-----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, VByTAigAu3HKjmM5SkcwCb84uUUS9HgSCRIV0nuVm5mfmWX1lrE3lJyw2aPyG2Iz IuGt5B1nLFx1o5U6EpVlXA== 0000891618-01-500776.txt : 20010516 0000891618-01-500776.hdr.sgml : 20010516 ACCESSION NUMBER: 0000891618-01-500776 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 1 CONFORMED PERIOD OF REPORT: 20010331 FILED AS OF DATE: 20010515 FILER: COMPANY DATA: COMPANY CONFORMED NAME: DIRECTV BROADBAND INC CENTRAL INDEX KEY: 0001102448 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-COMPUTER PROGRAMMING, DATA PROCESSING, ETC. [7370] IRS NUMBER: 770467929 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 000-30125 FILM NUMBER: 1639402 BUSINESS ADDRESS: STREET 1: 10355 N. DE ANZA BLVD. CITY: CUPERTINO STATE: CA ZIP: 95014 BUSINESS PHONE: 4088636600 MAIL ADDRESS: STREET 1: 10355 N. DE ANZA BLVD. CITY: CUPERTINO STATE: CA ZIP: 95014 FORMER COMPANY: FORMER CONFORMED NAME: TELOCITY DELAWARE INC DATE OF NAME CHANGE: 20000327 FORMER COMPANY: FORMER CONFORMED NAME: TELOCITY INC DATE OF NAME CHANGE: 20000104 10-Q 1 f72732e10-q.txt FORM 10-Q 1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934. FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2001 COMMISSION FILE NUMBER: 333-94271 DIRECTV BROADBAND, INC. (FORMERLY TELOCITY DELAWARE, INC.) (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) DELAWARE 77-0467929 (State or other jurisdiction of incorporation (I.R.S. Employer or organization) Identification Number) 10355 N. DEANZA BOULEVARD CUPERTINO, CALIFORNIA 95014 (Address of principal executive offices) (Zip Code) (408) 863-6600 (Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filled by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 30 days. Yes [X] No [ ] As of March 31, 2001, 82,468,226 shares of the Registrant's $0.001 par value Common Stock, were issued and outstanding. 2 DIRECTV BROADBAND, INC. (FORMERLY TELOCITY DELAWARE, INC.) INDEX
PAGE NO. -------- PART I. FINANCIAL INFORMATION (UNAUDITED) Item 1. Condensed Consolidated Financial Statements Condensed Consolidated Balance Sheets as of March 31, 2001 and December 31, 2000.................................................. 2 Condensed Consolidated Statements of Operations for the Three Months Ended March 31, 2001 and March 31, 2000.................................... 3 Condensed Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2001 and March 31, 2000.................................. 4 Notes to Condensed Consolidated Financial Statements.................................. 5 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations............................................................. 7 Item 3. Quantitative and Qualitative Disclosures About Market Risk............................ 11 PART II. OTHER INFORMATION (UNAUDITED) Item 1. Legal Proceedings..................................................................... 16 Item 2. Changes in Securities and Use of Proceeds............................................. 16 Item 6. Reports on Form 8-K................................................................... 16 Signatures............................................................................ 16
1 3 PART I. FINANCIAL INFORMATION ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS DIRECTV BROADBAND, INC. (FORMERLY TELOCITY DELAWARE, INC.) CONDENSED CONSOLIDATED BALANCE SHEETS (AMOUNTS IN 000'S, EXCEPT SHARE AMOUNTS)
March 31, December 31, 2001 2000 (unaudited) (Note 2) --------- --------- ASSETS Current assets: Cash and cash equivalents ................................................ $ 2,343 $ 38,422 Accounts receivable, net ................................................. 828 539 Prepaid expenses and other current assets ................................ 8,613 11,803 --------- --------- Total current assets ............................................... 11,784 50,764 Property and equipment, net ................................................... 53,689 45,311 Intangibles, net .............................................................. 252 278 Other assets .................................................................. 31,811 35,990 --------- --------- Total assets ....................................................... $ 97,536 $ 132,343 ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable ......................................................... $ 18,377 $ 23,761 Accrued liabilities ...................................................... 37,247 21,662 Deferred revenue ......................................................... 1,343 1,026 Capital lease obligations, current ....................................... 4,904 5,757 --------- --------- Total current liabilities .......................................... 61,871 52,206 Notes payable ................................................................. 20,000 -- Capital lease obligations, net of current portion ............................. 6,490 6,860 Other liabilities ............................................................. 314 264 --------- --------- Total liabilities .................................................. 88,675 59,330 --------- --------- Stockholders' equity: Common stock: $0.001 par value, 250,000,000 shares authorized; issued and outstanding: 82,468,226 in 2001 and 81,623,140 in 2000 ............ 79 78 Additional paid-in capital ............................................... 325,910 326,450 Receivable from stockholders ............................................. (3,427) (3,326) Unearned stock-based compensation ........................................ (6,739) (8,022) Accumulated deficit ...................................................... (306,962) (242,167) --------- --------- Total stockholders' equity ......................................... 8,861 73,013 --------- --------- Total liabilities and stockholders' equity ......................... $ 97,536 $ 132,343 ========= =========
The accompanying notes are an integral part of these condensed consolidated financial statements. 2 4 DIRECTV BROADBAND, INC. (FORMERLY TELOCITY DELAWARE, INC.) CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (AMOUNTS IN 000'S, EXCEPT SHARE AND PER SHARE AMOUNTS) (UNAUDITED)
THREE MONTHS ENDED March 31, March 31, 2001 2000 ------------ ------------ Revenues ................................................................................ $ 7,853 $ 350 ------------ ------------ Operating costs and expenses: Network and product costs .......................................................... 17,992 4,249 Sales and marketing ................................................................ 17,220 12,403 General and administrative ......................................................... 20,235 8,115 Research and development ........................................................... 6,031 4,535 Amortization of stock-based compensation (*) ....................................... 4,903 3,200 Depreciation and amortization ...................................................... 6,375 2,085 ------------ ------------ Total operating expenses ..................................................... 72,756 34,587 ------------ ------------ Loss from operations .................................................................... (64,903) (34,237) Interest income/(expense), net .......................................................... 132 (186) Other expense ........................................................................... (24) -- ------------ ------------ Net loss ................................................................................ (64,795) (34,423) Accretion on mandatorily redeemable convertible preferred stock ......................... -- (341) ------------ ------------ Net loss attributable to common stockholders............................... $ (64,795) $ (34,764) ============ ============ Net loss per share, basic and diluted ................................................... $ (0.83) $ (2.61) ============ ============ Shares used in computing net loss per share, basic and diluted .......................... 77,748,119 13,306,454 ============ ============ (*)Amortization of stock-based compensation: Network and product costs ........................................................... $ 16 189 Sales and marketing ................................................................. 4,309 374 General and administrative .......................................................... 443 2,276 Research and development ............................................................ 135 361 ------------ ------------ $ 4,903 $ 3,200 ============ ============
The accompanying notes are an integral part of these condensed consolidated financial statements. 3 5 DIRECTV BROADBAND, INC. (FORMERLY TELOCITY DELAWARE, INC.) CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (AMOUNTS IN 000'S) (UNAUDITED)
THREE MONTHS ENDED ------------------------ March 31, March 31, 2001 2000 -------- -------- Cash flows from operating activities: Net cash used in operating activities ................... $(40,719) $(27,572) -------- -------- Cash flows from investing activities: Proceeds from the sale of property and equipment ........... 23 -- Purchase of property and equipment ......................... (14,057) (6,472) -------- -------- Net cash used in investing activities ................... (14,034) (6,472) -------- -------- Cash flows from financing activities: Proceeds from issuance of common stock, net ................ 159 107 Proceeds from issuance of warrants for common stock ........ 38 -- Proceeds from issuance of warrants for preferred stock ..... -- 104 Proceeds from issuance of notes payable .................... 20,000 -- Repayments of notes payable ................................ -- (517) Principal payments on capital lease obligations ............ (1,223) (796) Increase in restricted cash related to commitments ......... (300) -- -------- -------- Net cash provided by (used in) financing activities ..... 18,674 (1,102) -------- -------- Net decrease in cash and cash equivalents ....................... (36,079) (35,146) Cash and cash equivalents, beginning of period .................. 38,422 66,978 -------- -------- Cash and cash equivalents, end of period ........................ $ 2,343 $ 31,832 ======== ========
The accompanying notes are an integral part of these condensed consolidated financial statements 4 6 DIRECTV BROADBAND, INC. (FORMERLY TELOCITY DELAWARE, INC.) NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 1. DESCRIPTION OF BUSINESS DIRECTV Broadband, Inc. (formerly Telocity Delaware, Inc.) (the "Company") develops, markets, integrates and delivers interactive online services to the residential market over high-speed, or broadband, connections. The Company has a single operating segment and has no organizational structure dictated by product lines, geography or customer type. All revenues earned to date have been generated from U.S. based customers. The Company has been successful in completing several rounds of financing with its last round arising from its initial public offering in March 2000 that raised approximately $120.7 million, net of issuance costs. However, the Company has incurred substantial losses and negative cash flows from operations every quarter since inception. For the three months ended March 31, 2001, the Company incurred a loss from operations of approximately $64.8 million and negative cash flows from operations of $40.7 million. As of March 31, 2001, the Company has an accumulated deficit of approximately $307.0 million. On December 21, 2000, the Company and HUGHES Electronics Corporation ("HUGHES") announced an agreement in which HUGHES, through a recently formed subsidiary, DIRECTV Broadband, Inc., would acquire all the Company's outstanding shares of common stock at a purchase price of $2.15 per share, or approximately $178.0 million, subject to the satisfaction of certain conditions. The cash tender offer for these shares was successfully completed on April 2, 2001. As of April 3, 2001, DIRECTV Broadband, Inc. merged with and into the Company and became a wholly owned subsidiary of HUGHES. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Basis of presentation The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amount reported in the financial statements. Actual results may differ from those estimates. The consolidated financial statements of the Company include the accounts of all its wholly owned subsidiaries. The accompanying condensed consolidated financial statements at March 31, 2001 and for the three month periods ended March 31, 2001 and 2000 are unaudited, but include all adjustments (consisting only of recurring adjustments) which, in the opinion of management, are necessary for a fair presentation of financial position and operating results. Operating results for the three-month period ended March 31, 2001 and 2000 are not necessarily indicative of results that may be expected for any future periods. The condensed consolidated balance sheet at December 31, 2000 has been derived from the audited consolidated financial statements at that date, but does not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. The information included in this report should be read in conjunction with the Company's 2000 Annual Report on Form 10-K and all other filings of the Company including current reports on Form 8-K, filed with the Securities and Exchange Commission through the date of this report. Cash and cash equivalents The Company considers all highly liquid investments with original or remaining maturities of three months or less at the date of purchase to be cash equivalents. At March 31, 2001, the Company had restricted cash of approximately $6.3 million, of which $4.8 million related to letter of credit facilities with a bank, which had terms in excess of one year. The current portion of restricted cash of $1.5 million has been included in "prepaid expenses and other current assets", while the long term balance of $4.8 million has been included in "other assets." 5 7 Research and development Research and development costs are expensed as incurred, except for certain software development costs. In January 1999 the Company adopted Statement of Position ("SOP") 98-1, which requires software development costs associated with internal use software to be charged to operations until certain capitalization criteria are met. For the three months ended March 31, 2001 and 2000, software development costs of approximately $306,000 million and $618,000, respectively, were capitalized and included in property and equipment. Advertising Costs Advertising costs are expensed the first time the advertising takes place. Included in prepaid expenses and other current assets and other assets at March 31, 2001 and December 31, 2000 is $19.5 million and $23.5 million, respectively, related to advertising commitments received from National Broadcasting Company, Inc. ("NBC") and NBC Internet, Inc. ("NBCi") in exchange for the issuance of Series C mandatorily redeemable preferred stock. Advertising expense for the three months ended March 31, 2001 and 2000 was $12.2 million and $7.9 million respectively; advertising expense for the three months ended March 31, 2001, is inclusive of stock-based compensation of $4.0 million. 3. RECLASSIFICATIONS Certain prior period amounts have been reclassified to conform to March 31, 2001 presentation. 4. NET LOSS PER SHARE Basic and diluted net loss per share have been computed using the weighted-average number of shares of common stock outstanding during the period, less shares subject to repurchase. Diluted net loss per share includes common equivalent shares outstanding during the period, if dilutive. The following table represents the calculation of basic and diluted net loss per share (in thousands, except share and per share amounts):
THREE MONTHS ENDED March 31, 2001 March 31, 2000 -------------- -------------- Numerator: Net loss .............................................. $ (64,795) $ (34,423) Accretion on mandatorily redeemable convertible preferred stock ...................................... -- 341 ------------ ------------ Net loss attributable to common stockholders .......... $ (64,795) $ (34,764) ============ ============ Denominator: Weighted-average common shares - basic and diluted .... 81,884,455 24,506,189 Weighted-average common shares subject to repurchase .. (4,136,336) (11,199,735) ------------ ------------ Denominator for basic and diluted calculation ......... 77,748,119 13,306,454 ============ ============ Basic and diluted net loss per share .................. $ (0.83) $ (2.61) ============ ============
Options to purchase 5,922,334 and 651,012 shares of common stock or convertible preferred stock at an average exercise price of $6.54 and $4.86 per share, respectively, and warrants to purchase 2,076,870 and 3,483,339 shares of common or convertible preferred stock at an average exercise price of $3.65 and $3.78 per share, respectively, and zero and 48,302,903 of convertible preferred stock outstanding, have not been included in the computation of diluted net loss per share for the three month periods ended March 31, 2001 and 2000, respectively, as their effect would have been anti-dilutive. 5. COMPREHENSIVE INCOME To date, the Company has not had any transactions that are required to be reported in comprehensive income. 6 8 6. NEW ACCOUNTING PRONOUNCEMENT In June 1998, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standard ("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging Activities", which establishes accounting and reporting standards for derivative instruments and hedging activities. It requires an entity to recognize all derivatives as either assets or liabilities in the balance sheet and measure those instruments at fair value. The Company adopted SFAS No. 133 (as amended by SFAS No. 138) as required by SFAS No. 137, "Deferral of the Effective Date the FASB Statement No. 133", effective January 1, 2001. The Company, to date, has not engaged in derivative and hedging activities, and accordingly the adoption of SFAS No. 133 did not have a material effect on the consolidated financial statements. 7. BORROWINGS During February and March 2001, the Company received $20 million from HUGHES under an 8% convertible subordinated unsecured note which matures on January 31, 2004. The note was issued to the Company, by HUGHES, in connection with the December 21, 2000 "Agreement and Plan of Merger by and among Telocity, HUGHES and DIRECTV Broadband, Inc." (See Note 1). 8. SUBSEQUENT EVENTS On April 2, 2001, through its recently formed subsidiary, DIRECTV Broadband, Inc., HUGHES completed its tender offer to acquire all of the Company's outstanding shares of common stock at a purchase price of $2.15 per share, or approximately $178.0 million in cash plus $20.0 million of interim financing. As of April 3, 2001, DIRECTV Broadband, Inc. merged with and into the Company, and the Company became a wholly owned subsidiary of HUGHES (See Note 1). During April 2001, approximately 19,700 of the Company's subscribers who received DSL connectivity through NorthPoint lost their service following NorthPoint's decision to shut down its network. The Company had received notice of the shutdown on March 28, 2001 following the United States Bankruptcy Court's approved sale of substantially all of NorthPoint's assets. The Company is in the process of reprovisioning service to NorthPoint subscribers where it has an alternate, financially secure, supplier of DSL connectivity. The Company is also entering into new agreements with suppliers of DSL connectivity in those geographical markets where it does not currently have an alternate, financially secure, supplier. Despite these efforts, however, the Company estimates that in excess of 13,000 subscribers will not be reprovisioned through a combination of no alternate last mile provider and customers choosing to terminate their service. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The discussion in this quarterly report on Form 10-Q contains forward-looking statements that involve risks and uncertainties. The statements contained in this Report that are not purely historical are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, including statements regarding our expectations, beliefs, intentions or strategies regarding the future. All forward-looking statements included in this document are based on information available to us on the date hereof, and we assume no obligation to update any such forward-looking statements. Our actual results could differ materially from those described in our forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, our ability to provision timely, consistent and reliable DSL services; our unproven business model and a limited operating history in a new and rapidly evolving industry; our ability to implement our business plan; and our ability to manage our growth, retain and grow our customer base and expand our service offerings. Additional risk factors are discussed under the heading "Risk Factors" both below and in our 2000 Annual Report on Form 10-K. OVERVIEW We develop, market and deliver to the residential market interactive online services and content designed for use over high-speed, or broadband, connections. These broadband connections allow our customers to enjoy services and content that they could not access with traditional slower speed Internet connections. Although we currently deliver our services to customers using digital subscriber line, or 7 9 DSL, technology, in the future we intend to utilize the technology we have developed to deliver these services and content over a variety of broadband technologies from a managed nationwide network to and throughout the home. Our goal is to become a leading provider of broadband access services, content and home networking services to the residential market. In July 1999, we began offering services commercially in Chicago. As of March 31, 2001, we were offering services in more than 150 metropolitan statistical areas nationwide. At March 31, 2001, we had approximately 65,000 active subscribers. During April 2001, approximately 19,700 of the Company's subscribers who received DSL connectivity through NorthPoint lost their service following NorthPoint's decision to shut down its network. The Company had received notice of the shutdown on March 28, 2001 following the United States Bankruptcy Court's approved sale of substantially all of NorthPoint's assets. The Company is in the process of reprovisioning service to NorthPoint subscribers where it has an alternate, financially secure, supplier of DSL connectivity. The Company is also entering into new agreements with suppliers of DSL connectivity in those geographical markets where it does not currently have an alternate, financially secure, supplier. Despite these efforts, however, the Company estimates that in excess of 13,000 subscribers will not be reprovisioned through a combination of no alternate last mile provider and customers choosing to terminate their service. Our maximum potential market is limited by the number of homes that are DSL-capable, meaning homes that are within approximately 2 1/2 and 3 miles from a local telephone office that has equipment necessary to support DSL service and have voice grade copper telephone lines that are in good condition. On December 21, 2000, we announced an agreement in which HUGHES, through a recently formed subsidiary, DIRECTV Broadband Inc., would acquire all of our outstanding shares of common stock at a purchase price of $2.15 per share, or approximately $178.0 million in cash, subject to the satisfaction to certain conditions. Also, to ensure we have sufficient access to funding during the period prior to the consummation of our merger with HUGHES, HUGHES agreed to provide unsecured interim financing of $20.0 million in the form of a convertible subordinated note. The cash tender offer for those shares commenced February 1, 2001 and was successfully completed on April 2, 2001. As of April 3, 2001, DIRECTV Broadband, Inc. merged with and into the Company, and the Company became a wholly owned subsidiary of HUGHES. Since our incorporation in August 1997, our primary activities have consisted of: - developing our residential broadband gateway technology; - obtaining space and locations for our network equipment; - deploying and installing our network; - developing and integrating our operational support system and other back office systems; - negotiating and executing network agreements with traditional telephone companies and new competitive carriers; - launching service in target markets; - developing a marketing and branding strategy; - building our customer service organization; - negotiating agreements for broadband content; - hiring management and other personnel; and - raising capital. We have incurred operating losses, net losses and negative earnings before interest, taxes, amortization of stock-based compensation, depreciation and amortization, or EBITDA, for each month since our formation. As of March 31, 2001, we had an accumulated deficit of $307.0 million. We incur network and product costs, sales and marketing expenses and capital expenditures when we enter a new market. Once we have developed our network in a market, we incur incremental expenditures as we connect new customers. These 8 10 incremental expenditures primarily include local access costs and gateway device costs. THREE MONTHS ENDED MARCH 31, 2001 COMPARED TO THREE MONTHS ENDED MARCH 31, 2000 Revenues. Installed billable subscribers increased from approximately 5,000 at March 31, 2000 to 65,000 at March 31, 2001. Major factors that contributed to our growth include an additional year of operating activity following the commercial launch of our operations in November 1999; and an expansion in our national footprint from 115 to 150 metropolitan statistical areas during the year. The increase in our subscriber base is a major driver behind the increase in revenue from $350,000 for the quarter ended March 31, 2000 to $7.9 million for the quarter ended March 31, 2001. The commercial launch in January 2001 of our first value added service package, "Connect&Protect(TM)", which provides home networking and enhanced computer security capabilities also contributed to the increase in revenues. As noted above under the heading "OVERVIEW", the size of our subscriber base will be negatively impacted by the NorthPoint bankruptcy proceedings. We anticipate that this will have an adverse impact on the size of our average subscriber base for the quarter ended June 30, 2001 compared to the quarter ended March 31, 2001, resulting in a reduction in revenue for the forthcoming quarter. Revenue will also be adversely impacted by the provision of a free month of service, provided as compensation for service interruption, to those NorthPoint subscribers which we successfully reprovision with another carrier during the forthcoming quarter. These reductions in revenue will, however, be offset in part by an anticipated increase in our average revenue per user arising from a higher customer penetration rate for our value added service and the adoption, in March 2001, of a national monthly pricing plan of $49.95 per incremental subscriber; previously certain geographical markets were priced at $39.95 per month. Network and product costs. Network and product costs increased from $4.2 million for the three months ended March 31, 2000, to $18.0 million for the three months ended March 31, 2001. The increase in these costs is directly attributable to incremental recurring access and installation fees payable to our suppliers of DSL connectivity following an increase in our installed subscriber base from approximately 5,000 at March 31, 2000, to 65,000 at March 31, 2001; and additional leased optical fiber costs arising from an expansion of our geographical coverage area and deeper penetration into our existing markets. Sales and marketing expenses. Sales and marketing expenses increased from $12.4 million for the three months ended March 31, 2000 to $17.2 million for the three months ended March 31, 2001. The overall increase in expenditure is consistent with the development of our business as we expanded our geographical service areas with Northern and Southern California in April 2000; the mountain states in July 2000; Texas in August 2000; and Connecticut, Rhode Island, Arizona and Western Florida in October 2000. The table below sets out the primary areas of increased expenditure for the three month period ended March 31, 2001, compared to the respective, prior year period (in thousands): Incremental advertising and promotional costs $ 894 Incremental employee costs $3,375
Sales and marketing expenses in the first quarter 2001 is net of the utilization of $4.0 million of our NBC and NBCi advertising credits which we began utilizing from September 2000, following the launch of our nationwide television advertising campaign, coincident with our nationwide network deployment. General and administrative expenses. General and administrative expenses increased from $8.1 million for the three months ended March 31, 2000 to $20.2 million for the three months ended March 31, 2001. The increased level of expenditures reflects the growth in the volume and complexity of our underlying business and the ongoing expansion of commercial operations to over 150 metropolitan statistical areas by March 31, 2001; and costs attributable to our acquisition by HUGHES. The following table sets out the primary areas of increased 9 11 expenditure for the three month period ended March 31, 2001 compared to the respective, prior year, period (in thousands): Incremental customer delivery and support expenditure $5,445 Incremental executive and general corporate expenditure $5,183 Incremental facilities expenditure $ 478
Research and development expenses. Research and development expenses increased from $4.5 million for the three months ended March 31, 2000 to $6.0 million for the three months ended March 31, 2001. These increases are primarily due to incremental charges, over the comparative period of the prior year, of $918,000 for the three months ended March 31, 2001, for the hiring of additional engineers and consultants involved in increased research and development activities associated with our service development platform and associated services. Amortization of stock-based compensation. Stock-based compensation increased from $3.2 million for the three months ended March 31, 2000, to $4.9 million for the three months ended March 31, 2001. The increase in stock-based compensation expense for the quarter ended March 23, 2001 is primarily attributable to the utilization of $4.0 million of advertising credits received from NBC and NBCi as part of our Series C round of financing, net of a $2.3 million reduction in employee and third party stock-based compensation compared to the corresponding quarter of the prior year. Depreciation and amortization expenses. Depreciation and amortization expenses increased from $2.1 million for the three months ended March 31, 2000 to $6.4 million for the three months ended March 31, 2001. This increase was primarily due to additional capital expenditures arising from the build out of our managed network and the capital expenditures associated with the increase in our subscriber base. LIQUIDITY AND CAPITAL RESOURCES From inception through March 31, 2001, we financed our operations primarily through the proceeds of our initial public offering, net of underwriting commissions, of $120.7 million; private placements of equity of approximately $149.0 million in cash and promotional services; the use of operating equipment leases totaling $18.3 million; and borrowings under notes payable of $31.9 million. As of March 31, 2001, we had an accumulated deficit of $307.0 million, cash and cash equivalents of $2.3 million and restricted cash of $6.3 million. During the three months ended March 31, 2001 and 2000, the net cash used in our operating activities was $40.7 million and $27.6 million, respectively. This cash was used for a variety of operating purposes, including salaries; consulting and legal expenses; transaction related expenses; network operations; marketing; customer care; and overhead expense. Our net cash used for investing activities for the three months ended March 31, 2001 and 2000, was $14.0 million and $6.5 million, respectively, and was primarily used for purchases of property and equipment coincident with the build out of our network and subscriber base. Net cash provided by financing activities for the three months ended March 31, 2001 was $18.7 million and came from receipts under notes payable of $20.0 million, proceeds from the exercise of common stock options and warrants of $197,000, partially offset by $1.2 million in principal payments under capital lease obligations and a $300,000 increase in restricted cash related to commitments. Net cash used by financing activities for the three months ended March 31, 2000 was $1.1 million and was primarily used for the repayment of notes and the payment of capital lease obligations of $1.3 million net of proceeds from the issuance of common stock and preferred stock warrants of $211,000. 10 12 RECENT ACCOUNTING PRONOUNCEMENTS In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities", which establishes accounting and reporting standards for derivative instruments and hedging activities. It requires an entity to recognize all derivatives as either assets or liabilities in the balance sheet and measure those instruments at fair value. The Company adopted SFAS No. 133 (as amended by SFAS No. 138) as required by SFAS No. 137, "Deferral of the Effective Date the FASB Statement No. 133", effective January 1, 2001. The Company, to date, has not engaged in derivative and hedging activities, and accordingly the adoption of SFAS No. 133 did not have a material effect on the consolidated financial statements. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK INTEREST RATE SENSITIVITY The primary objective of our investment activities is to preserve principal while at the same time maximizing the income we receive from our investments without significantly increasing risk. Some of the securities that we may invest in may be subject to market risk. This means that a change in prevailing interest rates may cause the principal amount of the investment to fluctuate. For example, if we hold a security that was issued with a fixed interest rate at the then-prevailing rate and the prevailing interest rate later rises, the principal amount of our investment will probably decline. To minimize this risk in the future, we intend to maintain our portfolio of cash equivalents and short-term investments in a variety of securities, including commercial paper, money market funds, government and non-government debt securities. In general, money market funds are not subject to market risk because the interest paid on such funds fluctuates with the prevailing interest rate. As of March 31, 2001, all of our cash and cash equivalents were in money market and checking funds. OTHER RISK FACTORS AT PRESENT, WE CANNOT PROVIDE OUR SERVICES UNLESS DSL ACCESS PROVIDERS SUPPLY US WITH DSL CONNECTIONS AND COOPERATE WITH US FOR THE TIMELY PROVISION OF DSL CONNECTIONS FOR OUR CUSTOMERS. We must obtain DSL connections from traditional telephone companies and new competitive carriers and have their continuing cooperation for the timely provision of DSL connections for our customers in order for us to provide our services. DSL operates over local telephone lines, which are under the control of traditional telephone companies and new competitive carriers and requires a special connection from our network to the telephone lines. We rely on them to provide us with these DSL connections, and if we were unable to use these connections, we would not be able to provide our services. In addition, we depend on traditional telephone companies and new competitive carriers to test and maintain the quality of the DSL connections that we use. An inability to obtain adequate and timely access to DSL connections on acceptable terms and conditions from traditional telephone companies and competitive carriers and to gain their cooperation in the timely provision of DSL connections for our customers could harm our business, as could their failure to properly maintain the DSL connection we use. MANY OF OUR VENDORS OR SUPPLIERS MAY NOT HAVE THE RESOURCES TO SUSTAIN THEIR BUSINESSES AND MAY NOT BE ABLE TO PROVIDE COMPONENT PARTS FOR OUR INFRASTRUCTURE OR DSL CONNECTIONS FOR OUR CUSTOMERS Many of our vendors or suppliers, including our DSL access providers, are facing serious financial difficulty. With the recent economic slow down and the down turn in the DSL market, many of these vendors or suppliers are forecasting that their revenue for the foreseeable future will be lower than anticipated, and some of these vendors and suppliers are experiencing, or are likely to experience, serious cash flow problems, and even bankruptcy. If some of these vendors or suppliers are not successful in generating sufficient revenue or securing alternate financing arrangements in order to sustain their operations, they may not be able to supply us with components for our infrastructure or DSL connections for our customers. If any of these failures occur, we may not be able to provide continued service to existing customers or install our service for new customers and further, we may be exposed to technical obsolescence for certain types of our gateway. For example, NorthPoint Communications, Inc., one of our DSL access providers, recently filed for bankruptcy and has shut down its DSL network, interrupting service to approximately 19,700 of our customers. We are diligently seeking to reprovision the affected customers; however, a substantial number of these customers have chosen to terminate their 11 13 relationship with us. The failure of our vendors or suppliers to provide us with component parts for our infrastructure or DSL connections for our customers will harm our business and will adversely affect our operating results. WE WILL COMPETE WITH OUR DSL ACCESS PROVIDERS IN PROVIDING BROADBAND INTERNET ACCESS, WHICH MAY CAUSE DELAYS, INCREASE EXPENSES, OR ADVERSELY IMPACT OUR MARGINS. Because in some instance our DSL access providers will also provide broadband Internet access and other services, we compete with them. Although our DSL access providers are required to provide DSL connections to us on a non-discriminatory basis under the Telecommunications Act of 1996, they may nevertheless be reluctant to cooperate with us. Compelling these DSL access providers to meet the regulatory requirements may be expensive and time-consuming and could result in delays and increased expenses associated with providing our services and content on a wider scale, which in turn could harm our business. In view of the comparative size of the traditional telephone companies, we may also be vulnerable to predatory pricing which could force us to either forgo orders because we operate at a comparative price disadvantage, or reduce our prices, thereby adversely impacting our margins and our long-term profitability. OUR FAILURE TO MANAGE OUR GROWTH COULD HARM OUR ABILITY TO RETAIN AND GROW OUR CUSTOMER BASE AND EXPAND OUR SERVICE OFFERINGS. We may not be able to install management information and control systems in an efficient and timely manner, and our current or planned personnel, systems, procedures and controls may not be adequate to support our future operations. Failure to manage our future growth effectively could harm our ability to retain and grow our customer base and expand our service offerings which would materially and adversely affect our business, prospects, operating results and financial condition. CUSTOMERS MAY NOT ACCEPT THE VALUE ADDED SERVICES WE ARE CURRENTLY DEVELOPING. IF THESE SERVICES DO NOT GAIN BROAD MARKET ACCEPTANCE, WE WILL NOT BE ABLE TO INCREASE OUR REVENUES AND BUILD OUR BUSINESS AS ANTICIPATED. We are currently developing a range of value-added services which include firewall and other internet safety features; multiple computer support; unified messaging; and consumer related content and voice services. Broadband services are a new and emerging business, and we cannot guarantee that these services will attract widespread demand or market acceptance. If this market fails to develop or develops more slowly than anticipated, we will not be able to increase our revenues, build our business, or improve our margins as anticipated. BECAUSE OUR CUSTOMER ACQUISITION COSTS ARE HIGH, IF WE FAIL TO RETAIN CUSTOMERS LONG ENOUGH TO PAY BACK OUR UP FRONT INVESTMENT, WE MAY NOT ACHIEVE PROFITABILITY. Our customer acquisition costs comprise a significant portion of our operating costs, including advertising, order fulfillment, installation, customer care, and the cost of our residential gateway. Because of our significant up-front investment in each customer, if our customers terminate their relationships with us before we recover our up front costs, we may fail to generate a profit. In addition, if we fail to reduce our customer acquisition costs, including by increasing the efficiency of our customer care organization and reducing the costs associated with the development and production of our gateways, our operating results will suffer. 12 14 THE SCALABILITY, RELIABILITY AND SPEED OF OUR NETWORK REMAIN LARGELY UNPROVEN AND MAY NOT SATISFY CUSTOMER DEMAND. We may not be able to scale our network and operational support system to meet our projected customer numbers while achieving and maintaining superior performance. This risk will continue to exist as long as we expand our services geographically to increasing numbers of customers. Our failure to achieve or maintain high-speed digital transmissions, for a number of reasons including the reliability and inter-operability of our network equipment, would significantly reduce customer demand for our services, resulting in decreased revenues and the inability to build our business as planned. FACTORS OUTSIDE OF OUR CONTROL MAY ADVERSELY AFFECT OUR TRANSMISSION SPEED. LOWER SPEEDS MAY RESULT IN CUSTOMER DISSATISFACTION AND ULTIMATELY A LOSS OF CUSTOMERS. Peak digital data transmission speeds currently offered across our networks when utilizing DSL are 1.5 megabits per second. However, the actual data transmission speeds over our networks can be significantly slower. These slower speeds may result in customer dissatisfaction and ultimately in the loss of customers and revenues. The speeds over our networks depend on a variety of factors, many of which are out of our control, including: - the distance an end-user is located from a central office; - the configuration of the telecommunications line being used; - the quality of the telephone lines provisioned by traditional telephone companies; - the inside wiring of our customers' homes; and - the limitations of our customers' computers. WE AND MANUFACTURERS OF OUR PRODUCTS RELY ON A CONTINUOUS POWER SUPPLY TO CONDUCT OPERATIONS, AND CALIFORNIA'S CURRENT ENERGY CRISIS COULD DISRUPT OUR BUSINESS AND INCREASE OUR EXPENSES California is in the midst of an energy crisis that could disrupt our operations and increase our expenses. In the event of an acute power shortage, that is, when power reserves for California fall below 1.5%, California has on some occasions implemented, and may in the future continue to implement, rolling blackouts. Virtually all of our operations are located in California and our backup power supplies can only work for a finite period of time. If blackouts are prolonged, we would be temporarily unable to continue operations at our facilities. Any such interruption in our ability to continue operations at our facilities could damage our reputation, harm our ability to retain existing customers and to obtain new customers, and could result in lost revenue, any of which could substantially harm our business and results of operation. The manufacturer of our residential gateway, Wellex, and a provider of our DSL connections, PacBell, are located in California. As a result of this crisis, Wellex may be unable to manufacture sufficient quantities of our gateway to meet our needs, or they may increase the fees they charge us for their services. In addition, PacBell would no longer be able to install DSL connections for our customers, or they may increase the fees they charge us for providing us with DSL connections. The inability of our contract manufacturer to provide us with adequate supplies of our gateway and the inability of PacBell to install DSL connections for new customers would cause a delay in our ability to fulfill our customers' orders, which would hurt our business, and any increase in their fees could adversely affect our financial condition. A SYSTEM FAILURE OR BREACH OF NETWORK SECURITY COULD CAUSE DELAYS OR INTERRUPTIONS OF SERVICE TO OUR CUSTOMERS, WHICH COULD HURT OUR BRAND IMAGE, LEAD TO A LOSS OF CUSTOMERS, AND RESULT IN A SIGNIFICANT DECREASE OF REVENUES. 13 15 Although we have not experienced any system failures or breaches of network security that materially affected us, if we experience one or more of the problems described below in the future, our financial performance and results of operations could be materially affected at that time. Our operations depend on our ability to avoid damages from fires, earthquakes, floods, power losses, excessive sustained or peak user demand, telecommunications failures, network software flaws, transmission cable cuts, and similar events. The occurrence of a natural disaster or other unanticipated problem at our network operations center, our operational support system, our managed network of leased communication lines or any metropolitan hubs or collocation facilities could cause interruptions in the services provided by us and these interruptions could result in the loss of customers and the attendant reduction of revenue. Additionally, if a traditional telephone company, new competitive carrier or other service provider fails to provide the communications capacity we require, as a result of a natural disaster, operational disruption or any other reason, then this failure could interrupt our services. WE ARE VULNERABLE TO CLAIMS THAT ANY ELEMENT OF OUR SERVICE DEPLOYMENT PLATFORM INFRINGES THIRD-PARTY INTELLECTUAL PROPERTY RIGHTS, AND ANY RESULTING CLAIMS AGAINST US COULD BE COSTLY TO DEFEND OR SUBJECT US TO SIGNIFICANT DAMAGES. Infringement claims could materially harm our business. From time to time, we may receive notice of claims of infringement of third parties' proprietary rights. The fields of telecommunications and Internet communications are filled with patents, both pending and issued. We may unknowingly infringe such a patent. We may be exposed to future litigation based on claims that our platform infringes the intellectual property rights of others, especially patent rights. Someone, including a competitor, might file a suit with little merit, in order to harm us commercially, to force us to re-allocate resources to defending such a claim, or extract a large settlement. In addition, our employees might utilize proprietary and trade secret information from their former employers without our knowledge, even though we prohibit these practices. OUR FAILURE TO MEET CHANGING CUSTOMER REQUIREMENTS AND EMERGING INDUSTRY STANDARDS WOULD LIMIT OUR ABILITY TO ATTRACT AND RETAIN CUSTOMERS. The market for high-speed broadband access is characterized by rapidly changing customer demands and short life cycles for services and content. If enhancements to our existing services, such as broadband Internet access, e-mail and storage for web pages, or development of new services, including electronic commerce, communications and utility services, take longer than planned, customer requirements and industry standards may have changed, which would adversely affect our ability to sell our services and cause our results of operations and financial condition to suffer. WE DEPEND ON SINGLE AND LIMITED SOURCE SUPPLIERS FOR KEY COMPONENTS OF OUR GATEWAY WHICH MAKES US SUSCEPTIBLE TO SUPPLY SHORTAGES OR PRICE FLUCTUATIONS THAT COULD ADVERSELY AFFECT OUR OPERATING RESULTS. We rely on Wellex Corporation to produce our proprietary residential gateway device and we will not have another supplier for at least three months. In the event of any significant delay, disruption, capacity constraint or quality control problem in its manufacturing operations, gateway shipments to our customers could be delayed, which would negatively affect our net revenues, competitive position and reputation. Should Wellex cease to be our contract supplier for any reason, we would then need to qualify a new gateway supplier and we may be unable to find a gateway supplier that meets our needs or that can source components as cost-effectively as Wellex. Qualifying a new gateway supplier and commencing volume production is expensive and time consuming. Transferring production operations can significantly disrupt gateway supply. If we are required or choose to change gateway suppliers, we may lose sales and may experience increased production or component costs, and our customer relationships may suffer. If any of our sole-source manufacturers delays or halts production of any of the components or equipment that we use in our residential gateway we would be unable to manufacture and ship our gateway, and, as a result, our revenues and operating results would decline and our customer relationships may suffer. OUR BUSINESS IS SIGNIFICANTLY AFFECTED BY THE LEGISLATIVE, REGULATORY AND JUDICIAL RULES APPLICABLE TO TELECOMMUNICATIONS SERVICES AND THE BROADBAND MARKETPLACE. 14 16 Changes in existing laws and regulations applicable to our business may not be favorable to us and may require us to direct time and money toward legal and regulatory matters. Since 1996, telecommunications laws have been in a state of particularly rapid change. We rely on our ability to purchase DSL access from both traditional telephone companies and new competitive carriers, vendor channels that may not remain open to use, or for which prices may rise, if the regulatory status of these service providers changes in the future. In order to protect our market options and business flexibility, we may also be required to participate in legislative, regulatory and judicial proceedings, or proceedings may be instituted against us by competitors seeking to harm our business, all of which could entail the diversion of substantial funds and management attention. If existing laws and regulations change, the competition among our DSL providers that we rely on to maintain efficiently priced and high quality DSL connections, could be adversely affected. In addition, if the Telecommunications Act of 1996 and recent decisions by the Federal Communications Commission implementing portions of the Act that have opened the existing telephone network to competition are stayed, reversed or modified by appellate courts, if the laws and decisions requiring traditional telephone companies and competitive carriers to sell DSL connections to companies like ours are changed or vacated, or if new regulatory mandates degrade competition, our costs will increase and we will have lower profit margins. OUR HEADQUARTERS AND SUPPLIERS ARE ALL LOCATED IN NORTHERN CALIFORNIA WHERE NATURAL DISASTERS MAY OCCUR WHICH COULD DAMAGE OUR FACILITIES AND RENDER US UNABLE TO PROVIDE SERVICES TO OUR CUSTOMERS. Currently, our corporate headquarters, network operations center and the only manufacturer of our residential gateway are all located in Northern California. Northern California historically has been vulnerable to natural disasters and other risks, such as earthquakes, fires and floods, which at times have disrupted the local economy and posed physical risks to our property and the property of the manufacturer of our residential gateway. In the event of such disaster, our business would suffer. We presently do not have redundant, multiple site capacity in the event of a natural disaster. 15 17 PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS From time to time, we may be involved in litigation that arises in the normal course of our business operations. As of the date of this filing, we are not party to any litigation that we believe could adversely affect our business relationship and our financial results. ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS NONE ITEM 6. REPORTS ON FORM 8-K The Company filed four reports on Form 8-K dated December 28, 2000, as amended on February 2, 2001; February 16, 2001; March 30, 2001; and April 4, 2001. SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. DIRECTV Broadband, Inc., (formerly TELOCITY DELAWARE, INC.) (Registrant) Date: May 15, 2001 BY: /s/ EDWARD HAYES ---------------------------------------------- Edward Hayes President & Chief Executive Officer /s/ DAVID WILSON ---------------------------------------------- David Wilson Vice President & Chief Financial Officer 16 -----END PRIVACY-ENHANCED MESSAGE-----