------------ Funded status $(19,609) $(19,636) $(12,306) $(19,299) $(10,706) $(8,528) Unrecognized prior service cost (181) -- (200) -- (1,668) (1,800) Unrecognized actuarial (gain) loss 4,041 8,119 (1,462) 7,752 (819) (1,515) ------------ ------------ ------------ ------------ ------------ ------------ Accrued benefit liability $(15,749) $(11,517) $(13,968) $(11,547) $(13,193) $(11,843) ------------ ------------ ------------ ------------ ------------ ------------ WEIGHTED-AVERAGE ASSUMPTIONS Discount rate 6.75% 6.75% 7.25% 6.75% 6.75% 7.25% Investment return 9.00% 7.00% 9.00% 8.00% -- -- Compensation increase 4.75% 6.00% 4.75% 6.00% -- --
The domestic pension plans consist principally of a qualified retirement plan that has satisfied the full funding limitation requirements under ERISA. The Company maintains unfunded supplemental retirement plans for certain members of management, and net periodic benefit cost and accrued benefit obligations for these plans are included in the amounts above. The Company's foreign pension plans consist principally of a Taiwan pension plan, which is funded under Taiwan's statutory requirements. The Company's domestic plan's assets consist of fixed income and equity securities, and the Taiwan plan's assets principally consist of fixed income securities. The assumed rate of future increases in health care cost during 1998 was 11.25% for pre-age 65 retirees and is expected to decline to 6% by the year 2005, and 9.0% for post-age 65 retirees and is expected to decline to 6% by the year 2003. Under the Plan, the actuarially determined effect of a one-percentage point change in the assumed health care cost trend rate would have the following effects: One-Percentage One-Percentage Point Increase Point Decrease ---------------- ---------------- Effect on postretirement benefit obligation $2,356 $(1,772) Effect on total of service and interest cost components 427 (303)
SAVINGS PLAN. The Company maintains a voluntary savings plan covering all non-union employees (prior to the Distributions, eligible employees of the Company participated in the Distributing Company's savings plan). Eligible employees may elect to contribute up to 10% of their salaries subject to certain limitations. The Company contributes an amount equal to 50% of the first 6% of the employee's salary that the employee contributes subject to certain limitations. The Company's expense related to these savings plans was $3 million, $4 million and $3 million for the years ended December 31, 1998, 1997 and 1996, respectively. F-21 Notes (Dollars in thousands, except per share data, unless otherwise noted) 18. STOCKHOLDERS' EQUITY COMMON SHARES. Pursuant to the Company's Amended and Restated Certificate of Incorporation, the authorized capital stock of the Company consists of 400 million shares. As discussed in Note 1, approximately 147.3 million shares of the Company's Common Stock, based on a ratio of one for one, were distributed to the Distributing Company's stockholders of record on July 25, 1997. STOCK OPTION AGREEMENTS. During 1997 and in prior years, certain employees of the Company were granted awards under the Distributing Company's 1993 Long-Term Incentive Plan (the "Distributing Company Plan"). Awards issued to employees of the Company consisted primarily of stock options. Immediately following the Distributions, awards outstanding under the Distributing Company Plan held by the Company's employees were replaced by substitute awards under the Company's 1997 Long-Term Incentive Plan (the "1997 Plan"), and the substitute awards preserved the economic value of the canceled Distributing Company options. Accordingly, the substitute options have the same ratio of the exercise price per option to the market value per share, the same aggregate intrinsic value (difference between market value per share and exercise price) and the same vesting provisions, option period and other terms and conditions as the Distributing Company options being replaced. The 1997 Plan provides for the granting of stock options, stock appreciation rights, restricted stock, performance units, performance shares and phantom shares and phantom stock to employees of the Company and its subsidiaries and the granting of stock options to directors of the Company. Generally, stock options have a 10-year term and vest within three or four years of grant. The number of shares of Distributing Company common stock subject to options held by the Company's employees at December 31, 1996 was approximately 9 million. The following table summarizes stock option activity relating to the Company's stock option plan subsequent to the Distributions. Weighted- Number of) Average Shares Exercise Price (In Thousands Per Share -------------- -------------- Distributing Company options related to employees of the Company, and outstanding at July 28, 1997 11,349 $22.45 -------------- Company options substituted for Distributing Company Options, and outstanding at July 28, 1997 16,655 15.30 Granted 3,069 16.59 Exercised (679) 13.78 (2,117) 15.93 Canceled -------------- 16,928 15.52 Outstanding at December 31, 1997 Granted 3,509 21.87 Exercised (5,342) 15.00 (1,240) 17.74 Canceled -------------- 13,855 17.13 Outstanding at December 31, 1998 --------------
The following table summarizes information about stock options outstanding and exercisable under the 1997 Plan.
Shares Under Options Outstanding Options Exercisable ---------------------------------------------------------------- ------------------------------------------ Options Weighted-Average Options Outstanding at Remaining Exercisable at Range of Exercise December 31, 1998 Contractual Weighted-Average December 31, 1998 Weighted-Average Prices (In Thousands) Term (Years) Exercise Price (In Thousands) Exercise Price - --------------------- -------------------- -------------------- -------------------- -------------------- -------------------- $ 1.03 - $ 1.87 67 4.0 $ 1.32 67 $ 1.32 10.82 - 13.82 154 4.2 11.08 151 11.03 14.14 - 15.75 7,749 7.8 15.24 3,654 14.98 16.00 - 17.80 2,069 7.2 17.09 1,319 17.16 18.57 - 20.88 758 8.8 20.07 41 20.19 21.69 - 24.44 2,996 9.6 21.75 -- -- 25.00 - 30.00 62 9.7 27.08 -- --
F-22 NOTES (Dollars in thousands, except per share data, unless otherwise noted) At December 31, 1998, 0.4 million shares were reserved for future awards under the 1997 Plan. The Company applies APB No. 25, "Accounting for Stock Issued to Employees," and related interpretations in accounting for its plan. Since the exercise price of all stock options granted was equal to the closing price of the Common Stock on the New York Stock Exchange on the date of grant, no compensation expense has been recognized by the Company under its stock option plan. Compensation expense would have been $19 million and $23 million for the years ended December 31, 1998 and 1997, respectively, had compensation cost for stock options awarded under the 1997 Plan and under the Distributing Company Plan been determined based upon the fair value at the grant date consistent with the methodology prescribed under SFAS No. 123, "Accounting for Stock-Based Compensation." The Company's net income for the year ended December 31, 1998 would have been $44 million and basic and diluted earnings per share would have been $0.28 and $0.26, respectively. The Company's pro forma net loss and pro forma loss per share (basic and diluted) for the year ended December 31, 1997 would have been $31 million and $0.21, respectively. The incremental fair value of the Company's options was determined using the Black-Scholes option-pricing model with the following weighted-average assumptions: an expected holding period of 4 years; a risk-free interest rate of 4.49% and 6.08% for 1998 and 1997, respectively; an expected volatility of 40% and 35% for 1998 and 1997, respectively; and an expected dividend yield of 0%. The weighted-average per share fair values of the options granted during 1998 and 1997 were estimated at $8.17 and $6.20, respectively. WARRANTS. In December 1997, the Company entered into agreements to supply an aggregate of 15 million of its two-way, interactive digital cable terminals to nine of the leading North American cable television multiple system operators ("MSOs") over a three to five year period, beginning in 1998. In connection with these legally binding supply agreements, the Company issued warrants to purchase approximately 29 million shares of the Company's Common Stock. Warrants aggregating 7.2 million, 7.3 million and 14.2 million issued to the MSOs will vest and become exercisable on December 31, 1998, 1999, and 2000, respectively, provided that in each of those years each such MSO fulfills its obligation to purchase a threshold number of digital terminals from the Company. Each warrant is exercisable for one share of Common Stock for a period of 18 months after it vests at an exercise price of $14.25 for each share of Common Stock. If, in any year, the Company fails to deliver the threshold number of digital terminals for such year, through no fault of the MSO, the total number of such MSOs warrants will vest for that year. If, in any year, an MSO fails to purchase the threshold number of terminals for such year, through no fault of the Company, no warrants for such year will vest, and the MSO shall be subject to legal proceedings and damages relating to such failure. The Company believes that the magnitude of such damages would be substantial. The Company believes it is probable that the MSOs will perform under the terms of the supply agreement because there is a sufficiently large disincentive for non-performance, accordingly, it believes a performance commitment has been met and the fair value of the warrants was determined as of the date of the supply agreement. The weighted-average per share fair value of the warrants granted during 1997 approximated $3.50 using the Black-Scholes pricing model with assumptions consistent with those discussed above, except for the expected holding periods for the warrants, which range from 2.5 to 4.5 years. The value of the warrants for each MSO is being expensed to cost of sales based upon actual units shipped to the MSO in a year in relation to the total threshold number of units required to be purchased by the MSO in such year. During 1998, the Company recorded $21.8 million to cost of sales related to these warrants, since the full amount of the 1998 warrants vested on December 31, 1998. On a quarterly basis, management assesses the Company's ability to deliver the threshold number of units and to the extent it believes the Company will not be able to deliver the committed number of units, a charge reflecting the fair value of warrants for the undeliverable units for that year would be recorded. STOCKHOLDER RIGHTS PLAN. On June 10, 1997, the Board of Directors adopted a stockholder rights plan designed to protect stockholders from various abusive takeover tactics, including attempts to acquire control of the Company at an inadequate price. Under the rights plan, each stockholder received a dividend of one right for each outstanding share of Common Stock. The rights are attached to, F-23 NOTES (Dollars in thousands, except per share data, unless otherwise noted) and presently only trade with, the Common Stock and currently are not exercisable. Except as specified below, upon becoming exercisable, all rights holders will be entitled to purchase from the Company one one-thousandth of a share of Series A Junior Participating Preferred Stock at a price of $85. The rights become exercisable and will begin to trade separately from the Common Stock upon the earlier of (i) the first date of public announcement that a person or group (other than an existing 15% stockholder or pursuant to a Permitted Offer, as defined) has acquired beneficial ownership of 15% or more of the outstanding Common Stock, or (ii) 10 business days following a person's or group's commencement of, or announcement of, an intention to commence a tender or exchange offer, the consummation of which would result in beneficial ownership of 15% or more of the Common Stock. Each right will entitle the holder to purchase Common Stock of the Company having a market value (immediately prior to such acquisition) of twice the exercise price of the right. If the Company is acquired through a merger or other business combination transaction (other than a Permitted Offer, as defined), each right will entitle the holder to purchase common stock of the surviving company having a market value (immediately prior to such acquisition) of twice the exercise price of the right. The Company may redeem the rights for $0.01 each at any time prior to such acquisition. The rights will expire on June 10, 2007, unless earlier redeemed. In connection with the rights plan, the Board of Directors approved the creation of, out of the authorized but unissued shares of Common Stock of the Company, a Series A Junior Participating Preferred Stock ("Participating Preferred Stock"), consisting of 400,000 shares with a par value of $0.01 per share. The holders of the Participating Preferred Stock are entitled to receive dividends, if declared by the Board of Directors, from funds legally available. Each share of Participating Preferred Stock is entitled to one thousand votes on all matters submitted to stockholder vote. The shares of Participating Preferred Stock are not redeemable by the Company or convertible into Common Stock or any other security of the Company. OTHER TRANSACTIONS. On September 9, 1998, the Company announced a share repurchase program authorizing the Company to repurchase up to 10 million shares of its outstanding Common Stock. Through December 31, 1998, the Company had repurchased a total of 6.3 million shares at a cost of $126.3 million. In January 1999, Sony Corporation purchased 7.5 million newly issued unregistered shares of Common Stock of the Company for $188 million. 19. RELATED PARTY TRANSACTIONS In connection with the asset purchase from TCI, which was consummated on July 17, 1998 (see Note 7), TCI obtained approximately a 12% ownership interest in the Company, and at December 31, 1998, such ownership interest was 13%. TCI is also a significant customer of the Company. Sales to TCI represented 31% of total Company sales for the year ended December 31, 1998. Management believes the transactions with TCI are at arms length and are under terms no less favorable to the Company than those with other customers. At December 31, 1998 accounts receivable from TCI totaled $81 million. 20. DERIVATIVES AND OTHER FINANCIAL INSTRUMENTS Derivative financial instruments are primarily used by the Company to reduce market risk arising from changes in foreign exchange and interest rates. The Company does not use derivative financial instruments for trading purposes, nor does it engage in currency or interest rate speculation. Derivatives used by the Company consist of foreign exchange instruments. The Company believes that the various counterparties with which the Company enters into these agreements consist of only financially sound institutions and, accordingly, believes that the credit risk for non-performance of these contracts is remote. The Company monitors its underlying market risk exposures on an ongoing basis and believes that it can modify or adapt its hedging strategies as needed. The Company enters into forward exchange contracts on a month-to-month basis to reduce foreign currency exposure with regard to certain monetary assets and liabilities denominated in currencies other than the U.S. dollar. These contracts generally do not subject the Company's results of operations to risk of exchange rate movements because gains and losses on these contracts generally offset, in the same period, gains and losses on the monetary assets and liabilities covered by the exchange contracts. F-24 NOTES (Dollars in thousands, except per share data, unless otherwise noted) On a selective basis, the Company (and the Distributing Company, on behalf of the Company, prior to the Distributions) enters into forward exchange and purchased option contracts to reduce the currency exposure of contractual and other firm commitments denominated in foreign currencies. The Company may also use forward exchange and purchased option contracts designed to limit the currency exposure of anticipated, but not yet committed, transactions expected to be denominated in foreign currencies. The purpose of these activities is to protect the Company from the risk that the eventual net cash flows in U.S. dollars from foreign receivables and payables will be adversely affected by changes in exchange rates. Gains and losses on such transactions related to contractual and other firm commitments are deferred and recognized in the Company's results of operations in the same period as the gain or loss from the settlement of the underlying transactions. Gains and losses on forward exchange contracts used to limit anticipated, but not yet committed, transactions are recognized in the Company's results of operations as changes in exchange rates for the applicable foreign currencies occur. Historically, foreign exchange contracts with respect to contractual and other firm commitments and anticipated, but not yet committed, transactions have been short-term in nature. In addition, purchased options have had no intrinsic value at the time of purchase. The Company generally settles forward exchange contracts at maturity at prevailing market rates. The Company recognizes in its results of operations over the life of the contract the amortization of the contract premium or discount. The amortization of these premiums or discounts during each of the three years in the period ended December 31, 1998 was not significant. As of December 31, 1998 and 1997, the Company had outstanding forward exchange contracts with notional amounts of $58 million and $73 million, respectively, comprised of foreign currencies that were to be purchased (principally the New Taiwan dollar and the Pound Sterling in 1998 and the New Taiwan and Canadian dollars in 1997) and $13 million and $11 million, respectively, comprised of foreign currencies that were to be sold (principally the Canadian dollar and the Deutsche Mark in 1998 and the Canadian dollar in 1997). All outstanding forward exchange contracts at December 31, 1998 and 1997 mature within 12 months, and the fair values of such contracts approximated their carrying values, which were not material. Accordingly, deferred gains or losses on such contracts at December 31, 1998 and 1997 were not significant. Foreign currency transaction losses included in operations were $1 million, $2 million and $2 million in 1998, 1997 and 1996, respectively. As of December 31, 1998 and 1997, the Company had no purchased option contracts outstanding. The estimated fair value of cash equivalents, accounts receivable, and accounts payable, approximates their carrying value. The Company has an investment in equity securities of a publicly traded company, which have certain restrictions, which may under certain circumstances cause the investment to be redeemed at cost. Such restrictions do not lapse until April 2000 and, therefore, the Company has not reflected this investment at its fair value at December 31, 1998. Accordingly, the Company is carrying this investment at its cost of $23 million, which has been included in "Investments and other assets" on the consolidated balance sheets as of December 31, 1998 and 1997. When such restrictions expire, the investment will be classified as available-for-sale with any unrealized gain or loss recorded through stockholders' equity. At December 31, 1998, the fair value of this investment, were it not restricted, would have been approximately $272 million. 21. SEGMENT AND GEOGRAPHIC INFORMATION The Company adopted SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information," during the fourth quarter of 1998. SFAS No. 131 established standards for reporting information about operating segments in annual financial statements and requires selected information about operating segments in interim financial reports issued to stockholders. It also established standards for related disclosure about products and services, and geographic areas. Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker in deciding how to allocate resources and in assessing performance. The Company's chief operating decision maker is the Chairman of the Board and Chief Executive Officer. F-25 NOTES (Dollars in thousands, except per share data, unless otherwise noted) The Company currently has two reportable segments: Broadband Networks Systems and Satellite and Broadcast Network Systems. The Broadband Networks Systems segment is comprised of digital and analog cable and wireless television systems and transmission network systems which includes cable television analog and digital set top terminal products and headend and amplifier equipment products for the transmission of voice, video and high speed data over cable TV networks. The Satellite and Broadcast Network Systems segment includes analog and digital satellite television system products which enable programmers, satellite operators and business users to deliver high quality, compressed video service to cable television headends, corporate locations or directly to consumer homes. Although both of the Company's segments provide communications equipment products that deliver video, audio and high-speed internet/data services, they have not been aggregated due primarily to different customer bases. The Company has also disclosed separately below the results of NLC for the years prior to the transfer of the net assets of NLC to the Partnership. As disclosed in Note 8, the results of the Partnership are included in other income (expense)-net in the statement of operations for the year ended December 31, 1998. The accounting policies of the segments are the same as those described in the summary of significant accounting policies, however, as described below, for internal management reporting purposes certain costs, such as corporate overhead and restructuring charges, have not been allocated to the segments. The Company measures segment performance based upon operating profit. Information on the segments and reconciliations to consolidated amounts are as follows: F-26 NOTES (Dollars in thousands, except per share data, unless otherwise noted)
Satellite Broadband and Broadcast Corporate Networks Network Next Level Unallocated Systems Systems Communications(a) and Other ------------- -------------- ------------------ ------------ 1998 Net sales $ 1,569,483 $418,342 $ -- $ -- Operating income (loss) 234,884 35,201 -- (165,838)(c) Other income (expense) - net (including equity interest in Partnership losses of $25,089) -- -- -- (11,815) Interest income (expense) - net -- -- -- 1,217 Income (loss) before income taxes -- -- -- 93,649 Segment assets(b) 649,183 203,119 -- 6,319(d) Capital expenditures 78,869 12,891 -- -- Depreciation and intangible amortization expense 41,215 23,975 -- 18,374(e) Warrant costs related to customer purchases 21,834 -- -- -- 1997 Net sales $ 1,292,930 $462,068 $ 9,090 $ -- Operating income (loss) 218,942 (7,449) (58,462) (163,226)(c) Other income (expense) - net -- -- -- 5,766 Interest income (expense) - net -- -- -- (5,210) Income (loss) before income taxes -- -- -- (9,639) Segment assets(b) 512,241 338,250 37,970 (19,937)(d) Capital expenditures 42,064 26,740 10,702 322 Depreciation and intangible amortization expense 33,962 33,225 4,133 18,537(e) 1996 Net sales $ 1,180,424 $575,161 $ -- $ -- Operating income (loss) 153,388 22,229 (29,781) (267,847)(c) Other income (expense) - net -- -- -- (1,427) Interest income (expense) - net -- -- -- (25,970) Income (loss) before income taxes -- -- -- (149,408) Segment assets(b) 588,284 321,138 12,214 (13,075)(d) Capital expenditures 99,172 27,040 8,048 93 Depreciation and intangible amortization expense 32,344 31,553 2,063 18,540(e) Total Company ------------- 1998 Net sales $ 1,987,825 Operating income (loss) 104,247 Other income (expense) - net (including equity interest in Partnership losses of $25,089) (11,815) Interest income (expense) - net 1,217 Income (loss) before income taxes 93,649 Segment assets(b) 858,621 Capital expenditures 91,760 Depreciation and intangible amortization expense 83,564 Warrant costs related to customer purchases 21,834 1997 Net sales $ 1,764,088 Operating income (loss) (10,195) Other income (expense) - net 5,766 Interest income (expense) - net (5,210) Income (loss) before income taxes (9,639) Segment assets(b) 868,524 Capital expenditures 79,828 Depreciation and intangible amortization expense 89,857 1996 Net sales $ 1,755,585 Operating income (loss) (122,011) Other income (expense) - net (1,427) Interest income (expense) - net (25,970) Income (loss) before income taxes (149,408) Segment assets(b) 908,561 Capital expenditures 134,353 Depreciation and intangible amortization expense 84,500
(a) See Note 8. (b) Segment assets include accounts receivable, inventories and property, plant and equipment. Other balance sheet items are not allocated to the segments. (c) Primarily reflects unallocated costs, including amortization of excess of cost over fair value of net assets acquired of $14 million, $15 million and $14 million in 1998, 1997 and 1996, respectively, and restructuring and other charges of $115 million, $122 million and $126 million in 1998, 1997 and 1996, respectively (see Notes 5, 6, and 16). The remaining reconciling amounts reflect unallocated corporate selling, general and administrative expenses. (d) Primarily reflects non-trade accounts receivable of $8 million, $15 million and $17 million at December 31, 1998, 1997 and 1996, respectively, and certain unallocated property, plant and equipment balances of $16 million, $17 million and $21 million at December 31, 1998, 1997 and 1996, respectively, offset by restructuring and other charge adjustments not allocated to the segments for internal management reporting purposes. (e) Primarily reflects amortization of excess of cost over fair value of net assets acquired of $14 million, $15 million and $14 million in 1998, 1997 and 1996, respectively, as well as intangible amortization of $4 million, $3 million and $4 million in 1998, 1997 and 1996, respectively. F-27 NOTES (Dollars in thousands, except per share data, unless otherwise noted) Net revenues are attributed to geographic areas based upon the location to which the product is shipped. A majority of the foreign long-lived assets are located in Taiwan and Mexico, where the Company manufactures or assembles a significant portion of its products.
U.S. Foreign Total ------------- ----------- ------------- 1998 Net revenues $ 1,683,072 $ 304,753 $ 1,987,825 Long-lived assets 1,090,126 100,167 1,190,293 1997 Net revenues $ 1,251,324 $ 512,764 $ 1,764,088 Long-lived assets 711,297 79,256 790,553 1996 Net revenues $ 1,294,646 $ 460,939 $ 1,755,585 Long-lived assets 745,000 78,333 823,333
A limited number of cable and satellite television operators provide services to a large percentage of television households in the U.S. The loss of some of these operators as customers could have a material adverse effect on the Company's sales. TCI, including affiliates, accounted for 31%, 14%, and 23% of the Company's consolidated net sales in 1998, 1997 and 1996, respectively. Time Warner, including affiliates, accounted for 14% and 13% of the Company's consolidated net sales in 1997 and 1996, respectively. PRIMESTAR accounted for 11% of the Company's consolidated net sales in 1998. On January 22, 1999, PRIMESTAR announced that it reached an agreement to sell its direct broadcast satellite medium-power business and assets as well as its rights to acquire high-power satellite assets to Hughes Electronics Corporation. The Company is currently uncertain whether and to what extent PRIMESTAR will continue to order and purchase medium-power equipment from the Company. Further, the Company does not expect to supply any high-power equipment to PRIMESTAR. Absent the failure of PRIMESTAR to honor its contractual commitments with the Company, the Company believes that the loss of PRIMESTAR's business will not have a material adverse effect on the Company's financial condition or results of operations. 22. QUARTERLY FINANCIAL DATA (UNAUDITED) Summarized quarterly data for 1998 and 1997 are as follows:
Quarter Ended -------------------------------------------------------------------------------------- March 31, June 30, September 30, December 31, -------------------- -------------------- -------------------- -------------------- 1998(a) 1997(b) 1998 1997(c) 1998 1997 1998 1997(d) --------- --------- --------- --------- --------- --------- --------- --------- Net sales $416,920 $408,028 $488,505 $450,403 $518,196 $464,582 $564,203 $441,075 Gross profit 92,988 113,514 141,121 117,618 152,863 133,441 169,526 63,033 Net income (loss) (59,891) 4,960 29,963 406 39,409 24,458 45,969 (45,937) Earnings (loss) per share - basic(e) $ (0.40) $ 0.20 $ 0.23 $ 0.17 $ 0.27 $ (0.31) Earnings (loss) per share - diluted(e) (0.40) 0.19 0.22 0.16 0.26 (0.31)
(a) Includes pre-tax charges of $124 million ($79 million net-of-tax) reflecting $16 million of restructuring charges (see Note 5) and $33 million of other charges (see Note 6) primarily including costs related to the closure of various facilities, including the Company's satellite TV manufacturing facility in Puerto Rico, severance and other employee separation costs, the write down of fixed assets to their estimated fair values and inventory to its lower of cost or market, as well as a $75 million charge to fully reserve for the R&D advance made to the Partnership (see Note 8). Of these charges, $27 million were recorded as cost of sales, $13 million were recorded as SG&A expense, $75 million were recorded as R&D expense and $9 million were recorded as other expense. (b) Includes a pre-tax charge of $3 million ($2 million net-of-tax), recorded as cost of sales, for employee costs related to dividing the Distributing Company's Taiwan operations between the Company and General Semiconductor. (c) Includes a pre-tax charge of $15 million ($11 million net-of-tax), recorded as cost of sales, for employee costs related to dividing the Distributing Company's Taiwan operations between the Company and General Semiconductor and a pre-tax charge of $6 million ($4 million net-of-tax), recorded as SG&A expense, related to legal and other professional fees incurred in connection with the Distributions. (d) Includes pre-tax charges of $86 million reflecting $36 million ($24 million net-of-tax) of restructuring charges (see Note 5) and $61 million ($44 million net-of-tax) of other charges (see Note 6), primarily related to the restructuring of the satellite business and the consolidation of the corporate headquarters, offset by $11 million ($7 million net of tax) of other income and interest income (see Note 6). These costs include $66 million recorded as cost of sales, $22 million recorded as SG&A expense and $9 million recorded as R&D expense, partially offset by $4 million of other income and $7 million of interest income. (e) Historical earnings (loss) per share for the periods prior to the Distributions have been omitted since the Company was not a separate company with a capital structure of its own. F-28 NOTES (Dollars in thousands, except per share data, unless otherwise noted) The Common Stock is listed and traded under the symbol GIC on the New York Stock Exchange. The Common Stock began trading on July 24, 1997, as a result of the Distributions. The Company did not pay dividends on its Common Stock during 1997 or 1998. The Company's ability to pay cash dividends on its Common Stock is limited by certain covenants contained in a credit agreement to which the Company is a party. The high and low stock prices of the Common Stock are listed below:
Stock Price Ranges ---------------------------- High Low ------------- ------------- 1997 Third Quarter $ 21 1/2 $ 16 Fourth Quarter $ 19 1/8 $ 12 5/8 1998 First Quarter $ 22 $ 16 7/16 Second Quarter $ 28 3/4 $ 19 3/4 Third Quarter $ 29 1/2 $ 16 11/16 Fourth Quarter $ 36 15/16 $ 17 1/2
F-29 INDEPENDENT AUDITORS' REPORT To the Board of Directors and Stockholders of General Instrument Corporation: We have audited the financial statements of General Instrument Corporation and its subsidiaries (formerly NextLevel Systems, Inc. and, prior thereto, the Communications Business of the former General Instrument Corporation) as of December 31, 1998 and 1997, and for each of the three years in the period ended December 31, 1998, and have issued our report thereon dated February 9, 1999; such report is included elsewhere in this Form 10-K. Our audits also included the financial state- ment schedule of General Instrument Corporation, listed in Item 14(a)2. This financial statement schedule is the responsibility of the Corporation's management. Our responsibility is to express an opinion based on our audits. In our opinion, such financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein. /s/ DELOITTE & TOUCHE LLP - ------------------------------------ DELOITTE & TOUCHE LLP Parsippany, New Jersey February 9, 1999 F-30 SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
Balance at Balance at Beginning of End of (In thousands) Period Additions Deductions Other Period ------------- ----------- ------------- ------------- ----------- Allowance For Doubtful Accounts: Year ended December 31, 1998 $ 3,566 $ 2,074 $ (1,807) $ -- $ 3,833 Year ended December 31, 1997 $ 12,910 $ 437 $ (4,781) $ (5,000)(a) $ 3,566 Year ended December 31, 1996 $ 10,144 $ 5,190 $ (2,424) $ -- $ 12,910
(a) Other represents the collection of certain receivables previously considered to be uncollectable. F-31 INDEPENDENT AUDITORS' REPORT To the Partners of Next Level Communications L.P.: We have audited the accompanying balance sheet of Next Level Communications L.P. as of December 31, 1998 and the related statements of operations, partners' deficit and cash flows for the year then ended. These financial statements are the responsibility of the Partnership's management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, such financial statements present fairly, in all material respects, the financial position of Next Level Communications L.P. as of December 31, 1998 and the results of its operations and its cash flows for the year then ended in conformity with generally accepted accounting principles. As discussed in Note 2, Next Level Communications L.P. has incurred operating losses and negative cash flows and is dependent upon obtaining additional capital to fund its operations and meet its obligations. /s/ DELOITTE & TOUCHE LLP - ----------------------------- DELOITTE & TOUCHE LLP San Francisco, California February 9, 1999 F-32 NEXT LEVEL COMMUNICATIONS L.P. BALANCE SHEET
December 31, -------------- (dollars in thousands) 1998 -------------- ASSETS CURRENT ASSETS: Cash and cash equivalents $ 28,983 Trade receivables (net of allowance for doubtful accounts of $490) 11,068 Other receivables 5,023 Inventories 20,670 Receivable from General Instrument 3,350 Other current assets 735 -------------- Total current assets 69,829 PROPERTY AND EQUIPMENT, NET 21,558 INTANGIBLE ASSETS, NET 6,266 OTHER ASSETS 118 -------------- TOTAL ASSETS $ 97,771 -------------- LIABILITIES AND PARTNERS' DEFICIT CURRENT LIABILITIES: Accounts payable $ 16,467 Accrued expenses 10,697 Deferred revenue 3,705 Current portion of capital lease obligations 396 -------------- Total current liabilities 31,265 NOTE PAYABLE TO GENERAL INSTRUMENT (INCLUDING ACCRUED INTEREST OF $5,940) 80,940 LONG TERM CAPITAL LEASE OBLIGATIONS 335 COMMITMENTS AND CONTINGENCIES (NOTE 12) PARTNERS' DEFICIT (14,769) -------------- TOTAL LIABILITIES AND PARTNERS' DEFICIT $ 97,771 --------------
See notes to financial statements. F-33 NEXT LEVEL COMMUNICATIONS L.P. STATEMENT OF OPERATIONS Year Ended December 31, ----------- (dollars in thousands) 1998 ----------- NET SALES: Equipment $ 39,243 Software 4,587 ----------- Total net sales 43,830 ----------- COST OF SALES: Equipment 43,172 Software 261 ----------- Total cost of sales 43,433 ----------- GROSS PROFIT 397 ----------- OPERATING EXPENSES: Research and development 47,086 Selling, general and administrative 26,248 Litigation settlement 5,000 ----------- Total operating expenses 78,334 ----------- LOSS FROM OPERATIONS (77,937) INTEREST EXPENSE (6,035) OTHER INCOME 2,241 ----------- NET LOSS $ (81,731) ----------- See notes to financial statements. F-34 NEXT LEVEL COMMUNICATIONS L.P. STATEMENT OF PARTNERS' DEFICIT
Year Ended December 31, 1998 -------------------------- Limited General Partner Partner Capital (dollars in thousands) Capital (Deficit) ------------ ------------ BALANCE, JANUARY 1, 1998 $ -- $ -- Partner capital contributions 10,000 56,962 Net loss (8,990) (72,741) ------------ ------------ BALANCE, DECEMBER 31, 1998 $ 1,010 $ (15,779) ------------ ------------ Partners' Capital (dollars in thousands) (Deficit) ------------ BALANCE, JANUARY 1, 1998 $ -- Partner capital contributions 66,962 Net loss (81,731) ------------ BALANCE, DECEMBER 31, 1998 $ (14,769) ------------
See notes to financial statements. F-35 NEXT LEVEL COMMUNICATIONS L.P. STATEMENT OF CASH FLOWS Year Ended December 31, ----------- (dollars in thousands) 1998 ----------- CASH FLOWS FROM OPERATING ACTIVITIES: Net loss $ (81,731) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization 10,733 Loss on disposal of assets 1,162 Changes in assets and liabilities: Trade receivables (6,323) Inventories (7,286) Prepaid expenses and other current assets (4,683) Accrued interest payable to General Instrument 5,940 Accounts payable 7,141 Accrued expenses 8,414 ----------- Net cash used by operating activities (66,633) ----------- CASH FLOWS FROM INVESTING ACTIVITIES: Purchases of property and equipment (9,612) Proceeds from notes receivable 264 ----------- Net cash used in investing activities (9,348) ----------- CASH FLOWS FROM FINANCING ACTIVITIES: Limited Partner capital contribution 19,587 General Partner capital contribution 10,000 Proceeds from note payable to General Instrument 75,000 ----------- Net cash provided from financing activities 104,587 ----------- NET INCREASE IN CASH AND CASH EQUIVALENTS 28,606 CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 377 ----------- CASH AND CASH EQUIVALENTS AT END OF YEAR $ 28,983 ----------- NONCASH INVESTING AND FINANCING ACTIVITIES: Equipment acquired under capital leases $ 731 See notes to financial statements. F-36 NEXT LEVEL COMMUNICATIONS L.P. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands, unless otherwise noted) 1. ORGANIZATION AND BUSINESS Next Level Communications L.P. (the "Partnership") designs, manufactures and markets broadband access systems capable of transmitting telephony, video, and data to homes and businesses. NEXT LEVEL COMMUNICATIONS - Next Level Communications ("NLC" or the "Limited Partner") was incorporated as a California corporation on June 22, 1994 and commenced operations in July 1994. In September 1995, Next Level Communications was acquired by General Instrument Corporation ("General Instrument") in an acquisition accounted for using the purchase method of accounting; accordingly, the purchase price was allocated to the fair value of assets and liabilities of Next Level Communications. Through December 31, 1997, Next Level Communications was a 100% owned subsidiary of General Instrument. In January 1998, General Instrument transferred the net assets, management and workforce of NLC to the Partnership in exchange for an 89% limited partner interest. Such 89% limited partnership interest is held by NLC, a wholly owned subsidiary of General Instrument. KK Manager LLC (the "General Partner"), acquired an 11% general partner interest in the Partnership in exchange for a $10 million cash contribution. Net losses have been allocated to the partners based on their respective partnership percentages. If the Partnership converts to a corporation (the "Successor Corporation") in conjunction with an Initial Public Offering ("IPO"), each partner will receive voting common stock of the Successor Corporation based on their respective partnership percentages. The General Partner has an option, which expires in January 2003, to acquire from the Limited Partner, up to 11% of the Successor Corporation common stock at a predetermined valuation of $700 million. Such option is exercisable after an IPO or in connection with a merger or sale of the Successor Corporation. Upon dissolution of the Partnership, the assets will be used to pay all liabilities of the Partnership and any remaining assets, after establishment of reserves, will be distributed to the partners in accordance with their respective partnership percentages. 2. Results of Operations for 1998 and Management Plans for 1999 In 1998, the Partnership incurred net losses of $81.7 million and net cash used by operating activities was $66.6 million. At December 31, 1998, partners' deficit was $14.8 million. The Partnership has prepared cash flow projections for 1999 which indicate that additional capital will be required during the latter part of 1999 to fund its operations and meets its obligations. The Partnership believes that it has several alternatives available to it to obtain the required capital, including additional equity contributions from its partners, private placement financing or an IPO. Management of the Partnership believes that cash and cash equivalents at December 31, 1998, cash flows from operations, capital contributions from the Limited Partner (see Note 8), and additional capital from the sources noted above will enable the Partnership to fund its operations and meet its obligations through at least December 31, 1999. 3. Significant Accounting Policies USE OF ESTIMATES - The preparation of the accompanying financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the year. Actual results could differ from these estimates. CASH EQUIVALENTS - The Partnership considers all highly liquid debt instruments with a maturity of three months or less at the date of purchase to be cash equivalents. INVENTORIES are stated at the lower of cost, determined on a first-in, first-out basis, or market. PROPERTY AND EQUIPMENT are stated at cost. Provisions for depreciation are based on estimated useful lives using the straight-line method. Useful lives range from the shorter of five to ten years or the lease term for leasehold improvements and two to seven years for machinery and equipment. Whenever events indicate that the carrying values of property and equipment may not be recoverable, the Partnership evaluates the carrying values of such F-37 NOTES (Dollars in thousands, unless otherwise noted) assets using estimated undiscounted cash flows. Management believes that, as of December 31, 1998, the carrying value of such assets are appropriate. INTANGIBLE ASSETS consists principally of goodwill which is being amortized on a straight-line basis over seven years. Management periodically reassesses the appropriateness of both the carrying value and remaining life of the intangible assets by assessing recoverability based on forecasted operating cash flows, on an undiscounted basis, and other factors. At December 31, 1998, accumulated amortization was $1,940. Management believes that, as of December 31, 1998, the carrying value and remaining lives of such assets are appropriate. FAIR VALUE OF FINANCIAL INSTRUMENTS - The carrying amounts of cash and cash equivalents, accounts receivable and accounts payable approximate fair value because of the short-term nature of these instruments. The fair value of long-term debt is based upon current interest rates for debt instruments with comparable maturities and characteristics. REVENUE RECOGNITION - The Partnership recognizes revenue from equipment sales when the product has been shipped. Sales contracts do not permit the right of return of product by the customer. Amounts received in excess of revenue recognized are recorded as deferred revenue. Software license revenues are recognized when software revenue recognition criteria have been met, pursuant to Statement of Position ("SOP") 97-2, SOFTWARE REVENUE RECOGNITION. Under SOP 97-2, license revenue is recognized when a non-cancelable license agreement has been signed, the product has been shipped, there are no uncertainties surrounding product acceptance, the fees are fixed and determinable and collection is probable. The portion of revenues from new license agreements which relate to the Partnership's obligations to provide customer support are deferred and recognized ratably over the maintenance period. PRODUCT WARRANTY - The Partnership provides for the estimated costs to fulfill customer warranty and other contractual obligations upon the recognition of the related revenue. Such provisions are determined based upon estimates of component failure rates. Actual warranty costs are charged against the accrual when incurred. INCOME TAXES are not included in the financial statements, since income taxes are the responsibility of the partners. STOCK-BASED COMPENSATION - Stock-based awards granted to employees are accounted for using the intrinsic value method in accordance with Accounting Principles Board Opinion ("APB") No. 25, ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES. COMPREHENSIVE INCOME - Statement of Financial Accounting Standards ("SFAS")No. 130, REPORTING COMPREHENSIVE INCOME, requires that all items recognized under accounting standards as components of comprehensive income be reported in an annual financial statement that is displayed with the same prominence as other annual financial statements. This statement also requires that an entity classify items of other comprehensive income by their nature in an annual financial statement. Comprehensive income includes net income and other comprehensive income. Comprehensive loss was the same as net loss for 1998. SEGMENT REPORTING - SFAS No. 131, DISCLOSURES ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION, establishes standards for the reporting of information about operating segments, including related disclosures about products and services, geographic areas and major customers, and requires selected information about operating segments in interim financial statements. Segment data has not been presented as management has determined that the Partnership does not operate in more than one reportable segment. NEW ACCOUNTING PRONOUNCEMENTS - In June 1998, SFAS No. 133, ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES, was issued, which establishes accounting and reporting standards for derivative instruments and hedging activities which are required for fiscal years beginning after June, 15, 1999. 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 Partnership believes the adoption of SFAS No. 133 will not have a material effect on the financial statements. CERTAIN SIGNIFICANT RISKS AND UNCERTAINTIES - Two customers comprised substantially all of the Partnership's revenue from equipment sales in 1998. As of December 31, 1998, 84% of the Partnership's trade accounts receivable were derived from these two customers. The loss of any of these customers or any substantial reduction in orders by any of these customers could have a material adverse affect on the Partnership operating F-38 NOTES (Dollars in thousands, unless otherwise noted) results. Additionally, the Partnership relies on certain contract manufacturers to perform substantially all of its manufacturing activities. The inability of its contract manufacturers to fulfill their obligations to the Partnership could adversely impact future results. The Partnership performs ongoing credit evaluations of its customers and generally does not require collateral from its customers. The Partnership maintains allowances for potential losses, and has not incurred any significant losses to date. 4. Acquisition of Telenetworks In September 1997, NLC acquired of all of the outstanding capital stock of Telenetworks, a specialized data protocol communications software company. The purchase price was approximately $7 million in cash. The acquisition was accounted for using the purchase method of accounting and accordingly, the assets acquired and liabilities assumed were recorded at their estimated fair values as of the date of acquisition. The $6.9 million excess of the purchase price over the net identifiable assets acquired was allocated to goodwill. In January 1998, in conjunction with the formation of the Partnership, the Limited Partner contributed the assets and liabilities of Telenetworks to the Partnership. In conjunction with the acquisition in September 1997, General Instrument granted $7 million in restricted common stock of General Instrument to certain Telenetworks employees. The restrictions on the common stock of General Instrument lapsed over a 270-day period which ended on May 31, 1998. Since this stock was contingently payable based on the individual's continued employment, prepaid compensation of $7 million was recorded and amortized to compensation expense over the life of the restrictions. Compensation expense of $3.9 million was recorded in 1998. In June 1998, the Partnership issued approximately $2.9 million in loans to former Telenetworks employees due to certain tax liabilities associated with the restricted stock, $2.5 million of which was outstanding at December 31, 1998 and recorded in other receivables. The loans are due in April 1999, and are collateralized by the common stock of General Instrument held by such employees. 5. Inventories Inventories at December 31, 1998 consist of: Raw materials $ 7,203 Work-in-process 1,157 Finished goods 12,310 --------- Total $ 20,670 ---------
The Partnership recorded a provision for inventory obsolescence of $5.8 million in 1998. 6. Property and Equipment - net Property and equipment - net at December 31, 1998 consists of: Leasehold improvements $ 4,457 Machinery and equipment 28,315 --------- Total 32,772 Less accumulated depreciation (11,214) --------- Property and equipment - net $ 21,558 ---------
Machinery and equipment includes assets acquired under capital leases of $.9 million and accumulated depreciation of $.2 million at December 31, 1998. 7. Accrued Expenses Accrued expenses at December 31, 1998 consists of: Accrued payroll and related expenses $ 4,767 Other accrued expenses 5,930 --------- Total $ 10,697 ---------
8. Related Party Transactions with General Instrument In January 1998, in conjunction with the formation of the Partnership, General Instrument advanced $75 million to the Partnership in exchange for a note (the "Note") bearing interest at a rate of 8%. The Note includes certain covenants including limitations on borrowings, and is due in 2005. The Note provides for the deferral of scheduled interest payments under certain circumstances. Deferred interest payments bear interest at 10% and are not payable until certain earnings levels, as defined, are met. The Partnership or the Successor Corporation has an option, following an IPO of the Successor Corporation, to repay the Note, together with accrued interest, in shares of stock of the Successor Corporation. In 1998, the Partnership deferred interest payments of $4.5 million. At December 31, 1998, the Partnership owed General Instrument $80.9 million under this Note, including accrued interest of $5.9 million. The fair value of the Note, computed based F-39 NOTES (Dollars in thousands, unless otherwise noted) upon current interest rates for debt instruments with comparable maturities and characteristics, at December 31, 1998 was approximately $62.5 million. General Instrument has agreed to provide an additional $34 million of capital contributions in 1999, payable in installments through April 1999, in return for an increase in its Partnership interest to 90.4%. 9. STOCK OPTION PLANS Certain employees of the Partnership have been granted contingently issuable stock options in NLC which expire in ten years. Such options are exercisable only in the event of an initial public offering or a change in control of NLC (the "Event"). Compensation expense will be recognized on the date of the Event based on the difference between the exercise price of the options and the fair value on the date of the Event. In addition, during 1997, as part of a tandem stock option grant certain employees of NLC were granted options for a total of 5.8 million shares of common stock of NLC, or options for a total of 1.5 million shares of General Instrument common stock (the "GI Options"). Under the terms of the grant, the exercise of options on either NLC or General Instrument common stock results in the cancellation of options in the other company's common stock at a ratio of approximately 4 shares of NLC common stock to 1 share of General Instrument common stock. The options have a ten year life and vest over three years. Statement of Financial Accounting Standards ("SFAS") No. 123, ACCOUNTING FOR STOCK BASED COMPENSATION, requires the disclosure of pro forma net income (loss) using the fair value method. The estimated fair value of an option grant is based, in part, on the estimated term of the option. NLC options granted under the NLC Plan are not exercisable unless an Event occurs. As a result, it is not practicable to determine the expected term of NLC options and therefore it is not possible to estimate the fair value of such options. Had compensation cost been determined under SFAS 123 for the GI Options under the tandem stock option grant, the Partnership's net loss would have been changed to the pro forma amounts indicated below: Net loss: As reported $ (81,731) Pro forma (84,494)
10. Employee Benefit Plans Employees of the Partnership, who meet certain eligibility requirements, are able to participate in the General Instrument 401(k) Plan. Employees may contribute up to 10% of their annual compensation, subject to the legal maximum. The Partnership, through General Instrument, contributes an amount equal to 50% of the first 6% of the employee's salary that the employee contributes. The Partnership's expense related to the 401(k) Plan was $.5 million for the year ended December 31, 1998. The Partnership's employees participate in General Instrument's Pension Plan, Post Retirement Benefit Plan and Post Employment Benefit Plan. The Partnership expense related to these plans was $.4 million for the year ended December 31, 1998. 11. Obligations Under Capital Leases The Partnership leases certain equipment under capital leases. Leases expire at various dates from 1999 to 2001 and all contain purchase options. Future minimum lease payments at December 31, 1998 are as follows: Years ending December 31: 1999 $ 396 2000 310 2001 25 --------- Total 731 Less current portion (396) --------- Total long-term capital lease obligations $ 335 ---------
12. Commitments and Contingencies The Partnership leases its facilities and certain equipment under operating leases. Leases expire at various dates from 1999 to 2006 and certain facilities leases have renewal options. During 1998 the Partnership entered into an operating lease for one of its buildings which expires in 2004. The lease provides for a purchase option but does not allow for renewal options. General Instrument has guaranteed a residual value to the lessor of approximately 82% of the underlying mortgage and equity investment. The table of future minimum operating lease payments below excludes any payments related to the residual guarantee. Rental expense recorded under the lease in 1998 was $.8 million. F-40 NOTES (Dollars in thousands, unless otherwise noted) Future minimum lease payments at December 31, 1998 are as follows: Years ending December 31: 1999 $ 3,154 2000 2,943 2001 2,357 2002 2,181 2003 2,098 Thereafter 2,548 --------- Total $ 15,281 ---------
Rent expense was $3.5 million for the year ended December 31, 1998. The Partnership has a commitment with a supplier to purchase approximately $2.1 million of products in the 12 months following the release of the product and approximately $4.3 million in the subsequent 12 months. In addition, the Partnership has a commitment to purchase $2.4 million of product prior to September 2002 with a minimum purchase of $.5 million each 12-month period following the release of the product. The Partnership expects the release of these products to occur during the second quarter of 1999. The Partnership has a commitment to another supplier to purchase approximately $14.7 million of products prior to December 2001. On May 5, 1998, the action entitled BroadBand Technologies, Inc., v. General Instrument Corp., pending in the United States District Court for the Eastern District of North Carolina, was dimissed with prejudice. In addition, on May 4, 1998, the action entitled Next Level Communications, Inc. v. BroadBand Technologies, Inc., was dismissed with prejudice. These dismissals were entered pursuant to a settlement agreement under which, among other things, the Partnership has paid BroadBand Technologies ("BBT") $5 million, which was expensed in 1998, and BBT and the Partnership have entered into a perpetual cross-license of patents applied for or issued currently or during the next five years. On March 5, 1998, an action entitled DSC Communications Corporation and DSC Technologies Corporation v. Next Level Communications, L.P., KK Manager, LLC, 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 alleged that in connection with the formation of the Partnership and the transfer of the switched digital video technology, the Partnership and KK Manager LLC misappropriated DSC's trade secrets; that General Instrument improperly disclosed trade secrets when it conveyed such technology to the Partnership; and that Spencer Trask & Co. conspired to misappopriate 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, General Instrument and the other defendants filed an action in the United 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 invloving DSC. On May 14, 1998, the United States District Court for the Eastern District of Texas granted a preliminary injunction preventing DSC from proceeding with the Delaware Action. That injunction order is now on appeal to the United States Court of Appeal for the Fifth Circuit where it has been briefed and awaits determination. On July 6, 1998, the defendants filed a motion for summary judgment with the Texas Court requesting a permanent injunction preventing DSC from proceeding with this litigation. As a result of the preliminary injunction, the Delaware Action has been stayed in its entirety. The Partnership intends to vigorously contest this action. While the ultimate outcome of these matters described above cannot be determined, management, KK Partners LLC and General Instrument intend to vigorously contest these actions and do not believe that the final disposition of these matters will have a material adverse effect on the financial statements taken as a whole. F-41 EX-10.12 2 SONY STOCK PURCHASE AGREEMENT Exhibit 10.12 STOCK PURCHASE AGREEMENT by and between SONY CORPORATION OF AMERICA and GENERAL INSTRUMENT CORPORATION November 30, 1998 TABLE OF CONTENTS ----------------- PAGE ARTICLE I TERMS OF PURCHASE AND SALE.....................................1 1.1 Purchase and Sale of Shares........................................1 1.2 The Closing........................................................1 ARTICLE II REPRESENTATIONS AND WARRANTIES OF THE COMPANY.................2 2.1 Corporate Organization.............................................2 2.2 Capitalization.....................................................2 2.3 Authority; No Violation............................................2 2.4 Consents and Approvals.............................................3 2.5 SEC Reports; Financial Statements..................................4 2.6 Compliance with Laws...............................................4 2.7 Absence of Certain Changes or Events...............................4 2.8 Legal Proceedings..................................................4 2.9 Brokers and Finders................................................5 2.10 No Other Representations or Warranties............................5 ARTICLE III REPRESENTATIONS AND WARRANTIES OF PURCHASER..................5 3.1 Corporate Organization.............................................5 3.2 Authority; No Violation............................................5 3.3 Consents and Approvals.............................................6 3.4 Investment Intent..................................................6 3.5 Financial Ability..................................................6 3.6 Compliance with Laws; Legal Proceedings............................6 3.7 Available Funds....................................................7 3.8 Brokers............................................................7 ARTICLE IV PRE-CLOSING COVENANTS.........................................7 4.1 Undertakings.......................................................7 4.2 Access.............................................................7 4.3 Share Listing......................................................7 ARTICLE V ADDITIONAL AGREEMENTS..........................................8 5.1 Restrictions on Transfer; Right of First Offer.....................8 5.2 Rights in the Event of a Public Offering; Closing Matters, etc....11 5.3 Standstill........................................................13 5.4 Registration Rights...............................................13 (a) Demand Registration Rights........................................13 (b) "Piggyback" Registrations.........................................15 (c) The Company's Obligations in Registration.........................17 (d) Payment of Registration Expenses..................................21 (e) Information from Holders..........................................21 (f) Indemnification...................................................21 (g) Exchange of Certificates..........................................23 (h) Obligations of the Holders........................................24 (i) Underwritten Registration.........................................24 (j) Exchange Act Compliance...........................................25 5.5 Restrictions on Transferability of Shares.........................25 (a) Restrictive Legend; Purchaser's Representation....................25 (b) Statement of Intention to Transfer; Opinion of Counsel............26 (c) Termination of Restrictions.......................................26 5.6 No Public Announcement............................................27 5.7 Confidentiality...................................................27 ARTICLE VI CONDITIONS TO PURCHASER'S OBLIGATIONS........................28 6.1 Representations, Warranties and Covenants of the Company..........28 6.2 No Proceedings....................................................28 6.3 Hart-Scott-Rodino Waiting Periods.................................28 6.4 Share Listing.....................................................28 6.5 Joint Development Agreement.......................................29 ARTICLE VII CONDITIONS TO THE COMPANY'S OBLIGATIONS.....................29 7.1 Representations, Warranties and Covenants of Purchaser............29 7.2 No Proceedings....................................................29 7.3 Hart-Scott-Rodino Waiting Periods.................................29 7.4 Stockholder Approval..............................................29 ARTICLE VIII TERMINATION PRIOR TO CLOSING...............................30 8.1 Termination of Agreement..........................................30 8.2 Effect of Termination.............................................30 ARTICLE IX DEFINITIONS....................................................30 ARTICLE X SURVIVAL; INDEMNIFICATION......................................33 10.1 Survival.........................................................33 10.2 Indemnification by Purchaser.....................................34 10.3 Indemnification by The Company...................................34 10.4 Indemnification Procedures.......................................34 -3- ARTICLE XI MISCELLANEOUS................................................35 11.1 Entire Agreement.................................................35 11.2 Successors and Assigns...........................................36 11.3 Assignment.......................................................36 11.4 Counterparts.....................................................36 11.5 Headings.........................................................36 11.6 No Waiver........................................................36 11.7 Fees and Expenses................................................36 11.8 Notices..........................................................36 11.9 Amendments.......................................................37 11.10 Governing Law...................................................37 11.11 Consent to Jurisdiction.........................................37 11.12 Specific Performance............................................38 -4- STOCK PURCHASE AGREEMENT THIS AGREEMENT, dated as of this 30th day of November 1998, by and between General Instrument Corporation, a Delaware corporation (the "Company"), and Sony Corporation of America, a New York corporation ("Purchaser"). W I T N E S S E T H : - - - - - - - - - - WHEREAS, Purchaser, and/or its direct or indirect Subsidiary, and the Company are concurrently entering into a Joint Development and Licensing Agreement (the "Joint Development Agreement") providing for certain joint activities to be undertaken by Purchaser and the Company with respect to the development of advanced digital television technologies; and WHEREAS, the Company desires to sell to Purchaser, and Purchaser desires to buy from the Company, an aggregate of 7,500,000 newly issued shares of common stock, par value $.01 per share of the Company (the "Common Stock"), together with the associated preferred share purchase rights (the "Rights" and, such shares of Common Stock, together with the associated Rights, the "Shares"); NOW, THEREFORE, in consideration of the premises and mutual representations, warranties, covenants and agreements contained herein, and upon the terms and subject to the conditions hereinafter set forth, the parties do hereby agree as follows: ARTICLE I TERMS OF PURCHASE AND SALE 1.1 PURCHASE AND SALE OF SHARES. On the Closing Date (as defined in Section 1.2), subject to the terms and conditions set forth herein, the Company shall sell to Purchaser, and Purchaser shall purchase from the Company, the Shares for the Purchase Price (as defined below). At the Closing (as defined in Section 1.2), the Company shall deliver to Purchaser certificates representing the Shares registered in the name of the Purchaser, and Purchaser shall deliver to the Company the amount of $187,500,000 in cash (the "Purchase Price"), by wire transfer of immediately available funds to the account designated by the Company in writing to Purchaser at least two Business Days prior to the Closing Date. 1.2 THE CLOSING. The purchase and sale of the Shares (the "Closing") shall take place at the offices of Fried, Frank, Harris, Shriver and Jacobson, One New York Plaza, New York, New York -5- 10004 at 10:00 A.M. on the second Business Day following the date on which all applicable waiting periods under the HSR Act shall have expired, or at such other time, place and/or date as the parties may mutually agree (the "Closing Date"). ARTICLE II REPRESENTATIONS AND WARRANTIES OF THE COMPANY The Company hereby represents and warrants to the Purchaser as follows: 2.1 CORPORATE ORGANIZATION. The Company is a corporation duly organized, validly existing and in good standing under the laws of the State of Delaware. The Company has the corporate power and authority to own or lease all of its properties and assets and to carry on its business as it is now being conducted, and is duly licensed or qualified to do business in each jurisdiction in which the nature of the business conducted by it or the character or location of the properties and assets owned or leased by it makes such licensing or qualification necessary, except where the failure to be so licensed or qualified would not, individually or in the aggregate, be reasonably expected to have a Material Adverse Effect on the Company and its Subsidiaries, taken as a whole. True and complete copies of the amended and restated certificate of incorporation and by-laws of the Company, in effect as of the date of this Agreement, have previously been made available by the Company to Purchaser. 2.2 CAPITALIZATION. (a) The authorized capital stock of the Company consists of 400,000,000 shares of Common Stock and 20,000,000 shares of Preferred Stock, par value $.01 per share (the "Preferred Stock"), 400,000 shares of which are designated Series A Junior Participating Preferred Stock (the "Series A Preferred Stock"). As of October 30, 1998, 167,391,015 shares of Common Stock were issued and outstanding, 44,360,925 shares of Common Stock were reserved for issuance pursuant to existing warrant agreements and stock option plans, 6,278,424 shares of Common Stock were held in treasury and no shares of Preferred Stock were outstanding. All of the issued and outstanding shares of the Company have been duly authorized and validly issued and are fully paid, non-assessable and free of preemptive rights, with no personal liability attaching to the ownership thereof. Except for (i) the Warrant Issuance Agreement, dated as of December 16, 1997, between the Company and NDTC (the "NDTC Warrant Issuance Agreement"), (ii) the various warrant issuance agreements between the Company and the MSOs (the "MSO Warrant Issuance Agreements"), (iii) the Company's employee benefits plans and the options and awards granted thereunder, and (iv) the Company's Rights Agreement, dated as of June 12, 1997, as amended, or as contemplated by this Agreement, the Company is not bound by any outstanding subscriptions, options, warrants, stock appreciation rights or agreements of any character calling for the purchase or issuance of any equity securities of the Company or any debt securities of the Company convertible into, or exchangeable for, any equity securities of the Company. (b) There are no "Significant Subsidiaries" of the Company (as defined in Regulation S-X under the federal securities laws of the United States). -6- 2.3 AUTHORITY; NO VIOLATION. (a) The Company has full corporate power and authority to execute and deliver this Agreement, to issue and deliver the Shares and to perform its other obligations hereunder, and to consummate the transactions contemplated hereby. The execution and delivery of this Agreement, the issuance and delivery of the Shares and the performance of the Company's other obligations hereunder and the consummation of the transactions contemplated hereby have been duly and validly approved by the Board of Directors of the Company. No other corporate proceedings on the part of the Company are necessary under Delaware law to approve this Agreement and to consummate the transactions contemplated hereby. This Agreement has been duly and validly executed and delivered by the Company and (assuming due authorization, execution and delivery by Purchaser) constitutes a valid and legally binding obligation of the Company, enforceable against the Company in accordance with its terms except to the extent that (i) its enforceability may be subject to applicable bankruptcy, insolvency, reorganization, moratorium and similar laws affecting the enforcement of creditor's rights generally and by general equitable principles and (ii) rights to indemnity or contribution contained herein may be limited by United States federal or state laws, regulations or public policy. (b) The Shares, when issued and delivered by the Company pursuant to this Agreement, against payment of the consideration set forth herein, will be validly issued, fully paid and non-assessable and the issuance of the Shares is not subject to preemptive or other similar rights of any securityholder of the Company. (c) The execution, delivery and performance of this Agreement by the Company do not, and the issuance and delivery of the Shares and the consummation by the Company of the transactions contemplated hereby will not (i) constitute a breach or violation of, or a default under, the certificate of incorporation or by-laws of the Company, (ii) constitute a breach or violation of, or a default under, or give rise to any Lien, any acceleration of remedies or any right of termination under, any law, any rule or regulation or any judgment, decree, order, governmental permit or license, or agreement, indenture or instrument of the Company or to which the Company or its properties is subject or bound, or (iii) require any consent or approval under any such law, rule, regulation, judgment, decree, order, governmental permit or license, agreement, indenture or instrument, except in the case of (ii) and (iii) above for such breaches, violations, defaults, Liens, accelerations, rights, consents or approvals as would not, individually or in the aggregate, be reasonably expected to result in a Material Adverse Effect on the Company and its Subsidiaries, taken as a whole. 2.4 CONSENTS AND APPROVALS. Except pursuant to the provisions of the HSR Act, the Securities Act, the Exchange Act, state securities laws, and the rules of the New York Stock Exchange, Inc. ("NYSE"), no notice to, filing with, authorization of, exemption by, or consent or approval of, any regulatory authority on the part of the Company is necessary for the consummation by the Company of the transactions contemplated by this Agreement, except where the failure to provide such notice, make such filing, or obtain such authorization, exemption, consent or approval would not, individually or in the aggregate, be reasonably expected to result in a Material Adverse Effect on the Company and its Subsidiaries, taken as a whole. -7- 2.5 SEC REPORTS; FINANCIAL STATEMENTS (a) Since March 31, 1998, the Company has filed all forms, reports, statements and other documents (such filings by the Company are collectively referred to as the "SEC Reports"), required to be filed by it with the Commission. The SEC Reports, including all SEC Reports filed after the date of this Agreement and prior to the Closing Date, (i) were or will be prepared in all material respects in accordance with the requirements of the Securities Act and the Exchange Act, as the case may be, and the rules and regulations of the Commission thereunder applicable to such SEC Reports at the time of filing thereof and (ii) did not at the time they were filed, or will not at the time they are filed, contain any untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary in order to make the statements therein, in the light of the circumstances under which they were made, not misleading. (b) Each of the consolidated financial statements (including, in each case, any related notes thereto) contained in the SEC Reports, including all SEC Reports filed after the date of this Agreement and prior to the Closing Date (i) have been or will be prepared in accordance with the published rules and regulations of the Commission and generally accepted accounting principles applicable at the time of filing thereof, applied on a consistent basis throughout the periods involved (except (A) to the extent required by changes in generally accepted accounting principles and (B) as may be indicated in the notes thereto) and (ii) fairly present, or will fairly present, in all material respects the consolidated financial position of the Company and its consolidated Subsidiaries as of the respective dates thereof and the consolidated results of operations and cash flows for the periods indicated (including reasonable estimates of normal and recurring year-end adjustments), except that (x) any unaudited interim financial statements were or will be subject to normal and recurring year-end adjustments, and (y) any pro forma financial statements contained in such consolidated financial statements are not necessarily indicative of the consolidated financial position of the Company and its consolidated Subsidiaries, as of the respective dates thereof and the consolidated results of operations and cash flows for the periods indicated. 2.6 COMPLIANCE WITH LAWS. The Company is in compliance with all applicable laws, regulations, orders, judgments and decrees, except where the failure to so comply would not, individually or in the aggregate, be reasonably expected to have a Material Adverse Effect on the Company and its Subsidiaries, taken as a whole. 2.7 ABSENCE OF CERTAIN CHANGES OR EVENTS. Since March 31, 1998, except as set forth in the SEC Reports or as set forth in the Company's press releases, no event has occurred which has had, individually or in the aggregate, a Material Adverse Effect on the Company and its Subsidiaries, taken as a whole. 2.8 LEGAL PROCEEDINGS. As of the date hereof, except as set forth in the SEC Reports or as disclosed to Purchaser, the Company is not a party to any, and there are no pending or, to the Company's knowledge, threatened, legal, administrative, or other proceedings, claims, actions or -8- governmental or regulatory investigations of any nature against the Company or any of its Subsidiaries which, individually or in the aggregate, would reasonably be expected to have a Material Adverse Effect on the Company and its Subsidiaries, taken as a whole. 2.9 BROKERS AND FINDERS. Except for the Company's retention of Merrill Lynch, Pierce, Fenner & Smith, Incorporated and Lazard Freres & Co., LLC (whose fees will be paid by the Company), the Company and its affiliates have not employed any broker or finder or incurred any liability for any broker's fees, commissions or finder's fees in connection with the transactions contemplated by this Agreement. 2.10 NO OTHER REPRESENTATIONS OR WARRANTIES. Except for the representations and warranties contained in this Article II, none of the Company or any other Person makes any express or implied representation or warranty with respect to the subject matter of this Agreement. ARTICLE III REPRESENTATIONS AND WARRANTIES OF PURCHASER Purchaser hereby represents and warrants to the Company as follows: 3.1 CORPORATE ORGANIZATION Purchaser is a corporation duly organized, validly existing and in good standing under the laws of Delaware. Purchaser has the corporate power and authority to own or lease all of its properties and assets and to carry on its business as it is now being conducted, and is duly licensed or qualified to do business in each jurisdiction in which the nature of the business conducted by it or the character or location of the properties and assets owned or leased by it makes such licensing or qualification necessary, except where the failure to be so licensed or qualified would not, individually or in the aggregate, be reasonably expected to materially adversely affect the ability of Purchaser to consummate the transactions contemplated by this Agreement. 3.2 AUTHORITY; NO VIOLATION. (a) Purchaser has full corporate power and authority to execute and deliver this Agreement, to perform its obligations hereunder, and to consummate the transactions contemplated hereby. The execution and delivery of this Agreement, the performance of Purchaser's obligations hereunder, and the consummation of the transactions contemplated hereby have been duly and validly approved by the Board of Directors of Purchaser. No other corporate proceedings on the part of Purchaser and no stockholder votes are necessary to approve this Agreement and to consummate the transaction contemplated hereby. This Agreement has been duly and validly executed and delivered by Purchaser and (assuming due authorization, execution and delivery by the Company) constitutes a valid and legally binding obligation of Purchaser, enforceable against Purchaser in accordance with its terms except to the extent that (i) -9- its enforceability may be subject to applicable bankruptcy, insolvency, reorganization, moratorium and similar laws affecting the enforcement of creditor's rights generally and by general equitable principles and (ii) rights to indemnity or contribution contained herein may be limited by United States federal or state laws, regulations or public policy. (b) The execution, delivery and performance of this Agreement by Purchaser do not, and the consummation by Purchaser of the transactions contemplated hereby, will not, (i) constitute a breach or violation of, or default under the certificate of incorporation or by-laws of Purchaser; (ii) constitute a breach or violation of, or a default rise to any Lien, any acceleration of remedies or termination under, any law, rule or regulation or decree, order, governmental permit or license, or indenture or instrument of Purchaser or to which Purchaser or its properties are subject or bound, or (iii) require any consent or approval under any such law, rule, regulation, judgment, decree, order, governmental permit or license, agreement, indenture or instrument except in the case of (ii) and (iii) above for such breaches, violations, defaults, Liens, accelerations, rights, consents or approvals as would not, individually or in the aggregate, be reasonably expected to materially adversely affect the ability of Purchaser to consummate the transactions contemplated by this Agreement. 3.3 CONSENTS AND APPROVALS. Except pursuant to the provisions of the HSR Act, no notice to, filing with, authorization of, exemption by, or consent or approval of, any regulatory authority is necessary for consummation by Purchaser of the transactions contemplated hereby, except where the failure to provide such notice, make such filing, or obtain such authorization, exemption, consent or approval would not, individually or in the aggregate, be reasonably expected to materially adversely affect the ability of Purchaser to consummate the transactions contemplated by this Agreement. 3.4 INVESTMENT INTENT. Purchaser acknowledges that the Shares have not been registered under the Securities Act, or under any state or foreign securities laws. Purchaser is not an underwriter, as such term is defined under the Securities Act, and is purchasing the Shares solely for investment with no present intention to distribute any of the Shares to any person, and Purchaser will not sell or otherwise dispose of any of the Shares, except in compliance with the registration requirements or exemption provisions under the Securities Act and the rules and regulations promulgated thereunder, and any other applicable state or federal securities laws. Purchaser is acquiring the Shares solely for its own account and not with a view to a sale or distribution thereof in violation of any state or federal securities laws. Purchaser acknowledges that it has received, or has had access to, all information which it considers necessary or advisable to enable it to make a decision concerning its purchase of the Shares, provided that the foregoing access shall not limit or otherwise affect the rights or remedies of Purchaser hereunder with respect to the breach of any representations, warranties, covenants or agreements of the Company contained herein. 3.5 FINANCIAL ABILITY. -10- Purchaser has the financial capacity to perform all of its obligations under this Agreement. 3.6 COMPLIANCE WITH LAWS; LEGAL PROCEEDINGS. Purchaser and its Subsidiaries are in compliance with all applicable laws, regulations, orders, judgments and decrees, except where the failure to so comply would not materially adversely affect the ability of Purchaser to consummate the transactions contemplated by this Agreement. Purchaser is not a party to any, and there are no pending, or to the best of Purchaser's knowledge threatened, legal, administrative or other proceedings, claims, actions or governmental or regulatory investigations of any nature against Purchaser or any of its Affiliates, which, individually or in the aggregate, would materially adversely affect the ability of Purchaser to consummate the transactions contemplated by this Agreement. 3.7 AVAILABLE FUNDS. At the Closing, Purchaser will have available to it all funds necessary to satisfy all of its obligations hereunder and in connection with the transactions contemplated hereby on the terms and conditions set forth herein. 3.8 BROKERS. Other than The Blackstone Group, L.P. (whose fees will be paid by Purchaser), Purchaser and its Affiliates have not employed any broker or finder or incurred any liability for any broker's fees, commissions or finder's fees in connection with the transactions contemplated by this Agreement. ARTICLE IV PRE-CLOSING COVENANTS The parties hereto hereby covenant and agree as follows: 4.1 UNDERTAKINGS. Each of the parties hereto agrees to use its reasonable best efforts promptly to take or cause to be taken all action and promptly to do or cause to be done all things necessary, proper or advisable under applicable laws and regulations to consummate and make effective the Closing of the transactions contemplated by this Agreement. Without limiting the foregoing, Purchaser and the Company (a) will use their reasonable best efforts to make all filings, including filings under the HSR Act, and obtain all other regulatory approvals necessary or, in the opinion of Purchaser or the Company, advisable in order to permit the consummation of the transactions contemplated hereby and (b) will not take actions that could reasonably be expected to have the effect of delaying or hindering the Closing of the transactions contemplated hereby. In no event, however, shall the Company or Purchaser be obligated to pay any money to any Person or to offer or grant other financial or other accommodations to any Person in connection with its obligations under this Section 4.1. Each party shall execute and deliver both before and after the Closing such further certificates, agreements and other documents and take such other -11- actions as the other party may reasonably request to consummate or implement the transactions contemplated hereby or to evidence such events or matters. 4.2 ACCESS. Subject to compliance by Purchaser with the provisions of Section 5.7, from the date of this Agreement to the Closing Date, the Company shall, and shall cause its Subsidiaries to, afford to Purchaser and its representatives reasonable access, upon reasonable notice and request and in such manner as will not unreasonably interfere with the conduct of the Company's and its Subsidiaries' business, to such public financial and other public information regarding the Company and its Subsidiaries as Purchaser reasonably considers necessary or advisable to allow it to make a decision concerning its purchase of the Shares. 4.3 SHARE LISTING. As soon as practicable but in any event prior to the Closing Date, the Company shall use its reasonable best efforts to cause the Shares to be listed for trading on the NYSE or such other exchange or quotation system on which the Common Stock is then listed or traded. ARTICLE V ADDITIONAL AGREEMENTS The Company, on the one hand, and Purchaser, on the other hand, hereby covenant to and agree with one another as follows: 5.1 RESTRICTIONS ON TRANSFER; RIGHT OF FIRST OFFER. (a) Notwithstanding any other provisions of this Agreement, Purchaser and any Permitted Transferee (each, a "Holder") shall not sell, transfer, pledge, hypothecate, assign or otherwise dispose of (a "Transfer") any Shares at any time prior to the date which is 540 days after the Closing Date. During the period between the 540th day after the Closing Date and the 905th day after the Closing Date (such period being referred to as the "Restricted Period"), a Holder shall not Transfer any Shares (other than pursuant to the provisions of Section 5.2) without first complying with the provisions of this Section 5.1. (b) If, during the Restricted Period, a Holder shall receive a bona fide offer in writing (an "Offer") to acquire all or part of the Shares (the "First Offer Shares"), which offer such Holder proposes to accept, such Holder shall deliver to the Company a notice (a "Notice of Sale") containing a copy of the Offer, and setting forth the identity of the proposed purchaser and an offer to sell the First Offer Shares to the Company on the following terms: (i) if the Offer contemplates a purchase of the First Offer Shares by the proposed purchaser for consideration -12- consisting solely of cash, then the Holder's offer shall be to sell the First Offer Shares for cash in an amount equal to the purchase price specified in, and otherwise on the terms and conditions contained in, the Offer, and (ii) if the Offer contemplates an acquisition of the First Offer Shares by the proposed purchaser for consideration any portion of which is not cash, then the offer shall be to sell the First Offer Shares for cash in an amount equal to the sum of the cash consideration and the fair market value of the noncash consideration (as determined pursuant to paragraph (d) below) specified in, and otherwise on the terms and conditions contained in, the Offer. The Notice of Sale shall specify the price at which the First Offer Shares are offered, as provided in the preceding sentence. If the Company desires to accept the offer set forth in a Notice of Sale, the Company shall, within 30 days of receipt of such Notice of Sale, notify the Holder in writing of its intention to acquire the First Offer Shares. The closing of such purchase and sale shall be subject to the additional provisions of paragraphs (d) and (e) of Section 5.2. (c) If (i) the Company does not timely accept the offer set forth in a Notice of Sale, or (ii) the purchase of the First Offer Shares is not consummated within the period set forth in Section 5.2(d)(iii) for any reason other than a breach by the Holder of any of its covenants, representations or warranties that are a condition to consummation of such purchase, then the Company shall be deemed to have rejected such offer as of the last date for accepting such offer or closing such purchase, as applicable, and the Holder shall have the right, at any time during the 30-day period beginning on the date that the offer set forth in a Notice of Sale is deemed rejected or the day following the last day of the period set forth in Section 5.2(d)(iii), as applicable, to enter into a binding agreement to sell all of the First Offer Shares to the proposed purchaser on terms and conditions no less favorable in the aggregate to the Holder than those set forth in the Offer, and thereafter (within the period specified below in this paragraph (c)) to sell all of the First Offer Shares to the proposed purchaser pursuant to such agreement. If the Holder does not enter into such an agreement during such 30-day period, or does not close the sale thereunder within 60 days after execution of such an agreement (subject to extension for a maximum of 180 additional days to the extent required to obtain all required governmental and third-party approvals), the procedure set forth above with respect to the Notice of Sale shall be repeated with respect to any subsequent proposed sale, assignment or other disposition of the Shares. Any First Offer Shares transferred to a Person other than the Company in compliance with the provisions of this Section 5.1 shall not thereafter be subject to the provisions of this Agreement. (d) Before submitting a Notice of Sale pursuant to paragraph (b) in response to an Offer that contemplates (i) a sale of the First Offer Shares in conjunction with other assets, or (ii) an acquisition of the First Offer Shares by the proposed purchaser for consideration any portion of which is not cash, the Holder and the Company shall cause (A) if the Offer contemplates a sale of the First Offer Shares in conjunction with other assets, the total consideration specified in the Offer to be allocated between the First Offer Shares and such other assets, (B) if the Offer contemplates an acquisition of the First Offer Shares by the proposed purchaser for consideration any portion of which is not cash, the fair market value of the noncash consideration to be determined, in each case pursuant to this paragraph (d): (i) The Holder shall deliver to the Company a notice stating that -13- the Holder intends to deliver a Notice of Sale to which this paragraph (d) applies and identifying an appraiser (the "First Appraiser") who has been retained by the Holder to allocate the total consideration specified in the Offer or to conduct an appraisal of the noncash consideration pursuant to this paragraph (d). Within ten business days after its receipt of the Holder's notice pursuant to the preceding sentence, the Company shall send a notice to the Holder identifying a second appraiser (the "Second Appraiser") who shall be retained by the Company to make such allocation or conduct such appraisal, as applicable, pursuant to this paragraph (d). (ii) The First Appraiser and the Second Appraiser shall submit their independent determinations of the amount of consideration allocable to the First Offer Shares or the fair market value of the noncash consideration as applicable, within 30 days after the date on which the Second Appraiser is retained. If the respective determinations of the First Appraiser and the Second Appraiser vary by less than ten percent of the higher determination, the amount of consideration allocable to the First Offer Shares or the fair market value of the noncash consideration, as applicable, for purposes of paragraph (b), shall be the average of the two determinations. (iii) If the respective determinations of the First Appraiser and the Second Appraiser vary by ten percent or more of the higher determination, the two Appraisers shall promptly designate a third appraiser (the "Third Appraiser"), who shall be retained by the Holder and the Company to make an allocation or conduct an appraisal pursuant to this paragraph (c). The First Appraiser and the Second Appraiser shall be instructed not to, and the Holder and the Company shall not provide any information to the Third Appraiser as to the determinations of the First Appraiser and the Second Appraiser or otherwise influence the Third Appraiser's determination in any way. The Third Appraiser shall submit its determination of the amount of consideration allocable to the First Offer Shares or the fair market value of the noncash consideration, as applicable, within thirty days after the date on which the Third Appraiser is retained. If a Third Appraiser is retained, the amount of consideration allocable to the First Offer Shares or the fair market value of the noncash consideration, as applicable, for purposes of paragraph (a), shall equal the average of the two closest of the three determinations, except that, if the difference between the highest and middle determinations is no more than 105% and no less than 95% of the difference between the middle and lowest determinations, then the amount of consideration allocable to the First Offer Shares or the fair market value of the noncash consideration, as applicable, for purposes of paragraph (a), shall equal the middle determination. (iv) Any appraiser retained pursuant to this paragraph (d) shall be nationally recognized as being qualified and experienced in the appraisal of assets comparable to the First Offer Shares and, if applicable, any other assets -14- proposed to be sold pursuant to the Offer and shall not be an Affiliate of any party to this Agreement. All fees and expenses of the First Appraiser shall be borne by the Holder, of the Second Appraiser shall be borne by the Company and of the Third Appraiser shall be borne equally by the Holder and the Company. (v) In determining the fair market value of the noncash consideration, each appraiser retained pursuant to this paragraph (d) shall: (A) assume that the fair market value of the applicable asset is the price at which the asset would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or sell and each having reasonable knowledge of all relevant facts; (B) assume that the applicable asset would be sold for cash; and (C) use valuation techniques then prevailing in the relevant industry. (e) Notwithstanding any provision of paragraphs (a), (b), (c) and (d) of this Section 5.1, Transfers of Shares may be made (i) at any time to a Permitted Transferee or (ii) at any time during the Restricted Period in open market transactions through a broker. (f) During the term of the Joint Development Agreement (whether during or after the Restricted Period), a Holder shall not knowingly Transfer Shares to any Person who is a competitor of the Company, or a Person controlled by, under common control with, or who controls, a competitor of the Company, unless such Transfer is made pursuant to a tender offer or exchange offer which is recommended by the Board of Directors of the Company. (g) The limitations provided in this Section 5.1 shall terminate (i) upon termination of the Joint Development Agreement, except if such termination is the result of a breach by the Purchaser of any of its representations, warranties, agreements or covenants set forth in the Joint Development Agreement or (ii) other than the limitations set forth in paragraph (f) above (which shall not terminate), upon the sale by the Company of securities representing 10% or more of the voting power of its then outstanding voting securities to a competitor of Purchaser, or a Person controlled by, under common control with, or who controls, a competitor of Purchaser, in each case only if the competitor is primarily engaged in the consumer electronics business. 5.2 RIGHTS IN THE EVENT OF A PUBLIC OFFERING; CLOSING MATTERS, ETC. (a) If, during the Restricted Period, any Holder desires to sell any Shares in a registered public offering for cash (an "Offering"), the Holder shall first offer such shares for sale to the Company in accordance with the following provisions. (b) If the Holder intends to cause the Company to register Shares pursuant to the terms of this Agreement, the Holder shall deliver a notice to the Company (in addition to any notice required pursuant to Section 5.4 of this Agreement) specifying (A) the number of the Shares the Holder desires to sell in the Offering (the "Offered Shares") and (B) the proposed timing of the Offering, and offering to sell the Offered Shares to the Company at the price determined below (an "Offering Notice"). If the Company desires to purchase the Offered -15- Shares, it shall so notify the Holder in writing within 10 days from the receipt of such Offering Notice (a "Reply Notice"). If, by its Reply Notice, the Company accepts the offer of the Holder, such Reply Notice shall constitute an agreement binding on the Company and the Holder to sell and purchase for cash all, but not less than all, the Offered Shares at the Fair Market Value for such shares as of the date of the Reply Notice. (c) If the Company does not accept the offer of the Holder pursuant to the foregoing provisions of this Section 5.2 or the purchase of the Offered Shares is not consummated within the period set forth in Section 5.2(d)(iii) for any reason other than a breach by the Holder of any of its covenants, representations or warranties that is a condition to consummation of such purchase, then the Company shall be deemed to have rejected such offer as of the last date for accepting such offer or closing such purchase, as applicable, and the Holder shall have the right to proceed with a registered public offering of the Offered Shares, subject to the further provisions of this Agreement; PROVIDED, HOWEVER, that any Offered Shares that have not been sold in a registered public offering prior to the first anniversary of the date that the offer set forth in the Offering Notice is deemed rejected for any reason other than the failure of the Company to comply with its covenants in Section 5.4 may not thereafter be sold in a registered public offering without complying with the provisions of this Agreement. Any Offered Shares transferred to a Person other than the Company in compliance with the provisions of this Section 5.2 shall not thereafter be subject to the provisions of this Agreement. (d) Any purchase by the Company of Shares pursuant to Section 5.1 or Section 5.2 shall be subject to the following additional terms and conditions: (i) The Holder shall represent and warrant that the Company will receive good and valid title to the Shares, free and clear of all Liens, of any nature whatsoever except for governmental and third party approvals required for transfers of shares of the Common Stock generally. (ii) The closing of the purchase and sale shall be subject to the satisfaction of the following conditions: (A) all governmental and third party approvals required with respect to the transactions to be consummated at such closing shall have been obtained, to the extent the failure to obtain such approvals would prevent the Company or the Holder from performing any of its material obligations under the transaction documents or would result in any material adverse change in, or Material Adverse Effect on, the Company; (B) there shall be no preliminary or permanent injunction or other order by any court of competent jurisdiction restricting, preventing or prohibiting the consummation of the transactions to be consummated at such closing; and (C) the representation and warranty of the Holder contemplated by clause (i) of this paragraph (d) shall be true and correct at the closing -16- of such sale with the same force and effect as if then made. (iii) Unless otherwise agreed by the applicable parties, the closing of any purchase and sale of Shares shall take place at the principal executive offices of the Company at 10:00 a.m. local time on a Business Day selected by the Company, provided that such closing shall occur as promptly as practicable, and in any event within 60 days after the acceptance of the applicable offer, subject to extension for a maximum of 30 additional days to the extent required to obtain all required governmental and third party approvals. (iv) Unless otherwise agreed by the applicable parties, the purchase price shall be payable by wire transfer of immediately available funds or by certified or cashier's check drawn to the order of the Holder, as specified by the Holder. (e) The Holder and the Company shall each use commercially reasonable efforts to cooperate with the other in connection with the Holder's efforts to transfer any interest in the Shares in accordance with the provisions of Sections 5.1 and 5.2, including making qualified personnel available for attending hearings and meetings respecting any approvals and authorizations required for such transfer and, at the request of the Holder, making all filings with, and giving all notices to third parties and governmental authorities that may be necessary or reasonably required to be made or given by the Holder and the Company in order to effect the contemplated transfers. Subject to the other provisions of this Agreement, neither the Holder nor the Company shall take any action to delay, impair or impede the receipt of any required consents, approvals or authorizations. "Commercially reasonable efforts" as used in this Section 5.2 shall not require any party to undertake extraordinary or unreasonable measures to obtain any consents, approvals or other authorizations. 5.3 STANDSTILL. Purchaser agrees that (except as contemplated hereby and by the Joint Development Agreement), from the date of this Agreement until the second anniversary of the Closing Date, Purchaser shall not, and shall cause each other member of the Purchaser Group not to, propose to the Company or its stockholders or any other Person any transaction between Purchaser or its Affiliates and the Company or involving any of the Company's capital stock, unless the Company shall have requested in writing that such member of the Purchaser Group make such proposal, and that Purchaser shall not, and shall cause each other member of the Purchaser Group not to, acquire, or assist, advise or encourage any other Persons in acquiring, directly or indirectly, control of the Company or any of its capital stock, businesses or assets unless the Company shall have consented in advance in writing to such action; provided, however, that notwithstanding anything to the contrary contained herein, Purchaser may (i) propose a transaction to the Company (whether or not Purchaser is invited in writing to do so) in conjunction with any or all of Forstmann, Little & Co., Tele-Communications, Inc. and/or any of their respective Affiliates (each such person a "Permitted Person"), (ii) directly or indirectly acquire in conjunction with any Permitted Person, or assist, advise or encourage any Permitted Person to acquire, control of the Company or any of its capital stock, businesses or assets or (iii) -17- acquire any capital stock of the Company owned directly or indirectly by any Permitted Person. Purchaser also agrees that neither it nor any other member of the Purchaser Group will seek a waiver of the provisions of this Section 5.3 and that the Company shall be entitled to equitable relief, including injunction, in the event of any breach of the provisions of this Section 5.3 and that neither Purchaser nor any member of the Purchaser Group shall oppose the granting of such relief. 5.4 REGISTRATION RIGHTS. (a) DEMAND REGISTRATION RIGHTS. (i) At any time and from time to time after the date hereof, any Holder shall have the right to request the Company to effect the registration under the Securities Act of all or part of its Registrable Securities; PROVIDED, that so long as Purchaser shall hold any Registrable Securities, no Holder shall have the right to request any such registration without the written consent of Purchaser. Holders shall exercise such right by delivering to the Company a notice stating (A) the number of Registrable Securities to be included in such registration statement and (B) Holder's intended method of distribution (which may include an underwritten offering). Upon receipt by the Company of any such request, the Company shall promptly give notice of such proposed registration to all Holders who hold Registrable Securities and thereupon shall, as expeditiously as possible, use reasonable efforts to effect the registration under the Securities Act of: (1) all Registrable Securities that the Company has been requested to register pursuant to clause (i) of this Section 5.4(a); and (2) all other Registrable Securities that Holders have, within 20 days after the Company has given such notice, requested the Company to register; all to the extent requisite to permit the sale or other disposition by the Holders of the Registrable Securities so to be registered. (ii) If the managing underwriter (selected pursuant to Section 5.4(i)(A) hereof) of the public offering of any Registrable Securities to be effected pursuant to a registration statement filed pursuant to clause (i) of this Section 5.4(a) shall advise the Company in writing (with a copy to each holder of Registrable Securities requesting registration) that, in its opinion, the number of securities requested to be included in such registration (including securities of the Company that are not Registrable Securities) exceeds the number that can be sold in such offering without having an adverse effect on such offering, the Company will include in such registration to the extent of the number that the Company is so advised can be sold in such offering: (A) FIRST, Registrable Securities requested to be included in such registration by Purchaser and its Affiliates, pro rata based on the number of shares to be included; (B) SECOND, Registrable Securities requested to be included in such -18- registration by Holders other than Purchaser and its Affiliates, pro rata based on the number of shares to be included; and (C) THIRD, other securities of the Company proposed to be included pursuant to Section 5.4(a)(viii) in such registration, in accordance with the priorities, if any, then existing among the Company and the holders of such other securities. (iii) The Holders requesting inclusion in a registration statement under this Section 5.4(a) may withdraw from any requested registration pursuant to this Section 5.4(a) by giving written notice to the Company prior to the date an underwriting agreement is executed or such registration statement becomes effective; PROVIDED, HOWEVER, that for a period of three months after such withdrawal, such Holders may not request any registration pursuant to this Section 5.4(a), unless (A) such Holders pay the Company for that portion of its out-of-pocket expenses relating to the inclusion of Registrable Securities owned by such Holder in such registration, (B) the registration statement had not been filed within 90 days of the initial request for registration pursuant to Section 5.4(a)(i) or had not become effective within 120 days of such request or (C) the Company otherwise failed to comply with its obligations under this Section 5.4 with respect to such registration. (iv) The Company shall not be required to effect more than a total of two effective registrations under this Section 5.4(a). Notwithstanding the foregoing, if all the Holders withdraw from an offering after the registration statement for the shares to be offered thereby has become effective due to the occurrence of any of the events set forth in Sections 5.4(c)(vii), (viii) or (ix), then such registration shall not be counted as an effective registration for purposes of this Section 5.4(a)(iv). (v) The Company shall not be required to effect a registration pursuant to this Section 5.4(a) unless the offering includes Registrable Securities having a Fair Market Value of at least $10 million in the aggregate. (vii) The Company shall not be required to effect any registration within six (6) months of the effective date of any other registration under this Section 5.4(a). (viii) If the managing underwriter in an underwritten offering has not limited the number of Registrable Securities to be underwritten, then the Company may include securities for its own account or for the account of others in such registration statement and underwriting if (x) the managing underwriter so agrees, (y) the number of Registrable Securities held by Holders which would otherwise have been included in such registration statement and underwriting will not thereby be limited, and (z) the managing underwriter advises the Holders in writing that, in its judgment, the inclusion of such securities in such registration statement should not have a significant adverse effect on the price of the Registrable Securities offered or the timing of the offering. The inclusion of such shares shall be on the same terms as the registration of -19- Registrable Securities held by the Holders. In the event that the managing underwriter excludes some of the securities to be registered, the securities to be sold for the account of the Company and any other holders shall be excluded in their entirety prior to the exclusion of any Registrable Securities of the Holders. (b) "PIGGYBACK" REGISTRATIONS. If the Company at any time proposes to register any of its securities under the Securities Act (other than pursuant to Section 5.4(a)) on a registration statement on Form S-1, S-2 or S-3 or on any other form upon which may be registered securities similar to the Registrable Securities for sale to the general public except Form S-4 and Form S-8, the Company will at each such time give prompt notice to the Holders of its intention to do so setting forth the date on which the Company proposes to file such registration statement, which date shall be no earlier than 30 days from the date of such notice, and advising the Holders of their right to have Registrable Securities included therein. Upon the written request of any Holder given to the Company not less than 10 days prior to the proposed filing date of such registration statement set forth in such notice, the Company will use reasonable best efforts to cause each of the Registrable Securities that the Company has been requested to register by such Holder to be registered under the Securities Act. If the securities to be so registered for sale include securities to be sold for the account of the Company and to be distributed by or through a firm of underwriters of recognized standing under underwriting terms appropriate for such transaction, then the Registrable Securities shall also be included in such underwriting, PROVIDED that if, in the reasonable written opinion of the managing underwriter or underwriters, the total amount of such securities to be so registered, when added to such Registrable Securities, will exceed the maximum amount of the Company's securities that can be marketed (i) at a price reasonably related to their then current market value, or (ii) without otherwise materially and adversely affecting the price, timing or distribution of the entire offering, the Company will include in such registration to the extent of the number which the Company is so advised can be sold in such offering securities determined as follows: (i) if such registration as initially proposed by the Company was solely a primary registration of its securities: (A) FIRST, the securities proposed by the Company to be sold for its own account, (B) SECOND, any Registrable Securities requested to be included in such registration pro rata among the Holders of such Registrable Securities and the holders of such other shares of Common Stock on the basis of the number of Registrable Securities and other shares of Common Stock requested to be included by each such holder, and (C) THIRD, any other securities of the Company proposed to be included in such registration statement in accordance with the provisions and relative priorities, if any, then existing among the holders of such securities, and -20- (ii) if such registration as initially proposed by the Company was in whole or in part requested by holders of securities of the Company (the "Requesting Holders"), other than Holders of Registrable Securities, pursuant to demand registration rights, (A) FIRST, such securities held by the Requesting Holders, pro rata among the Requesting Holders, on the basis agreed upon by such holders and the Company, (B) SECOND, Registrable Securities requested to be included in such registration pro rata among the Holders of such Registrable Securities and the holders of such other shares of Common Stock on the basis of the number of Registrable Securities and other shares of Common Stock requested to be included by each such holder, and (C) THIRD, any securities of the Company proposed to be included in such registration statement in accordance with the priorities, if any, then existing among the holders of such securities. To the extent that the managing underwriter in an underwritten offering pursuant to this Section 5.4(b) determines that the public sale or other distribution of any Registrable Securities, shares of Common Stock or other securities of the Company other than those included in such underwritten offering should be delayed following the effective date of such registration statement, the Holders agree to enter, together with and on the same terms as the Company and any other holders of securities included in such registration statement, into an agreement not to sell any other Registrable Securities, shares of Common Stock or other securities of the Company during such period following the effective date of such registration statement as the managing underwriter reasonably determines is necessary in connection with such underwritten offering, which period shall in no event exceed 180 days following the effective date of such registration statement. The Holders requesting inclusion in a registration statement under this Section 5.4(b) may withdraw from any requested registration pursuant to this Section 5.4(b) by giving written notice to the Company prior to the date an underwriting agreement is executed or such registration statement becomes effective. (c) THE COMPANY'S OBLIGATIONS IN REGISTRATION. If and whenever the Company is obligated by the provisions of this Section 5.4 to use reasonable best efforts to effect the registration of any Registrable Securities under the Securities Act, the Company will: (i) prepare and file with the Commission, as expeditiously as possible within 90 days after the initial request from holders to register such Registrable Securities, a registration statement with respect to such Registrable Securities and use reasonable best efforts to cause such registration statement to become effective within 180 days after such initial request and to remain effective; PROVIDED, HOWEVER, that before filing a registration -21- statement or prospectus (or any amendments or supplements thereto), the Company will furnish to any Holder requesting such registration pursuant to this Section 5.4 draft copies of all documents proposed to be filed at least five business days prior thereto, which documents will be subject to the reasonable review of any such Holder, their agents and representatives; PROVIDED, FURTHER, that the Company shall not be required to keep such registration statement effective, or to prepare and file any amendments or supplements thereto, later than the earlier of (x) such time as all Registrable Securities have been sold and (y) 5:00 P.M., New York City time, on the last business day of the sixth month following the month in which such registration statement becomes effective under the Securities Act or such longer period during which the Commission requires that such registration statement be kept effective with respect to any of the Registrable Securities so registered; (ii) prepare and file with the Commission such amendments and supplements (including, but not limited to, post-effective amendments and supplements) to such registration statement and the prospectus used in connection therewith as may be necessary to keep such registration statement effective and to comply with provisions of the Securities Act with respect to the disposition of all Registrable Securities covered by such registration statement whenever the Holders for whom such Registrable Securities are registered or are to be registered shall desire to dispose of the same, subject, however, to the provisos contained in the immediately preceding clause (i); (iii) notify the Holders requesting such registration and (if requested) confirm such notice in writing, as soon as practicable after notice thereof is received by the Company (A) when the registration statement and any amendment thereto has been filed and becomes effective and the prospectus or any amendment or supplement to the prospectus has been filed, (B) of any request by the Commission for amendments or supplements to the registration statement or the prospectus or for additional information or (C) if any representation of the Company made in any underwriting agreement contemplated hereby becomes untrue in any material respect; (iv) furnish each Holder for whom such Registrable Securities are registered or are to be registered such numbers of copies of each registration statement and printed prospectus, including a preliminary prospectus and any amendments or supplements thereto and any documents incorporated by reference therein, in conformity with the requirements of the Securities Act, and such other documents and information as such Holder may reasonably request in order to facilitate the disposition of such Registrable Securities; (v) use reasonable best efforts to register or qualify the Registrable Securities covered by such registration statement under such other securities or blue sky laws of such jurisdictions as each Holder shall reasonably request, and do any and all other acts and things that may be necessary or advisable to enable such Holder to consummate the disposition in such jurisdictions of such Registrable Securities except that the Company shall not for any purpose be required to (A) qualify generally to do business as a foreign -22- corporation in any jurisdiction wherein it would not but for the requirements of this clause (v) be obligated to be so qualified, (B) subject itself to taxation in any such jurisdiction or (C) consent to general service of process in any such jurisdiction unless the Company is already subject to general service of process in such jurisdiction; (vi) furnish to the Holders for whom such Registrable Securities are registered or are to be registered at the time of the disposition of such Registrable Securities by such Holders a signed copy of an opinion of counsel for the Company reasonably acceptable to such holders and substantially to the effect that, a registration statement covering such Registrable Securities has been filed with the Commission under the Securities Act and has been made effective by order of the Commission; said registration statement and the prospectus contained therein comply as to form in all material respects with the requirements of the Securities Act and, based upon such investigation and inquiry as said counsel deems necessary or appropriate, nothing has come to said counsel's attention that would cause it to believe that either said registration statement or said prospectus contains an untrue statement of a material fact or omits to state a material fact required to be stated therein or necessary to make the statements therein (in the case of said prospectus, in the light of the circumstances under which they were made) not misleading; said counsel knows of no legal or governmental proceedings required to be described in said prospectus that are not described as required, or of any contract or documents of a character required to be described in said registration statement or said prospectus or to be filed as an exhibit to said registration statement or to be incorporated by reference therein that is not described and filed as required; no stop order has been issued by the Commission suspending the effectiveness of such registration statement and that, to the best of such counsel's knowledge, no proceedings for the issuance of such a stop order are threatened or contemplated; the applicable provisions of the securities or blue sky laws of each state in which the Company shall be required, pursuant to clause (v) of this Section 5.4(c), to register or qualify such Registrable Securities, have been complied with, assuming the accuracy and completeness of the information furnished to such counsel with respect to each filing relating to such laws; it being understood that said counsel may rely, as to all factual matters and financial data treated therein, on certificates of the Company (copies of which shall be delivered to such Holders), and as to all questions of the laws of each state in which the Company shall be so required to register or qualify such Registrable Securities, on the opinion of counsel from such state reasonably acceptable to such Holders, copies of which shall be delivered to such Holders; (vii) immediately notify each Holder of Registrable Securities covered by such registration statement, at any time when a prospectus relating thereto is required to be delivered under the Securities Act, of the Company's determination that, or the happening of any event as a result of which, the prospectus included in such registration statement, as then in effect, includes an untrue statement of a material fact or omits to state any material fact required to be stated therein or necessary to make the statements therein not misleading in the light of the circumstances under which they were made, and at the request of any such Holder promptly prepare, file with the Commission and furnish to -23- such Holder a reasonable number of copies of, a supplement to or an amendment of such prospectus as may be necessary so that, as thereafter delivered to the purchasers of such securities, such prospectus shall not include an untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary to make the statements therein not misleading in the light of the circumstances under which they were made; (viii) advise each Holder of Registrable Securities covered by such registration statement, promptly after it shall receive notice or obtain knowledge thereof, of the issuance of any stop order by the Commission suspending the effectiveness of such Registration Statement or the initiation or threatening of any proceeding for that purpose; and use its reasonable best efforts to comply with all applicable rules and regulations of the Commission, and make generally available to the seller of Registrable Securities covered by such Registration Statement, earnings statements satisfying the provisions of Section 11(a) of the Securities Act, no later than 45 days after the end of any 12-month period (or 90 days, if such period is a fiscal year) (a) commencing at the end of any fiscal quarter in which Securities are sold to underwriters in an underwritten offering, or (b) if not sold to underwriters in such an offering, beginning with the first day of the month of the Company's first fiscal quarter commencing after the effective date of a registration statement; (ix) permit any holder holding Registrable Securities covered by such registration statement or prospectus to withdraw their Registrable Securities from such registration statement or prospectus if such Holder has informed the Company that it believes that such amendment or supplement does not comply in all material respects with the requirements of the Securities Act or the rules and regulations thereunder, after having been furnished with a copy thereof at least 5 Business Days prior to the filing thereof; (x) enter into such customary agreements (including an underwriting agreement in customary form, if applicable) and take all such other actions as holders of a majority of the Registrable Securities being sold or the underwriters retained by such Holders, if any, reasonably request in order to expedite or facilitate the disposition of such Registrable Securities, including customary opinions and indemnification and lock-up agreements; (xi) if requested by the managing underwriters or a Holder of Registrable Securities being sold in connection with an underwritten offering, promptly incorporate in a prospectus supplement or post-effective amendment such information as the managing underwriters and the holders of a majority of the Registrable Securities being sold agree should be included therein relating to the plan of distribution with respect to such Registrable Securities including, without limitation, information with respect to the securities being sold to such underwriters, the purchase price being paid therefor by such underwriters and with respect to any other terms of the underwritten offering of the Registrable Securities to be sold in such offering; and make all required filings of such prospectus supplement or post-effective amendment as soon as notified of the matters to -24- be incorporated in such prospectus supplement or post-effective amendment; (xii) list such Registrable Securities on any securities exchange on which the Common Stock is then listed, if such Registrable Securities are not already so listed and if such listing is then permitted under the rules of such exchange, and provide a transfer agent and registrar for such Registrable Securities covered by such registration statement not later than the effective date of such registration statement; (xiii) obtain a CUSIP number for all Registrable Securities (unless already obtained) not later than the effective date of such registration statement; (xiv) subject to the provisions of Section 5.7 of this Agreement and appropriate safeguards of confidentiality, make available for inspection by any Holder requesting such registration, any underwriter participating in such disposition pursuant to such registration statement and any representative or agent retained by any such Holder or underwriter, all material financial and other material information of the Company, necessary in connection with such registration statement; and (xv) obtain customary "cold comfort" letters and updates from the Company's independent public accountants in customary form covering such matters of the type customarily covered by "cold comfort" letters as any managing underwriter shall reasonably request. The period of time that the Company is obligated to keep any registration statement effective, or to prepare and file any amendments or supplements thereto, pursuant to Section 5.4(c)(i) shall be extended by the number of days that any such Holder is unable to sell Registrable Securities due to the matters set forth in Sections 5.4(c)(vii) and (viii) above. (d) PAYMENT OF REGISTRATION EXPENSES. The Company shall pay all Registration Expenses in connection with each registration pursuant to this Section 5.4. (e) INFORMATION FROM HOLDERS. Notices and requests delivered by Purchaser to the Company pursuant to this Section 5.4 shall contain the information required by Section 5.4(a)(i). (f) INDEMNIFICATION. (i) INDEMNIFICATION BY THE COMPANY. In the event of any registration under the Securities Act of any Registrable Securities pursuant to this Section 5.4, the Company hereby agrees to indemnify and hold harmless the Holders, their respective agents, directors, officers and employees, each other Person, if any, who controls (within the meaning of the Securities Act) the Holders and each other Person (including -25- underwriters) who participates in the offering of such Registrable Securities, against any and all losses, claims, damages or liabilities, to the extent that such losses, claims, damages or liabilities (or proceedings in respect thereof) arise out of or are based upon (x) any untrue statement or alleged untrue statement of any material fact contained in any registration statement, on the effective date thereof, under which such Registrable Securities were registered under the Securities Act, in any preliminary prospectus or final prospectus contained therein or in any amendment or supplement to any preliminary prospectus or final prospectus (if used during the period the Company is required to keep such registration statement current in any such case), (y) arise out of or are based upon the omission or alleged omission to state therein a material fact required to be stated therein or necessary to make the statements therein not misleading, or (z) arise out of or are based upon any violation by the Company of the Securities Act or any state securities or blue sky laws and relating to action or inaction required of the Company in connection with the registration or qualification of securities under such laws and will reimburse such Holders, such agents, directors, officers and employees and each such controlling person or participating person (including underwriters) for any legal, investigative or any other expenses reasonably incurred by such Holders, such agents, directors and officers or such controlling person or participating person (including underwriters) in connection with investigating or defending any such loss, claim, damage, liability or proceeding, PROVIDED, that the Company will not be liable to any Person indemnified hereunder in any such case to the extent that any such loss, claim, damage or liability arises out of or is based upon an untrue statement or alleged untrue statement or omission or alleged omission made in such registration statement, said preliminary or final prospectus or said amendment or supplement in reliance upon and in conformity with information furnished to the Company in writing by such indemnified person, specifically for use in the preparation of such registration statement; and PROVIDED, FURTHER, that, with respect to any untrue statement or omission or alleged untrue statement or omission made in any preliminary prospectus, the Company will not be liable to any Holder to the extent that any loss, claim, damage, liability or expense results from the fact that a current copy of the final prospectus was not sent or given to the Person asserting any such loss, claim, damage, liability or expense at or prior to the written confirmation of the sale of the Registrable Securities concerned to such Person if it is finally determined that it was the responsibility of such Holder to provide such Person with a current copy of the final prospectus and such current copy of the final prospectus was provided to such Holder and would have cured the defect giving rise to such loss, claim, damage, liability or expense. (ii) INDEMNIFICATION BY THE HOLDERS. The Holders, each individually and not jointly, agree to indemnify and hold harmless the Company, its respective agents, directors, officers and employees, each other Person, if any, who controls (within the meaning of the Securities Act) the Company and each other Person (including underwriters) who participates in the offering of such Registrable Securities, against any and all losses, claims, damages and liabilities to which the Company, such agents, directors, officers and employees, or other Persons (including underwriters), may become subject under the Securities Act or otherwise, insofar as such losses, claims, damages or liabilities arise out of or are based upon any untrue statement of any material fact -26- contained in any such registration statement, on the effective date thereof, under which such Registrable Securities were registered under the Securities Act, in any preliminary prospectus or final prospectus contained therein or in any amendment or supplement to any preliminary prospectus or final prospectus (if used during the period the Company is required to keep such registration statement current in any such case), or arise out of or are based upon the omission or alleged omission to state therein a material fact required to be stated therein or necessary to make the statements therein not misleading, but only if and to the extent that any such loss, claim, damage or liability arises out of or is based upon any such statement or omission made in such registration statement, said preliminary or final prospectus or said amendment or supplement in reliance upon and in conformity with written information furnished to the Company by the Holders and specifically stated to be for use in the preparation of such registration statement; PROVIDED, that, with respect to any untrue statement or omission or alleged untrue statement or omission made in any preliminary prospectus, no Holder shall be liable to any Person indemnified hereunder to the extent that any loss, claim, damage or liability results from the fact that a current copy of the final prospectus was not sent or given to the Person asserting any such loss, claim, damage or liability at or prior to the written confirmation of the sale of the Registrable Securities concerned to such Person if it is finally determined that it was not the responsibility of such Holder to provide such Person with a current copy of the final prospectus and such current copy of such final prospectus would have cured the defect giving rise to such loss, claim, damage or liability. (iii) NOTICES OF CLAIMS, ETC. Each party entitled to be indemnified pursuant to Section 5.4(f)(i) or (ii) above shall, promptly but not later than 30 days after its receipt of notice of the commencement of any action against it in respect of which indemnity may be sought from any indemnifying party pursuant to this Section 5.4(f), notify such indemnifying party in writing of the commencement thereof. In case any such action shall be brought against any indemnified party and it shall notify such indemnifying party of the commencement thereof, such indemnifying party will be entitled to participate therein and, to the extent that it may wish, to assume the defense thereof, with counsel satisfactory to such indemnified party, and such indemnified party may participate in such defense, which participation by the indemnified party shall be at its expense unless (i) the employment of counsel by such indemnified party has been authorized by the indemnifying party, (ii) the indemnified party shall have been advised by its counsel in writing that there is a conflict of interest between the indemnifying party and the indemnified party in the conduct of the defense of such action (in which case the indemnifying party shall not have the right to direct the defense of such action on behalf of the indemnified party) or (iii) the indemnifying party shall not in fact have employed counsel to assume the defense of such action, in each of which cases the fees and expenses of the indemnified party's counsel shall be at the expense of the indemnifying party. The failure of any such indemnified party to give notice as provided herein shall not relieve such indemnifying party of its obligations under this Section 5.4(f) unless such failure to give notice shall materially adversely affect such indemnifying party in the defense of any such claim or any such litigation. With respect to any claim or litigation the defense of which is being conducted by such indemnifying party, no indemnified -27- party shall, except with the consent of such indemnifying party, consent to entry of any judgment or enter into any settlement of any claim as to which indemnity may be sought. No indemnifying party, in the defense of any such claim or litigation, shall, except with the consent of each indemnified party, consent to entry of any judgment or enter into any settlement which does not include as an unconditional term thereof the giving by the claimant or plaintiff to such indemnified party of a release from all liability in respect to such claim or litigation or which requires such indemnified party to concede any fault or wrongdoing. (iv) CONTRIBUTION. To the extent that the undertaking to indemnify, pay and hold harmless set forth in paragraphs (i) and (ii) of this Section 5.4(f) may be unenforceable because it is violative of any law or public policy, each party that would have been required to provide the indemnity shall contribute the maximum portion which it is permitted to pay and satisfy under applicable law, to the payment and satisfaction of all indemnified liabilities incurred by each party entitled to indemnification under this Section 5.4(f); provided that in no event shall a Holder of Registrable Securities be required to contribute an amount greater than the dollar amount of net proceeds received by such Holder upon the sale of such Registrable Securities. (g) EXCHANGE OF CERTIFICATES. As soon as possible after the effectiveness of any registration statement under the Securities Act pursuant to this Section 5.4, the Company will deliver to the Holders of any Shares so registered, upon demand of the Holders and their delivery to the Company of a certificate or certificates representing such Shares bearing the legend set forth in Section 5.5(a), a new certificate or certificates representing such Shares but not bearing such legend. (h) OBLIGATIONS OF THE HOLDERS. The Holders agree: (i) that upon receipt of any notice from the Company of any determination or the happening of any event of the kind described in Section 5.4(c)(vii), the Holders will forthwith discontinue its disposition of Registrable Securities pursuant to the registration statement relating to such Registrable Securities until their receipt of the copies of the supplemented or amended prospectus contemplated by Section 5.4(c)(vii) and, if so directed by the Company, will use their reasonable best efforts to deliver to the Company (at the Company's expense) all copies, other than permanent file copies, then in such Holder's possession of the prospectus relating to such Registrable Securities current at the time of receipt of such notice, and (ii) that they will immediately notify the Company at any time when a prospectus relating to the registration of such Registrable Securities is required to be delivered under the Securities Act, of the happening of any event as a result of which information previously furnished by such Holder to Company for inclusion in such prospectus contains an untrue statement of a material fact or omits to state any material fact required to be stated therein or necessary to make the statements therein not -28- misleading in the light of the circumstances under which they were made. (i) UNDERWRITTEN REGISTRATION. (A) If any of the Registrable Securities covered by a registration pursuant to Section 5.4(a) are to be sold in an underwritten offering, the investment banker or investment bankers and manager or managers that will administer the offering will be selected by the Holders of a majority in Fair Market Value of such Registrable Securities included in such offering. No Person may participate in any such underwritten registration hereunder unless such Person (1) agrees to sell its Registrable Securities or other securities of the Company on the basis provided in an underwriting agreement provided by the Holders of a majority in Fair Market Value of the Registrable Securities to be sold in such underwritten offering and (2) completes and executes all questionnaires, powers of attorney, indemnities, underwriting agreements and other documents required under the terms of such underwriting arrangements. (B) If any of the Registrable Securities covered by a registration pursuant to Section 5.4(b) are to be sold in an underwritten offering, the investment banker or investment bankers and manager or managers that will administer the offering will be selected by the holders of a majority in Fair Market Value of securities being registered. No Holder may participate in any such underwritten registration hereunder unless such Holder (a) agrees to sell its Registrable Securities on the basis provided in an underwriting agreement approved by the Company or the holders of a majority in Fair Market Value of the securities being registered and (b) completes and executes all questionnaires, powers of attorney, indemnities, underwriting agreements and other documents required under the terms of such underwriting arrangements. (j) EXCHANGE ACT COMPLIANCE. The Company shall comply with all of the reporting requirements of the Exchange Act and shall comply with all other public information reporting requirements of the Commission which are conditions to the availability of Rule 144 for the sale of Registrable Securities. The Company shall cooperate with each Holder in supplying such information as may be necessary for such Holder to complete and file any information reporting forms presently or hereafter required by the Commission as a condition to the availability of Rule 144. 5.5 RESTRICTIONS ON TRANSFERABILITY OF SHARES. Notwithstanding any provisions contained in this Agreement to the contrary, the Shares shall not be transferable except upon the conditions specified in this Section 5.5 and Sections 5.1 and 5.2, which conditions are intended, among other things, to ensure compliance with the provisions of the Securities Act in respect of the transfer of the Shares. Purchaser agrees that it will not (i) transfer any Shares prior to delivery to the Company of the opinion of counsel (which opinion shall be reasonably satisfactory to the Company) referred to in, and to the effect described in, clause (i) of Section 5.5(b), or until registration of such Shares under the Securities Act has become effective, or (ii) transfer any Shares without compliance with Sections 5.1 and 5.2. Purchaser agrees that such opinion of counsel must be reasonably satisfactory to the Company. -29- (a) RESTRICTIVE LEGEND; PURCHASER'S REPRESENTATION. Unless and until otherwise permitted by this Section 5.5, each certificate representing Shares, and any certificate issued at any time upon transfer of, or in exchange for or replacement of, any certificate bearing the legend set forth below shall be stamped or otherwise imprinted with a legend in substantially the following form: "THE SECURITIES REPRESENTED BY THIS CERTIFICATE HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933 AND MAY NOT BE SOLD, ASSIGNED, TRANSFERRED, OR OTHERWISE DISPOSED OF EXCEPT IN COMPLIANCE WITH THE REGISTRATION REQUIREMENTS UNDER SUCH ACT OR AN EXEMPTION THEREFROM. THE SECURITIES REPRESENTED BY THIS CERTIFICATE ARE SUBJECT TO THE TERMS AND CONDITIONS OF A STOCK PURCHASE AGREEMENT DATED AS OF NOVEMBER __, 1998, BY AND BETWEEN THE HOLDER AND GENERAL INSTRUMENT CORPORATION. COPIES OF SUCH AGREEMENT MAY BE OBTAINED UPON WRITTEN REQUEST TO THE SECRETARY OF GENERAL INSTRUMENT CORPORATION." Without limiting the foregoing, Purchaser acknowledges and agrees that the Shares have not and will not be registered under the Securities Act or any applicable state securities laws and it agrees that it will reoffer or resell the Shares (i) only (A) to the Company, (B) pursuant to any transaction under and meeting the requirements of Rule 144A, as amended from time to time, promulgated under the Securities Act, (C) pursuant to an exemption from registration under the Securities Act in accordance with Rule 144, as amended from time to time, promulgated under the Securities Act, or (D) in accordance with any other available exemption from the requirements of Section 5 of the Securities Act and (ii) in accordance with any applicable federal and state securities laws and this Agreement. Purchaser and each holder of Shares by its acceptance of such security further understands that such security may bear a legend as contemplated by this Section 5.5. (b) STATEMENT OF INTENTION TO TRANSFER; OPINION OF COUNSEL. Purchaser, by its acceptance of this Agreement, agrees that prior to any transfer of any Shares, Purchaser will deliver to the Company a notice of such proposed transfer and a signed copy of the opinion of Purchaser's counsel reasonably satisfactory to the Company as to the necessity or non-necessity for registration under the Securities Act in connection with such transfer. (i) If, in the opinion of Purchaser's counsel (which opinion shall be reasonably satisfactory to the Company), the proposed transfer of any Shares may be effected without registration under the Securities Act of such Shares, then Purchaser shall be entitled to transfer such Shares in accordance with the intended method of disposition specified in the notice delivered by Purchaser to the Company, subject to compliance with the other provisions of this Article V. (ii) Notwithstanding the foregoing provisions of this Section 5.5(b), no opinion -30- of any counsel need be furnished (x) in the event of any proposed transfer of any Shares to an institutional investor who is an "accredited investor" as defined in Regulation D promulgated under the Securities Act and which transfer is otherwise exempt from the registration requirements of the Securities Act or (y) in the event of any proposed transfer of Shares in connection with a registration under the Securities Act. (c) TERMINATION OF RESTRICTIONS. Notwithstanding the foregoing provisions of this Section 5.5, the restrictions imposed by this Section 5.5 upon the transferability of the Shares shall cease and terminate as to any particular Shares when, (i) such Shares shall have been effectively registered under the Securities Act and sold by Purchaser in accordance with such registration or (ii) in the opinion of counsel for the holder of such Shares, if such opinion is satisfactory in form and substance to the Company, such restrictions are no longer required in order to ensure compliance with the Securities Act. If and whenever the restrictions imposed by this Section 5.5 shall terminate as to a Share as hereinabove provided, Purchaser may and the Company shall, as promptly as practicable upon the request of Purchaser and at the Company's expense, cause to be stamped or otherwise imprinted upon the certificates representing such Shares a legend in substantially the following form: "The restrictions on transferability of this [these] [securities] terminated on _________, and are of no further force or effect." All certificates issued upon transfer, division or combination of, or in substitution for, any Shares entitled to bear such legend shall have a similar legend endorsed thereon. Whenever the restrictions imposed by this Section 5.5 shall terminate as to any Shares, as hereinabove provided, Purchaser shall be entitled to receive from the Company without expense, a new certificate representing such Shares not bearing the restrictive legend set forth in Subsection (a) of this Section 5.5. 5.6 NO PUBLIC ANNOUNCEMENT. Neither party hereto shall make any public announcement concerning the transactions contemplated by this Agreement without the prior approval of the other party, which approval shall not be unreasonably withheld. Notwithstanding the foregoing, in the event any such public announcement is required by law to be made by the party proposing to make the same, such party shall consult in good faith with the other party before the making of such public announcement. 5.7 CONFIDENTIALITY. (a) Unless otherwise agreed to in writing by the Company, Purchaser shall, except as required by law (and then only in compliance with Section 5.7(b)), (i) keep all Proprietary Information confidential and not disclose or reveal any Proprietary Information to any person other than to a limited number of Purchaser's and its Affiliates' directors, officers, advisors and employees and to cause those Persons to observe the terms of this Section 5.7, (ii) not use Proprietary Information for any purpose other than in connection with Purchaser's and -31- its Affiliates' proposed business relationship with the Company (including any internal evaluation thereof) and (iii) not disclose to any Person (other than to a limited number of Purchaser's and its Affiliates' directors, officers, advisors and employees who Purchaser causes to observe the terms of this Section 5.7) any information that is not otherwise publicly available about the transactions contemplated hereby, or the terms or conditions or any other facts relating thereto or the status thereof, or the nature of any Proprietary Information that has been made available to Purchaser. Purchaser will be responsible for any breach of the terms of this Section 5.7 by Purchaser or its advisors and employees. (b) In the event that Purchaser or its Affiliates or any of Purchaser's or its Affiliates' directors, officers, advisors and employees are requested pursuant to, or required by, applicable law or legal process to disclose any Proprietary Information or any other information concerning the Company or the transactions contemplated hereby, Purchaser will provide the Company with prompt notice of such request or requirement so that the Company may seek an appropriate protective order or other remedy or waive compliance with the terms of this Agreement and Purchaser will take all reasonable steps to cooperate with the Company, at the Company's expense, with respect to taking steps to resist or narrow the scope of such request or requirement. In the event that no such protective order or other remedy is obtained or the Company waives compliance with the terms of this Section 5.7, Purchaser may furnish only that portion of the Proprietary Information or other information which is legally required to be furnished or necessary to avoid contempt proceedings or other official sanctions and will use its reasonable efforts at the Company's expense to ensure that all Proprietary Information and other information that is so disclosed will be accorded confidential treatment. (c) In the event that the Closing does not occur by February 1, 1999, Purchaser will, upon the request of the Company, promptly deliver to the Company or destroy all Proprietary Information, including all copies, reproductions, summaries, analyses or extracts thereof or based thereon, in Purchaser's or its Affiliates' possession or in the possession of any of their respective directors, officers, advisors or employees and certify to the Company in writing that such delivery and/or destruction has taken place. ARTICLE VI CONDITIONS TO PURCHASER'S OBLIGATIONS The obligations of Purchaser to consummate the transactions contemplated hereby shall be subject to the satisfaction on or prior to the Closing Date of all of the following conditions, except such conditions as Purchaser may waive: 6.1 REPRESENTATIONS, WARRANTIES AND COVENANTS OF THE COMPANY. The Company shall have complied in all material respects with all of its agreements and covenants contained herein required to be complied with at or prior to the Closing Date, and all the representations and warranties of the Company contained herein which are qualified as to materiality shall be true, and all representations and warranties of the Company which are not qualified as to materiality shall be true in all material respects, on and as -32- of the Closing Date with the same effect as though made on and as of the Closing Date, except as otherwise contemplated hereby, and except to the extent that such representations and warranties expressly make reference to a specified date and as to such representations and warranties the same shall continue on the Closing Date to have been true in all material respects as of the specified date. Purchaser shall have received a certificate of the Company, dated as of the Closing Date and signed by an officer of the Company, certifying as to the fulfillment of the conditions set forth in this Section 6.1. 6.2 NO PROCEEDINGS. No Governmental Entity of competent jurisdiction shall have issued any Order restraining, enjoining, prohibiting, imposing burdensome penalties on, or otherwise making illegal the consummation of the transactions contemplated by this Agreement or the Joint Development Agreement. No action, suit or other proceeding by any Governmental Entity shall have been instituted that seeks to restrain, enjoin, prohibit, impose burdensome penalties on or otherwise make illegal the performance of this Agreement or the Joint Development Agreement or the consummation of the transactions contemplated hereby or thereby. 6.3 HART-SCOTT-RODINO WAITING PERIODS. All applicable waiting periods under the HSR Act shall have expired or early termination thereof shall have been granted. 6.4 SHARE LISTING. The Shares shall have been listed for trading, subject to official notice of issuance, on the NYSE or such other exchange or quotation system on which the Common Stock is then listed or traded. 6.5 JOINT DEVELOPMENT AGREEMENT. Concurrently with the execution of this Agreement, the Company shall have executed and delivered the Joint Development Agreement and on or before the Closing Date shall have performed such of the Company's obligations under the Joint Development Agreement as are to be performed on or before the Closing Date. ARTICLE VII CONDITIONS TO THE COMPANY'S OBLIGATIONS The obligations of the Company to consummate the transactions contemplated hereby shall be subject to the satisfaction on or prior to the Closing Date of all of the following conditions, except such conditions as the Company may waive: -33- 7.1 REPRESENTATIONS, WARRANTIES AND COVENANTS OF PURCHASER. Purchaser shall have complied in all material respects with all of its agreements and covenants contained herein required to be complied with at or prior to the Closing Date, and all of the representations and warranties of Purchaser contained herein which are qualified as to materiality shall be true, and all representations and warranties of the Purchaser which are not qualified as to materiality shall be true in all material respects, on and as of the Closing Date with the same effect as though made on and as of the Closing Date, except as otherwise contemplated hereby, and except to the extent that such representations and warranties expressly make reference to a specified date and as to such representations and warranties the same shall continue on the Closing Date to have been true as of the specified date. The Company shall have received a certificate of Purchaser, dated as of the Closing Date and signed by an officer of Purchaser, certifying as to the fulfillment of the condition set forth in this Section 7.1. 7.2 NO PROCEEDINGS. No Governmental Entity of competent jurisdiction shall have issued any Order restraining, enjoining, prohibiting, imposing burdensome penalties on, or otherwise making illegal the consummation of the transactions contemplated by this Agreement or the Joint Development Agreement. No action, suit or other proceeding by any Governmental Entity shall have been instituted that seeks to restrain, enjoin, prohibit, impose burdensome penalties on or otherwise make illegal the performance of this Agreement or the Joint Development Agreement or the consummation of the transactions contemplated hereby or thereby. 7.3 HART-SCOTT-RODINO WAITING PERIODS. All applicable waiting periods under the HSR Act shall have expired or early termination thereof shall have been granted. 7.4 JOINT DEVELOPMENT AGREEMENT. Concurrently with the execution of this Agreement, Purchaser and/or its direct or indirect Subsidiary shall have executed and delivered the Joint Development Agreement and on or before the Closing Date shall have performed such of Purchaser's and/or its direct or indirect Subsidiary's obligations under the Joint Development Agreement as are to be performed on or before the Closing Date. ARTICLE VIII TERMINATION PRIOR TO CLOSING 8.1 TERMINATION OF AGREEMENT. (a) This Agreement may be terminated at any time prior to the Closing: (i) By the mutual written consent of Purchaser and the Company; or -34- (ii) By either Purchaser or the Company in writing if the Closing shall not have occurred on or before February 1, 1999; provided, however, that the right to terminate this Agreement under this Section 8.1(a)(ii) shall not be available to any party whose failure to fulfill any obligation under this Agreement has been the cause of, or resulted in, the failure of the Closing to occur on or before such date; or (iii) By either Purchaser or the Company if there shall be in effect any law, regulation or Order that prohibits the consummation of the Closing or if consummation of the Closing would violate any Order. 8.2 EFFECT OF TERMINATION. If this Agreement is terminated in accordance with Section 8.1 hereof and the transactions contemplated hereby are not consummated, this Agreement shall become null and void and of no further force and effect except that (i) the terms and provisions of Sections 5.7, 8.2, 11.7, 11.8, 11.10 and 11.11 shall remain in full force and effect, and (ii) any termination of this Agreement shall not relieve any party hereto from any liability for any breach of its obligations hereunder. ARTICLE IX DEFINITIONS The terms defined in this Article IX, whenever used in this Agreement, shall, unless the context otherwise requires, have the respective meanings hereinafter specified and, unless the context otherwise requires, words in the singular or in the plural shall each include the singular and the plural and the use of any gender shall include all genders. "AFFILIATE" of a Person has the meaning set forth in Rule 12b-2 under the Exchange Act. "ASSOCIATE" of a Person has the meaning set forth in Rule 12b-2 under the Exchange Act. "BUSINESS DAY" shall mean any day other than Saturday, Sunday or a day on which banking institutions in New York City are authorized or obligated by law to close. "CLOSING" shall have the meaning set forth in Section 1.2. "CLOSING DATE" shall have the meaning set forth in Section 1.2. "COMMISSION" shall mean the Securities and Exchange Commission. "EXCHANGE ACT" shall mean the Securities Exchange Act of 1934, as amended. "FAIR MARKET VALUE" of a share of Common Stock, as of a particular date, shall -35- mean the average of the daily closing prices (i.e. the last reported sales price, regular way, for such day as reported on the NYSE) of the Common Stock for the period of 30 consecutive trading days commencing 35 trading days prior to such date. "GOVERNMENTAL ENTITY" shall mean any government or any agency, bureau, board, commission, court, department, political subdivision, tribunal, or other instrumentality of any government (including any regulatory or administrative agency), whether federal, state or local, domestic or foreign. "HOLDER" shall mean Purchaser and any Person acquiring Registrable Securities from Purchaser other than in an offering registered under the Securities Act or in a sale made pursuant to Rule 144 promulgated under the Securities Act. "HSR ACT" shall mean the Hart-Scott-Rodino Antitrust Improvement Act of 1976. "LIEN" shall mean any security interest, claim, voting agreement, restriction, option, mortgage, deed of trust, pledge, hypothecation, assignment, charge or deposit arrangement, encumbrance, lien (statutory or other) or preferential arrangement of any kind or nature whatsoever and any contingent or other agreement to provide any of the foregoing. "MSO" shall mean cable television multiple system operators. "MSO WARRANT ISSUANCE AGREEMENTS" shall have the meaning set forth in Section 2.2. "MATERIAL ADVERSE EFFECT" shall mean with respect to the Company or Purchaser, as the case may be, a material adverse effect on the business, operations, financial condition or results of operations of such party and its Subsidiaries taken as a whole, excluding effects reasonably attributable to the general state of the industry, to general economic conditions, to the transactions contemplated by this Agreement. "MEMBER" shall mean a member of the Purchaser Group. "NYSE" shall have the meaning set forth in Section 2.3. "NDTC" shall mean National Digital Television Center, Inc., a Colorado corporation and a subsidiary of Tele-Communications, Inc. and its Affiliates. "NDTC WARRANT ISSUANCE AGREEMENT" shall have the meaning set forth in Section 2.2. "ORDER" means any judgment, decree, order, writ, award, ruling, stipulation, injunction or determination of an arbitrator or court or other Governmental Entity. -36- "PERMITTED TRANSFEREE" shall mean any wholly owned Subsidiary of Purchaser or Sony Corporation (Japan) who agrees to be bound by the terms of this Agreement to the same extent as Purchaser and such Subsidiary at all times remains wholly owned by Purchaser or Sony Corporation (Japan). "PERSON" shall mean any natural person, corporation, business trust, joint venture, association, company, partnership, limited liability company or other entity or any government, or any agency or political subdivision thereof. "PROPRIETARY INFORMATION" shall mean all information about the Company furnished by or on behalf of the Company, whether furnished before or after the date hereof, whether oral or written, and regardless of the manner in which it is furnished, and including any summaries or analyses thereof or other documents containing or reflecting any such information, whether prepared by the Company or Purchaser. Proprietary Information does not include, however, information which (a) is or becomes generally available to the public other than as a result of a disclosure by Purchaser or its employees or advisors or (b) was or becomes available to Purchaser on a nonconfidential basis from a person other than the Company or one of its employees or advisors who is not otherwise bound by a confidentiality agreement with the Company, or, to the knowledge of Purchaser, is otherwise not under a contractual, legal, or fiduciary obligation to the Company not to transmit the information to Purchaser. "PURCHASE PRICE" shall have the meaning set forth in Section 1.1. "PURCHASER GROUP" shall mean (a) Purchaser, (b) any Subsidiary or direct or indirect parent of Purchaser, (c) any Affiliate of Purchaser controlled by Purchaser such that Purchaser has the power (including through negative control) to cause such Affiliate to comply with the terms of this Agreement applicable to Purchaser, and (d) any Person with whom Purchaser or any Person included in the foregoing clauses (b) or (c) is part of a 13D Group. "REGISTRABLE SECURITIES" shall mean the Shares and any securities which may be distributed in respect thereof or result therefrom, by way of stock dividend, stock split or other distribution, recapitalization, merger, consolidation, reclassification or reorganization or otherwise. As to any particular Registrable Securities once issued, such securities shall cease to be Registrable Securities when (i) a registration statement with respect to the sale of such securities shall have become effective under the Securities Act and such securities shall have been disposed of in accordance with such registration statement, (ii) such securities shall have been distributed to the public pursuant to Rule 144 (or any successor provision) under the Securities Act, (iii) such securities shall have been otherwise transferred, new certificates for them not bearing a legend restricting further transfer shall have been delivered by the Company and subsequent disposition of them shall not require registration or qualification of them under the Securities Act, or (iv) such securities shall have ceased to be outstanding. "REGISTRATION EXPENSES" shall mean any and all expenses incident to performance of or compliance with Section 5.4, including, without limitation, (i) all Commission and stock exchange or National Association of Securities Dealers, Inc. registration, filing fees and listing expenses, (ii) all fees and expenses of complying with securities or blue sky laws (including -37- reasonable fees and disbursements of counsel for any underwriters in connection with blue sky qualification of any Shares), (iii) all printing, messenger and delivery expenses, (iv) the fees and disbursements of counsel for the Company and of its independent public accountants, including the expenses of any special audits and/or "cold comfort" letters required by or incident to such performance and compliance, (v) the fees and disbursements of counsel retained in connection with such registration by Holders of the Shares being registered, (vi) all roadshow and related expenses of the Company and the underwriters, and (vii) any fees and disbursements of underwriters customarily paid by issuers or sellers of securities, including the fees and expenses of any special experts retained in connection with the requested registration. "RESTRICTED PERIOD" shall have the meaning set forth in Section 5.1. "SEC REPORTS" shall have the meaning set forth in Section 2.5. "SECURITIES ACT" shall mean the Securities Act of 1933, as amended. "SUBSIDIARY" shall mean, when used with respect to any party means any corporation, partnership, limited liability company, or other organization, whether incorporated or unincorporated, of which such party owns 50% or more of the outstanding voting securities or economic interest. "13D GROUP" shall mean any group of Persons who, with respect to those acquiring, holding, voting or disposing of Common Stock would, assuming ownership of the requisite percentage thereof, be required under Section 13(d) of the Exchange Act and the rules and regulations thereunder to file a statement on Schedule 13D with the Commission as a "person" within the meaning of Section 13(d)(3) of the Exchange Act, or who would be considered a "person" for purposes of Section 13(g)(3) of the Exchange Act. ARTICLE X SURVIVAL; INDEMNIFICATION 10.1 SURVIVAL. The representations and warranties of the Company and Purchaser contained in this Agreement shall survive the Closing, but shall terminate on the first anniversary of the Closing Date; it being understood that in the event notice of any claim for indemnification under Section 10.2 (a)(i) or Section 10.3(a)(i) hereof shall have been given within the applicable survival period, the representations and warranties that are the subject of such indemnification claim shall survive until such time as such claim is finally resolved. Each party shall have no indemnification obligation with respect to any indemnification claim made for breach of a representation or warranty contained in this Agreement if such claim is made after the end of the applicable survival period. -38- 10.2 INDEMNIFICATION BY PURCHASER. (a) Purchaser hereby agrees that it shall indemnify, defend and hold harmless the Company, its Affiliates, and, if applicable, their respective directors, officers, shareholders, partners, attorneys, accountants, agents and employees and their heirs, successors and assigns (the "Company Indemnified Parties") from, against and in respect of any damages, claims, losses, charges, actions, suits, proceedings, deficiencies, interest, penalties, and reasonable costs and expenses (including without limitation reasonable attorneys' fees, removal costs, remediation costs, closure costs, fines, penalties and expenses of investigation and ongoing monitoring) (collectively, the "Losses") imposed on, sustained, incurred or suffered by or asserted against any of the Company Indemnified Parties, directly or indirectly relating to or arising out of (i) any breach of any representation or warranty made by Purchaser contained in this Agreement and (ii) any breach of any covenant or agreement of Purchaser contained in this Agreement. (b) As to any Losses with respect to the matters contained in Section 10.2(a)(i), Purchaser shall be liable to the Company Indemnified Parties to the extent (but only to the extent) the Losses therefrom exceed an aggregate amount equal to $1,000,000. 10.3 INDEMNIFICATION BY THE COMPANY. (a) The Company hereby agrees that it shall defend and hold harmless Purchaser, its Affiliates and, if applicable, their respective directors, officers, shareholders, partners, attorneys, accountants, agents and employees and their heirs, successors and assigns (the "Purchaser Indemnified Parties"; collectively with the Company Indemnified Parties, the "Indemnified Parties") from, against and in respect of any Losses imposed on, sustained, incurred or suffered by or asserted against any of the Purchaser Indemnified Parties, directly or indirectly relating to or arising out of (i) any breach of any representation or warranty made by the Company contained in this Agreement, and (ii) any breach of any covenant or agreement of the Company contained in this Agreement. (b) As to any Losses with respect to the matters contained in Section 10.3(a)(i), the Company shall be liable to the Purchaser Indemnified Parties to the extent (but only to the extent) the Losses therefrom exceed an aggregate amount equal to $1,000,000. 10.4 INDEMNIFICATION PROCEDURES. With respect to third party claims, all claims for indemnification by any Indemnified Party hereunder (other than claims for which indemnification is provided under Section 5.4, which shall be resolved in accordance therewith) shall be asserted and resolved as set forth in this Section 10.4. In the event that any written claim or demand for which an indemnifying party, the Company or Purchaser, as the case may be (an "Indemnifying Party"), would be liable to any Indemnified Party hereunder is asserted against or sought to be collected from any Indemnified Party by a third party, such Indemnified Party shall promptly, but in no event more than 30 days following such Indemnified Party's receipt of such claim or demand, notify the Indemnifying Party of such claim or demand and the amount or the estimated amount thereof to the extent then feasible (which estimate shall not be conclusive of the final amount of such claim and demand) (the "Claim Notice"); PROVIDED, HOWEVER, that if the Claim Notice has -39- been given within any applicable survival period, failure to notify the Indemnifying Party within such 30-day period shall relieve the Indemnifying Party of its indemnification obligation only to the extent that the Indemnifying Party is actually prejudiced thereby. The Indemnifying Party shall have 30 days from the personal delivery or mailing of the Claim Notice (the "Notice Period") to notify the Indemnified Party (a) whether or not the Indemnifying Party disputes the liability of the Indemnifying Party to the Indemnified Party hereunder with respect to such claim or demand and (b) whether or not it desires to defend the Indemnified Party against such claim or demand. All costs and expenses incurred by the Indemnifying Party in defending such claim or demand shall be a liability of, and shall be paid by, the Indemnifying Party; PROVIDED, HOWEVER, that the amount of such costs and expenses that shall be a liability of the Indemnifying Party hereunder shall be subject to the limitations set forth in Sections 10.3(b) and (c) hereof. Except as hereinafter provided, in the event that the Indemnifying Party notifies the Indemnified Party within the Notice Period that it desires to defend the Indemnified Party against such claim or demand, the Indemnifying Party shall have the right to defend the Indemnified Party by appropriate proceedings using counsel reasonably satisfactory to the Indemnified Party and shall have the power to direct and control such defense with counsel satisfactory to the Indemnified Party, and such Indemnified Party may participate in such defense, which participation by the Indemnified Party will be at its expense unless (i) the employment of counsel by such Indemnified Party has been authorized by the Indemnifying Party, (ii) the Indemnified Party shall have been advised by its counsel in writing that there is a conflict of interest between the Indemnifying Party and the Indemnified Party in the conduct of the defense of such action (in which case the Indemnifying Party shall not have the right to direct and control the defense of such action on behalf of the Indemnified Party) or (iii) the Indemnifying Party shall not in fact have employed counsel to assume the defense of such action, in each of which cases, the expenses and fees of the Indemnified Party's counsel shall be at the expense of the Indemnifying Party. To the extent the Indemnifying Party shall direct, control or participate in the defense or settlement of any third party claim or demand, the Indemnified Party will give the Indemnifying Party and its counsel reasonable access to, during normal business hours and upon reasonable notice, the relevant business records and other documents, and shall permit them to consult with the employees and counsel of the Indemnified Party. Regardless of which Person assumes control of the defense of any claim, each party shall cooperate in the defense thereof. The Indemnified Party shall not consent to the entry of any judgment or enter into any settlement with respect to such matter without the written consent of the Indemnifying Party (which shall not be unreasonably withheld or delayed). The Indemnifying Party shall not consent to the entry of judgment or any settlement which does not include as an unconditional term thereof the giving by the claimant or plaintiff to the Indemnified Party of an unconditional release from all liability in respect of such claim or litigation or which requires the Indemnified Party to concede any fault or wrong-doing. ARTICLE XI MISCELLANEOUS 11.1 ENTIRE AGREEMENT. This Agreement and the Joint Development Agreement constitute the sole -40- understanding of the parties with respect to the subject matter hereof. 11.2 SUCCESSORS AND ASSIGNS. Except as otherwise expressly provided herein, the provisions hereof shall inure to the benefit of, and be binding upon, the Company's successors and permitted assigns. 11.3 ASSIGNMENT. Other than as expressly set forth herein, neither this Agreement nor any rights or obligations hereunder shall be assignable. 11.4 COUNTERPARTS. This Agreement may be executed in one or more counterparts, each of which shall for all purposes be deemed to be an original and all of which shall constitute the same instrument. 11.5 HEADINGS. The headings of the Articles, Sections and paragraphs of this Agreement are inserted for convenience only and shall not be deemed to constitute part of this Agreement or to affect the construction hereof. 11.6 NO WAIVER. No action taken pursuant to this Agreement, including any investigation by or on behalf of any party hereto, will be deemed to constitute a waiver by the party taking any action of compliance with any representation, warranty or agreement contained herein. The waiver by any party hereto of any condition or of a breach of any other provision of this Agreement will not operate or be construed as a waiver of any other condition or subsequent breach. The waiver by any party of any of the conditions precedent to its obligations under the Agreement will not preclude it from seeking redress for breech of this Agreement other than with respect to the condition so waived. 11.7 FEES AND EXPENSES. The Company and Purchaser shall each pay all costs and expenses incurred by it or on its behalf in connection with this Agreement and the transactions contemplated hereby, including, without limiting the generality of the foregoing, fees and expenses of its own financial consultants, accountants and counsel. 11.8 NOTICES. notice, request, instruction or other document to be given hereunder by any party hereto to any other party hereto shall be in writing and shall be deemed to have been duly given, if delivered personally, by telecopier or sent by first class mail, postage prepaid, as follows (or to such other address as shall be furnished in writing to the other parties hereto): if to the Company to: -41- General Instrument Corporation 101 Tournament Drive Horsham, Pennsylvania 19044 Attention: General Counsel Telephone: 215-323-1000 Telecopier: 215-323-1293 with a copy to: Fried, Frank, Harris, Shriver & Jacobson One New York Plaza New York, New York 10004 Attention: Lois Herzeca Telephone: 212-859-8000 Telecopier: 212-859-4000 if to Purchaser to: Sony Corporation of America 550 Madison Avenue New York, New York 10022 Attention: Legal Department Telephone: 212-833-6828 Telecopier: 212-833-4579 with a copy to: White & Case 1155 Avenue of the Americas New York, NY 10036-2787 Attention: William F. Wynne, Jr. Telephone: 212-819-8200 Telecopier: 212-354-8113 Any notice shall be deemed given upon receipt. 11.9 AMENDMENTS. This Agreement may be amended, supplemented or waived only by a subsequent writing signed by each of the parties hereto. 11.10 GOVERNING LAW. THIS AGREEMENT SHALL BE GOVERNED BY, AND CONSTRUED AND ENFORCED IN ACCORDANCE WITH, THE LAW OF THE STATE OF NEW YORK WITHOUT REGARD TO THE PRINCIPLES OF CONFLICTS OF LAWS THEREUNDER. 11.11 CONSENT TO JURISDICTION. -42- Each of Purchaser and the Company consents and submits to the exclusive jurisdiction of the courts of the State of New York and of the courts of the United States for the Southern District of the State of New York for all purposes of this Agreement and any related document to which it is a party, including, without limitation, any action or proceeding instituted for the enforcement of any right, remedy, obligation or liability arising under or by reason hereof and thereof (and agree not to commence any litigation relating thereto except in such courts), and further agrees that service of any process, summons, notice or document by U.S. registered mail to its respective address set forth in Section 11.8 shall be effective service of process for any such litigation brought in any such court. Each of Purchaser and the Company hereby irrevocably and unconditionally waives any objection to the laying of venue of any such litigation in the courts of the State of New York or of the United States of America in each case located in the County of New York and hereby further irrevocably and unconditionally waives and agrees not to plead or clam in any such court that any such litigation brought in any such court has been brought in an inconvenient forum. 11.12 SPECIFIC PERFORMANCE. Each party hereto acknowledges that, in view of the uniqueness of the transactions contemplated by this Agreement, the other party would not have an adequate remedy at law for money damages in the event that this Agreement has not been performed in accordance with its terms. Each party therefore agrees that the other party shall be entitled to specific enforcement of the terms hereof in addition to any other remedy to which it may be entitled, at law or in equity. IN WITNESS WHEREOF, each of the parties hereto has caused this Agreement to be executed on its behalf as of the date first above written. GENERAL INSTRUMENT CORPORATION By: /s/ Edward D. Breen ------------------------------------- Name: Edward D. Breen Title: Chief Executive Officer SONY Corporation of America By: /s/ Howard Stringer ------------------------------------- Name: Howard Stringer Title: President -43- EX-21 3 SUBSIDIARIES OF THE COMPANY EXHIBIT 21 GENERAL INSTRUMENT CORPORATION SUBSIDIARIES Access Control Center, Inc. Incorporated: Delaware Charger Industries Incorporated: California DBS Services, Inc. Incorporated: California Ensambladora de Matamoros, S.A. de C.V. Incorporated: Mexico Fuba Communications Systems GmbH Incorporated: Germany General Instrument (Argentina) S.A. Incorporated: Argentina General Instrument (Australia) Pty Ltd Incorporated: Australia General Instrument Authorization Services, Inc. Incorporated: Delaware General Instrument (Brasil) Ltda. Incorporated: Brazil General Instrument (Canada) Inc. Incorporated: Canada General Instrument Corporation (Chile) Limitada Incorporated: Chile General Instrument China Holdings, Inc. Incorporated: Delaware General Instrument Equity Corporation Incorporated: Delaware General Instrument (Europe) Ltd. Incorporated: England General Instrument (France) SAS Incorporated: France General Instrument HDTV Corporation Incorporated: Delaware General Instrument Holdings (Taiwan), Inc. Incorporated: Delaware General Instrument (Hong Kong) Limited Incorporated: Hong Kong General Instrument (India), Inc. Incorporated: Delaware General Instrument International, Inc. Incorporated: Delaware General Instrument (Japan) Ltd. Incorporated: Japan General Instrument (Mauritius), Inc. Incorporated: Delaware General Instrument (Mexico), S.A. de C.V. Incorporated: Mexico General Instrument of Taiwan, Ltd. Incorporated: Taiwan General Instrument Packet Systems, Inc. Incorporated: Delaware General Instrument Purchasing Corp. Incorporated: Delaware General Instrument Services, Inc. Incorporated: Delaware General Instrument (Singapore) Pte. Ltd. Incorporated: Singapore GI India Pvt. Ltd. Incorporated: India GI Mauritius Holdings, Ltd. Incorporated: Mauritius Jerrold DC Radio, Inc. Incorporated: Delaware Magnitude Compression Systems, Inc. Incorporated: California Next Level Communications Incorporated: California NextLevel Systems (Puerto Rico), Inc. Incorporated: Delaware The NextLevel Systems Foundation Incorporated: Illinois EX-23 4 CONSENT OF DELOITTE & TOUCHE EXHIBIT 23 INDEPENDENT AUDITORS' CONSENT We consent to the incorporation by reference in Registration Statement Nos. 333-29719 and 333-33399 of General Instrument Corporation (formerly NextLevel Systems, Inc.) on Forms S-8 of our reports dated February 9, 1999 included in this Annual Report on Form 10-K of General Instrument Corporation for the year ended December 31, 1998. /s/ DELOITTE & TOUCHE LLP - ------------------------- DELOITTE & TOUCHE LLP Parsippany, New Jersey March 29, 1999 EX-27 5 FDS
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE FINANCIAL STATEMENTS OF GENERAL INSTRUMENT CORPORATION AS OF AND FOR THE YEAR ENDED DECEMBER 31, 1998 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 YEAR DEC-31-1998 DEC-31-1998 148,675 4,865 343,872 (3,833) 281,451 890,703 513,039 (275,908) 2,187,760 453,678 0 0 0 1,734 1,648,437 2,187,760 1,987,825 1,987,825 1,431,327 1,431,327 0 0 1,217 93,649 (38,199) 55,450 0 0 0 55,450 0.35 0.33
EX-99 6 FORWARD LOOKING INFORMATION 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, 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 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 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 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. CERTAIN RESTRICTIONS UNDER CREDIT FACILITIES The Credit Agreement dated as of July 23, 1997, as amended, among the Company, certain banks, and The Chase Manhattan Bank, as Administrative Agent (the "Credit Agreement"), contains certain restrictive financial and operating covenants, including, among others, requirements that the Company satisfy 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 (excluding $203 million of charges incurred in 1997 and 1998) in comparison to net interest expense of greater than 5 to 1; and (iii) maintenance of a leverage ratio comparing total indebtedness to EBITDA (excluding $203 million of charges incurred in 1997 and 1998) of less than 3 to 1. The failure of the Company to satisfy the financial and/or operating covenants contained in the Credit Agreement could cause the Company to be unable to borrow under the Credit Agreement and would cause the Company to seek alternative sources of working capital financing and, depending upon the Company's financial condition at such time, could have a material adverse effect on the operations and financial condition of the Company. 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 and account for a significant portion of the capital expenditures made by cable television system operators. The loss of business from a significant MSO could have a material adverse effect on the business of the Company. 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 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 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. In addition, because of the competitive environment and the nature of the Company's business, there have been and may continue to be threats by third parties asserting their intellectual property rights and challenging the Company's ability to deploy new technologies. 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. There can be no assurance, however, that competitors will not be able to develop systems compatible with, or that are alternatives to, the Company's proprietary technology or systems. 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. 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 or another relevant currency appreciates relative to the U.S. dollar. 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. DEVELOPMENTS RELATED TO PRIMESTAR, INC. On January 22, 1999, PRIMESTAR, Inc. ("PRIMESTAR") announced that it reached an agreement to sell its direct broadcast satellite ("DBS") medium-power business and assets as well as its rights to acquire high-power satellite assets to Hughes Electronics Corporation ("Hughes"). PRIMESTAR, the second largest provider of satellite television entertainment in the United States, currently operates a 160 channel medium-power DBS service. The Company is currently the sole supplier of digital satellite receivers and digital satellite encoders to PRIMESTAR, representing approximately 11% of the Company's sales for the year ended December 31, 1998. While the announcement stated that Hughes' DIRECTV expects to operate PRIMESTAR's medium-power business for a period of approximately two years, during which time it intends to transition PRIMESTAR subscribers to the high-power DIRECTV service, the Company is currently uncertain whether and to what extent PRIMESTAR will continue to order and purchase medium power-equipment from the Company. Further, the Company does not expect to supply any high-power equipment to PRIMESTAR. The announcement stated that if the proposed transaction with Hughes is not consummated for any reason, PRIMESTAR intends to continue its medium-power business. Prior to this announcement, the Company estimated that 1999 revenues from the sale of equipment to PRIMESTAR would be approximately $100 million. The Company believes that, if the proposed acquisition is consummated, such revenues will be substantially reduced. While the Company expects to minimize the effect of the potential loss of revenue from PRIMESTAR through increased sales of its digital cable systems and reductions in overhead expenses, there can be no assurance that the Company will be successful in replacing this lost revenue. The Company has evaluated its overhead structure and has taken steps to further consolidate its San Diego, CA and Horsham, PA operations, including reducing headcount by approximately 200. The Company expects to take a pre-tax charge during the first quarter of 1999 of approximately $15 million, for severance and facility consolidation costs. The loss of PRIMESTAR as a continuing customer will have a significant impact on the Company's satellite business. However, absent the failure of PRIMESTAR to honor its contractual commitments with the Company, the Company believes that the loss of PRIMESTAR's business will not have a material adverse effect on the Company's financial condition or results of operations. 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. 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-----