Prepared by MERRILL CORPORATION

10-Q 1 a2046619z10-q.htm 10-Q Prepared by MERRILL CORPORATION
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q

(MARK ONE)

/x/	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2001.

/ /	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: 0-23289

HYBRID NETWORKS, INC.
(Exact name of registrant as specified in its charter)

Delaware		77-0252931
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

6409 Guadalupe Mines Road, San Jose, California 95120
(Address of principal executive offices)

(408) 323-6500
(Registrant's telephone number, including area code)

Not Applicable
(Former name, former address and former fiscal year, if
changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Sections 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes /x/ No / /

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date:

Common shares outstanding at March 31, 2001: 22,203,859

HYBRID NETWORKS, INC.
INDEX

			PAGE NO.
PART I.		FINANCIAL INFORMATION
	ITEM 1.	FINANCIAL STATEMENTS
		Unaudited Condensed Balance Sheets as of March 31, 2001 and December 31, 2000	3
		Unaudited Condensed Statements of Operations for the Three Months Ended March 31, 2001 and 2000	4
		Unaudited Condensed Statements of Cash Flows for the Three Months Ended March 31, 2001 and 2000	5
		Notes to Unaudited Condensed Financial Statements	6
	ITEM 2.	MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	9
	ITEM 3.	QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	21
PART II.		OTHER INFORMATION
	ITEM 2.	CHANGES IN SECURITIES AND USE OF PROCEEDS	22
	ITEM 6.	EXHIBITS AND REPORTS ON FORM 8-K	22
SIGNATURES			23

As used in this report on Form 10-Q, unless the context otherwise requires, the terms "we," "us," "the Company" or "Hybrid" refer to Hybrid Networks, Inc., a Delaware corporation.

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

HYBRID NETWORKS, INC.
UNAUDITED CONDENSED BALANCE SHEETS
(in thousands, except per share data)

				March 31, 2001			December 31, 2000*
ASSETS
Current assets:
	Cash and cash equivalents			$	5,628		$	1,878
	Accounts receivable, net of allowance for doubtful accounts of $200 in 2001 and 2000				4,566			7,699
	Inventories				6,704			7,303
	Prepaid expenses and other current assets				424			519

			Total current assets		17,322			17,399
Property and equipment, net					1,998			2,000
Intangibles and other assets					1,075			265

			Total assets	$	20,395		$	19,664

LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
	Current portion of capital lease obligations				4			29
	Accounts payable				2,806			4,529
	Accrued liabilities and other				6,891			6,517

			Total current liabilities		9,701			11,075
Convertible debentures					7,429			5,500
Other long-term liabilities					132			132

			Total liabilities		17,262			16,707

Stockholders' equity:
	Convertible preferred stock, $.001 par value:
		Authorized: 5,000 shares;
		Issued and outstanding: no shares in 2001 or 2000			—			—
	Common stock, $.001 par value:
		Authorized: 100,000 shares;
		Issued and outstanding:22,204 shares in 2001 and 21,935 shares in 2000.			22			22
	Additional paid-in capital				132,349			125,899
	Accumulated deficit				(129,238	)		(122,964	)

			Total stockholders' equity		3,133			2,957

			Total liabilities and stockholders' equity	$	20,395		$	19,664

*Condensed from audited financial statements

The accompanying notes are an integral part of these condensed financial statements

HYBRID NETWORKS, INC.
UNAUDITED CONDENSED STATEMENTS OF OPERATIONS
(in thousands, except per share data)

				Three Months Ended March 31,
				2001			2000
Gross sales				$	5,089		$	1,801
	Sales discounts				—			124

	Net sales				5,089			1,677
Cost of sales					6,229			1,866

Gross (loss)					(1,140	)		(189	)

Operating expenses:
	Research and development				1,884			1,393
	Sales and marketing				796			3,005
	General and administrative				1,822			3,124

		Total operating expenses			4,502			7,522

			Loss from operations		(5,642	)		(7,711	)
Interest income and other					24			209
Interest expense					(656	)		(461	)

			NET LOSS		(6,274	)		(7,963	)
Other comprehensive loss:
	Realized gain on available-for-sale securities included in net loss				—			(56	)

			Total comprehensive loss	$	(6,274	)	$	(8,019	)

Basic and diluted net loss per share				$	(0.28	)	$	(0.57	)

Shares used in basic and diluted per share calculation					22,059			13,991

The accompanying notes are an integral part of these condensed financial statements.

HYBRID NETWORKS, INC.
UNAUDITED CONDENSED STATEMENTS OF CASH FLOWS
(in thousands)

					Three Months Ended March 31,
					2001			2000
Cash flows from operating activities:
	Net loss				$	(6,274	)	$	(7,963	)
	Adjustments to reconcile net loss to net cash used in operating activities:
			Depreciation and amortization			267			300
			Amortization of discount relative to convertible debenture			375			—
			Sales discounts recognized on issuance of warrants			—			2,507
			Stock for services			30			—
			Compensation recognized on issuance of stock and stock options			221			2,044
			Interest added to principal of convertible debentures			52			183
			Provision for excess and obsolete inventory			(96	)		783
			Beneficial conversion of convertible debentures			—			74
			Change in unrealized gain on securities			—			(56	)
			Change in assets and liabilities:
				Accounts receivable		3,133			638
				Inventories		694			(2,677	)
				Prepaid expenses and other assets		(778	)		(10	)
				Accounts payable		(1,724	)		345
				Other long term liabilities		2			2
				Accrued liabilities and other		374			(351	)

			Net cash used in operating activities			(3,724	)		(4,181	)

Cash flows from investing activities:
	Purchase of property and equipment					(201	)		(29	)

			Net cash used in investing activities			(201	)		(29	)

Cash flows from financing activities:
	Proceeds from issuance of convertible debenture					7,500			—
	Repayment of capital lease obligations					(25	)		(103	)
		Net proceeds from issuance of common stock				200			457

			Net cash provided by financing activities			7,675			354

Increase (decrease) in cash and cash equivalents						3,750			(3,856	)
Cash and cash equivalents, beginning of period						1,878			13,394

Cash and cash equivalents, end of period					$	5,628		$	9,538

SUPPLEMENTAL SCHEDULE OF NONCASH FINANCING ACTIVITIES:
	Discount relative to convertible debenture				$	5,999		$	—
	Common stock issued to settle class action liability					—			1,303
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
	Interest paid					1			345
	Income taxes paid					—			—

The accompanying notes are an integral part of these condensed financial statements.

HYBRID NETWORKS, INC.
NOTES TO UNAUDITED CONDENSED FINANCIAL STATEMENTS

BASIS OF PRESENTATION

The accompanying condensed financial statements of Hybrid Networks, Inc. (the "Company" or "Hybrid") have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions for Form 10-Q and Article 10 of Regulation S-X. The balance sheet as of March 31, 2001, the statements of operations for the three months ended March 31, 2001 and March 31, 2000 and the statements of cash flows for the three month periods ended March 31, 2001 and March 31, 2000 are unaudited but include all adjustments (consisting only of normal recurring adjustments) which the Company considers necessary for a fair presentation of the financial position at such dates and the operating results and cash flows for those periods. Although the Company believes that the disclosures in the accompanying financial statements are adequate to make the information presented not misleading, certain information normally included in financial statements and related footnotes prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission. The December 31, 2000 condensed balance sheet data included herein were derived from audited financial statements but do not include all disclosures required by generally accepted accounting principles. The accompanying financial statements should be read in conjunction with the financial statements as contained in the Company's Annual Report on Form 10-K for the year ended December 31, 2000.

Results for any interim period are not necessarily indicative of results for any other interim period or for the entire year.

The Company was organized in 1990 and has had operating losses since then. The Company's accumulated deficit was $129,238,000 as of March 31, 2001 and $122,964,000 as of December 31, 2000. In 1997, we raised $42.5 million in net proceeds through our initial public offering and other debt and equity financing. In September 1999, we raised $18.1 million through the issuance and sale of convertible debentures to Sprint Corporation and certain venture capital sources. In February 2001, we issued and sold to a fund managed by the Palladin Group L.P., $7.5 million in convertible debentures. This transaction also included a common stock Purchase Warrant which would, under certain conditions, provide up to an additional $7.5 million to the Company. Other than the agreement with Palladin, as of March 31, 2001, we have no available line of credit or other source of borrowings or financing. We believe that, with respect to our current operations, our cash balance, after giving effect to the financing completed in February 2001, plus revenues from operations and non-operating cash receipts will be sufficient to meet our working capital and expenditure needs through 2001. We may seek additional financing during 2001 through debt, equity or equipment lease financing, or through a combination of financing vehicles. There is no assurance that additional financing will be available to us on acceptable terms, or at all, when we require it.

REVENUE RECOGNITION

We normally ship our products based upon a bona fide purchase order and volume purchase agreement. We recognize revenue at the time a transaction is shipped and collection of the resulting account receivable is probable. Shipments on customer orders with acceptance criteria, installation criteria or rights of return are recognized as revenue only when the criteria are satisfied. Revenue related to shipments to distributors is normally recognized upon receipt of payment for such

transactions. As of March 31, 2001 the total amount of shipments not recognized as revenue due to acceptance or testing criteria or because they were sold to a distributor was $5.5 million.

We generally sell our software together with a one-year technical support contract, for which we charge separately, to provide upgrades, maintenance, system support and service. We recognize revenue on the software sale without reference to the maintenance contract, and we recognize revenue on the technical support contract over its term on a straight-line basis. Other service revenue, primarily training and consulting, is generally recognized at the time the service is performed.

In September 1999, Sprint committed to purchase $10 million of our products subject to certain conditions. In connection with Sprint's commitment, we issued to Sprint warrants to purchase up to $8,397,873 in debentures that are convertible into 2,946,622 shares of our common stock at $2.85 per share. In accordance with the Statement of Financial Accounting Standards No. 123 (SFAS 123), "Accounting for Stock-Based Compensation," transactions in equity instruments with non-employees for goods or services are accounted for using the fair value method prescribed by SFAS 123. SFAS 123 requires that in each period in which the warrants are earned, a non-cash charge is to be recorded. Using the Black-Scholes valuation model, we determined that the estimated value of the warrant was $20.8 million. We applied $7.2 million of this amount as sales discounts during the four quarters of 2000 and the balance of $13.6 million was charged as an expense of the Sales and Marketing department over the first three quarters of 2000. There were no charges related the Sprint purchase warrants in the quarter ending March 31, 2001.

CONVERTIBLE DEBENTURES

On February 16, 2001 the Company entered into a Securities Purchase Agreement with the Halifax Fund. The Company received proceeds of $7,500,000 in exchange for (1) a $7,500,000 6% convertible debenture; (2) an adjustment warrant and (3) a purchase warrant to purchase 833,333 shares of common stock. The Company incurred loan fees of $899,642 that will be amortized over the term of the debenture.

Debenture and Adjustment Warrant—Interest is due quarterly in arrears. All principal and accrued interest is due February 16, 2003. The Debenture, including accrued interest will automatically convert to common stock at $6.3212 per share upon the date that a registration statement filed with the SEC to register the underlying shares is declared effective. The number of shares issued pursuant to the automatic conversion may be further adjusted by the Adjustment Warrant. The Company must issue additional shares based on the following formula: ($8,625,000/Adjustment Price) less the number of shares previously issued. The Adjustment Price is the average of the 15 lowest daily volume weighted average sales price of the common stock, not including the 3 lowest days, during the 65 trading day period following the effective date of the registration statement. No shares will be issued if the Adjustment Price exceeds $7.2694. The Adjustment Price will not be below $3.50.

If the registration statement is not declared effective by August 15, 2001, then the holder can request that the Company redeem the debenture at 120% of the original principal amount plus accrued interest. If the Company elects not to, or fails to, redeem, then conversion is at the option of the holder at the lower of the five day volume weighted average price prior to conversion or $6.3212.

Purchase Warrant—The purchase warrant is a five year warrant exercisable at any time by the holder at $9 per share. The Company can call the warrant at the lesser of $9 per share or 94% of the market price only after there is an effective registration statement and the adjustment period related to determining the number of shares issuable related to the Adjustment Warrant expires, and the market price exceeds $3.50.

The original principle amount of the debenture of $7,500,000 has been reduced due to the allocation of a portion of the proceeds from the securities purchase agreement to the relative fair value of the purchase warrant and the beneficial conversion feature associated with the debenture. The

discount totaled $5,998,988 and is being amortized over the term of the debenture. Amortization during the quarter ended March 31, 2001 amounted to $375,000, which was recorded as additional interest expense in the accompanying condensed financial statements. If, and when, the debenture is converted, the remaining unamortized discount will be recognized as additional interest expense.

Please see the footnotes to the audited financial statements for the year ended December 31, 2000 contained in our annual report on Form 10-K for details as to the other components of Convertible Debentures.

COMPUTATION OF BASIC AND DILUTED LOSS PER SHARE

Basic earnings per share excludes dilution and is computed by dividing income available to common stockholders by the weighted average number of shares of common stock outstanding for the period. Diluted earnings per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the entity. All such securities or other contracts were anti-dilutive for all periods presented and, therefore, excluded from the computation of earnings per share.

INVENTORIES

Inventories are comprised of the following (in thousands):

	March 31, 2001		December 31, 2000
Raw materials	$	2,446	$	2,633
Work in progress		1,182		1,144
Finished goods		3,076		3,526

	$	6,704	$	7,303

At March 31, 2001 and December 31, 2000, finished goods inventory included $2,665,000 and $2,730,000, respectively, of equipment that had been shipped to customers but for which the related revenue was deferred pending final customer acceptance.

The allowance for excess and obsolete inventory was $1,885,000 and $1,980,000 at March 31, 2001 and December 31, 2000, respectively. The provision for excess and obsolete inventory included in cost of sales was $530,000 and $235,000 for the three months ended March 31, 2001 and for the year ended December 31, 2000, respectively.

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The discussion in this Item should be read in conjunction with the Condensed Financial Statements and the Notes thereto included in Item 1 of this report on Form 10-Q. The discussion in this Item contains forward-looking statements relating to future events or financial results, such as statements indicating that "we believe," "we expect," "we anticipate" or "we intend" that certain events may occur or certain trends may continue. Other forward-looking statements include statements about the future development of products or technologies, matters relating to our proprietary rights, facilities needs, our liquidity and capital needs and other statements about future matters. All these forward-looking statements involve risks and uncertainties. You should not rely too heavily on these statements; although they reflect the good faith judgment of our management, they involve future events that might not occur. We can only base such statements on facts and factors that we currently know. Our actual results could differ materially from those in these forward-looking statements as a result of various factors, including those set forth under "Risk Factors" and elsewhere in this report on Form 10-Q.

OVERVIEW

GENERAL

We are a broadband access equipment company that designs, develops, manufactures and markets wireless systems that provide high-speed access to the Internet for businesses and consumers. Our products greatly accelerate the response time for accessing bandwidth-intensive information. Since 1996, our principal product line has been the Hybrid Series 2000, which consists of head end routers, network and subscriber management tools and a line of wireless end-user routers or modems.

We currently sell our products primarily in the United States and Canada, although we are pursuing opportunities in other countries and we think that international sales may represent an increasingly greater proportion of our sales in the future. Our customers primarily include broadband wireless system operators and national and regional telephone companies. A small number of customers have accounted for a substantial portion of our net sales, and we expect that trend to continue. As a result, we have experienced, and expect to continue to experience, significant fluctuations in our results of operations on a quarterly and an annual basis. The sales cycle for our products has been lengthy, and is subject to a number of significant risks, including customers' budgetary constraints and internal acceptance reviews. Any delay or loss of an order that is expected in a quarter can have a major effect on our sales and operating results for that quarter. The same is true of any failure of a customer to pay for products on a timely basis.

The market for high-speed network connectivity products and services is intensely competitive and is characterized by rapid technological change, new product development, product obsolescence, and evolving industry standards. Our ability to develop and offer competitive products on a timely basis could have a material effect on our business. The market for our products has historically experienced significant price erosion over the life of a product, and we have experienced, and expect to continue to experience, pressure on our unit average selling prices. While we have initiated cost reduction programs to offset pricing pressures on our products, there can be no assurance that we will keep pace with competitive price pressures or improve our gross margins. Further, we anticipate that in the future the sales mix of our products will be increasingly weighted toward lower-margin products, thereby adversely affecting our gross margins.

At March 31, 2001, we had 75 full-time employees and 10 consultants, contractors, and temporary workers.

REVENUE RECOGNITION

RESULTS OF OPERATIONS

NET SALES. Our net sales increased by 203% to $5,089,000 for the quarter ended March 31, 2001 from $1,677,000 for the quarter ended March 31, 2000. The increase was due primarily to increased shipments of customer premises equipment (CPE) to Sprint, none of which was subject to acceptance criteria.

For the three months ended March 31, 2001, broadband wireless systems operators and cable system operators accounted for 98% and 2% of net sales, respectively. During the same period in 2000, broadband wireless system operators accounted for 88.5% of net sales and cable system operators accounted for 11.5% of net sales. One customer, Sprint Corporation, accounted for 84% of net sales during the first quarter of 2001 compared to three customers who accounted for 22%, 17%, and15% of net sales during the first quarter of 2000. International sales accounted for less than 1% of net sales during the three months ended March 31, 2001 and 22% for the comparable period in 2000. International sales declined during the quarter due to the absence of sales to Look Communication during the period.

GROSS MARGIN. Gross margin was a negative 22.4% and negative 11.3% of net sales for the quarters ended March 31, 2001 and 2000, respectively. The decrease in gross margin was primarily due to the higher ratio of CPE's to head end equipment in the sales mix for the period. In the first quarter of 2001, 87% of net sales were in lower margin CPE equipment compared to 45% in the comparable period in 2000.

RESEARCH AND DEVELOPMENT. Research and development expenses include ongoing head end, software and cable modem development expenses, as well as design expenditures associated with product cost reduction programs of existing products. Research and development expenses increased 35.2% to $1,884,000 for the quarter ended March 31, 2001 from $1,393,000 for the quarter ended March 31, 2000. Research and development expenses as a percentage of net sales were 37.0% and 83.1% for the first quarters of 2001 and 2000, respectively. Personnel and related costs increased $479,000 during the quarter ending March 31, 2001 compared to the first quarter of 2000. During the three months ended March 31, 2001, compensation recognized on the vesting of stock options with exercise prices at below fair market value for employees engaged in research and development amounted to $135,000.

SALES AND MARKETING. Sales and marketing expenses consist of salaries and related payroll costs for sales and marketing personnel, commissions, advertising, promotions and travel. Sales and marketing expenses decreased 73.5% to $796,000 for the quarter ended March 31, 2001 from

$3,005,000 for the quarter ended March 31, 2000. Sales and marketing expenses as a percentage of net sales were 15.6% and 179.2% for the first quarters of 2001 and 2000, respectively. The largest component of the sales and marketing expense for the first quarter of 2001 was salary and related benefits of $365,000. The largest component of the sales and marketing expenses for the first quarter of 2000 was the non-cash discount of $2,383,000 resulting from scheduled shipments to Sprint during the quarter. This discount and the related sales discount are described under the heading "Revenue Recognition" above. During the three months ended March 31, 2001, compensation recognized on the vesting of stock options with exercise prices at below fair market value for employees engaged in sales and marketing amounted to $7,000.

GENERAL AND ADMINISTRATIVE. General and administrative expenses consist primarily of executive personnel compensation, provision for doubtful accounts, travel expenses, legal fees and costs of outside services. General and administrative expenses decreased 41.7% to $1,822,000 for the quarter ended March 31, 2001 from $3,124,000 for the quarter ended March 31, 2000. General and administrative expenses as a percentage of net sales were 35.8% and 186.3% for the first quarters of 2001 and 2000, respectively. The decline in general and administrative expenses for the first quarter of 2001 was due primarily to the lack of extraordinary charges during the period. During the comparable period in 2000, there were $1,502,000 in non-cash charges relating to executive personnel changes. During the three months ended March 31, 2001, compensation recognized on the vesting of stock options with exercise prices at below fair market value for employees engaged in administration amounted to $61,000.

INTEREST INCOME (EXPENSE) AND OTHER EXPENSE, NET. We incurred net interest expense of $632,000 for the three months ended March 31, 2001 compared to net interest expense of $252,000 for the three months ended March 31, 2000. Interest expense during the first quarter of 2001 included interest on our debentures, the amortization of loan fees related to the debentures, and the amortization of the discount relative to the $7,500,000 convertible debenture issued in February 2001 in the amount of $375,000 as described above in the notes to financial statements. We expect to incur substantial increases in interest expense over the year 2000 until the debenture is converted, at which time the unamoritzed discount will be fully recognized.

LIQUIDITY AND CAPITAL RESOURCES

We have historically financed our operations primarily through a combination of debt, equity and equipment lease financing. In 1997, we raised $42.5 million in net proceeds through our initial public offering (in November 1997) and other debt and equity financing. In September 1999, we raised $18.1 million through the issuance and sale of convertible debentures to Sprint (in the amount of $11.0 million) and certain venture capital sources (in the amount of $7.1 million). During the quarter ended June 30, 2000, at the request of the Company, the holders agreed to convert the entire principal amounting to a face value of $18.1 million plus accrued interest through June 30, 2000 of $594,000, into 6,559,310 shares of common stock. Upon the conversion, we paid a premium, as an inducement to the holder's equivalent to the interest that would have been added to the principal of the debentures for the third and fourth quarters of 2000, amounting to $375,750. The premium was paid in the form of additional shares of common stock calculated at the conversion price of $2.85 per share and was equivalent to 131,842 shares of common stock.

Additionally, Sprint acquired warrants to purchase up to $8.4 million of additional convertible debentures, which debentures were convertible at December 31, 2000 into 2,946,622 shares of common stock common stock, on the same terms as the convertible debentures referred to above. The warrants were issued in consideration for Sprint's obligation to accept shipments of at least $10 million of our products. The amount of shipments in 2000 totaled at least $10,000,000. In accordance with the Statement of Financial Accounting Standards No. 123 (SFAS 123), "Accounting for Stock-Based Compensation," transactions in equity instruments with non-employees for goods or services are

accounted for using the fair value method prescribed by SFAS 123. SFAS 123 requires that in each period in which the warrants are earned, a non-cash charge is to be recorded. Using the Black-Scholes valuation model, we determined that the estimated value of the warrant was $20.8 million. We applied $7.2 million of this amount as sales discounts during the four quarters of 2000 and the balance of $13.6 million was charged as an expense of the Sales and Marketing department over the first three quarters of 2000. There were no charges relating to the Sprint purchase warrants in the quarter ending March 31, 2001.

Assuming that as of March 31, 2001, Sprint exercised all its warrants, it would own 7,013,068 shares of our common stock, representing approximately 27.9% of the 25,150,481 shares of our common stock that would then be outstanding (assuming no other security holders exercised their options, warrants or conversion privileges). On a fully diluted basis, assuming that as of March 31, 2001 all other security holders exercised their options, warrants and conversion privileges as well as Sprint, Sprint would own approximately 19.6% of the 35,867,409 fully diluted shares of our common stock that would then be outstanding.

In addition to the above financing, we have outstanding a senior secured convertible debenture in the face amount of $5.5 million due in April 2002 and bearing interest at 12% per annum, payable quarterly. The conversion price is subject to weighted average antidilution provisions whereby, if we issue shares in the future for consideration below the existing conversion price, then (with certain exceptions) the conversion price will automatically be decreased, allowing the holder of the debenture to receive additional shares of common stock upon conversion.

Pursuant to a securities purchase agreement dated February 16, 2001 among the Company and Halifax Fund L.P., a fund managed by the Palladin Group, L.P., we issued and sold to Halifax on that date:

•: a $7.5 million principal amount 6% convertible debenture due February 16, 2003, which is convertible into shares of our common stock at a conversion price of $6.3212 per share.
•: a common stock purchase warrant to purchase 833,333 shares of common stock at $9.00 per share (subject to adjustment) which is exercisable at the election of Halifax, or at our election at a price which is the lower of $9.00 or 94% of the average daily volume weighted average sale price; and
•: an adjustment warrant. Halifax may exercise the adjustment warrant at any time following the 18^th consecutive trading day following the date of the registration statement we are required to file for resale of common shares acquired by Halifax. The aggregate number of shares issuable upon the exercise of the adjustment warrant is determined by dividing $8,625,000 by the adjustment price, as described below, and then subtracting the sum of the number of shares of common stock previously issued pursuant to the conversion of the debenture and the number issued upon any previous exercise of the adjustment warrant, subject to exceptions. The adjustment price is the average of the 15 lowest daily volume weighted average sale prices of our common stock as reported on Nasdaq, not including the three lowest days, during the 65 trading day period following the effective date of the registration statement, but not less than $3.50. If the adjustment price is greater than $7.2694, then Halifax shall not be entitled to acquire any shares under the adjustment warrant. The adjustment warrant terminates three months after the end of the 65 trading day period described above.

In consideration for these securities, Halifax paid a purchase price of $7,500,000. Under the securities purchase agreement we granted Halifax certain rights of first refusal, preemptive rights and other rights. Pursuant to the securities purchase agreement, we also entered into registration rights agreement with Halifax.

Net cash used in operating activities was $3,724,000 and $4,181,000 during the first quarters of 2001 and 2000, respectively. The net cash used in operating activities in the first quarter of 2001 was primarily due to our net loss of $6,274,000, a reduction in accounts payable of $1,724,000, and an offsetting increase in accounts receivable of $3,133,000. Net cash used in operating activities in the first quarter of 2000 was primarily the result of our net loss of $7,963,000, an increase in inventories of $2,677,000 and a decrease in other accrued liabilities of $351,000, offset by non-cash charges attributable to (i) sales discounts recognized on the issuance of warrants of $2,507,000 (see "Revenue Recognition"), (ii) compensation of $2,044,000 recognized on the issuance of stock and the vesting of stock options and (iii) an increase in the provision for excess and obsolete inventory of $783,000

Net cash used in investing activities was $201,000 and $29,000 during the first quarters of 2001 and 2000, respectively, and was used in both periods for purchases of property and equipment (primarily computers, and engineering test equipment). At March 31, 2001, we did not have any material commitments for capital expenditures.

Net cash provided by financing activities was $7,705,000 and $354,000 during the first quarters of 2001 and 2000. Net cash provided by financing activities during the first quarter of 2001 was primarily due to the $7,500,000 convertible debenture issued in February 2001. Net cash provided by financing activities during the first quarter of 2000 was primarily due to the exercise of stock options by employees and others offset by the repayment of capital lease obligations.

At March 31, 2001, the Company's liquidity consisted of cash and cash equivalents of $5,628,000 and working capital of $7,621,000. The Company's principal indebtedness consisted of $5.5 million in convertible debentures due in April 2002 and $7,553,000 in convertible debentures due in February 2003. We have no available line of credit or other source of borrowings or financing. While we believe that, with respect to our current operations, our cash balance, plus revenues from operations and non-operating cash receipts will be sufficient to meet our working capital and expenditure requirements over the balance of 2001, we may seek additional financing during 2001 through debt, equity or equipment lease financing, or through a combination of financing vehicles. There is no assurance that additional financing will be available to us on acceptable terms, or at all, when we require it.

SEASONALITY AND INFLATION

We do not believe that our business is seasonal or is impacted by inflation.

RISK FACTORS

AN INVESTMENT IN OUR COMMON STOCK INVOLVES A HIGH DEGREE OF RISK. YOU SHOULD CAREFULLY CONSIDER THE RISKS DESCRIBED BELOW AND THE OTHER INFORMATION IN THIS REPORT ON FORM 10-Q BEFORE INVESTING IN OUR COMMON STOCK. THE RISKS DESCRIBED BELOW ARE NOT THE ONLY ONES WE FACE. ADDITIONAL RISKS THAT WE ARE NOT AWARE OF OR THAT WE CURRENTLY BELIEVE ARE IMMATERIAL MAY BECOME IMPORTANT FACTORS THAT AFFECT OUR BUSINESS. IF ANY OF THE FOLLOWING RISKS OCCUR, OR IF OTHERS OCCUR, OUR BUSINESS, OPERATING RESULTS AND FINANCIAL CONDITION COULD BE SERIOUSLY HARMED AND THE PRICE OF OUR COMMON STOCK COULD DECLINE.

WE LIKELY WILL NEED ADDITIONAL CAPITAL.

Although we raised $42.5 million in net proceeds in 1997 through our initial public offering (in November 1997) and other debt and equity financing, our capital resources were virtually exhausted by September 1999. In September 1999, we raised $18.1 million through the issuance and sale of convertible debentures. In February 2001, we entered an agreement with a fund of The Palladin Group under which we have received $7.5 million of cash financing and may receive up to an additional $7.5 million. While we believe we have sufficient capital to continue operations through the year 2001, we likely will be required to raise additional cash in the future to support further growth in our business. We have agreed with Sprint Corporation to manufacture, ship, test, install and perform maintenance on certain quantities of our products this year. In addition, we have agreed to provide other services including enhancing our existing products and developing certain new products. This agreement with Sprint and other orders that we have recently received will increase our need for capital.

Our ability to raise additional capital may be limited by a number of factors, including (i) Sprint's veto rights, right of first refusal and other substantial rights and privileges, (ii) our dependence upon Sprint's business (which is not assured) and, to a lesser extent, the business of a few other customers, (iii) possible continuing uncertainties and concerns as a result of our past financial reporting difficulties, class action litigation and related issues, (iv) our need to increase our work force quickly and effectively and to reduce the cost of our existing products and develop new products, (v) uncertainty regarding our financial condition and results of operations, (vi) our history of heavy losses, and (vii) the other risk factors referred to below. We can give no assurance that we will be able to raise the additional capital we will need in the future or that any financing we may be able to obtain will not be on terms that are detrimental to our business and our ability to raise additional capital. We may not have sufficient capital or other resources necessary to meet the requirements of the Sprint agreement and other large customers in the future. Accordingly, we may need to seek strategic alliances with other companies to assist in the development of new products and services. We might not be able to form such alliances at all or on terms that are beneficial for us.

WE ARE LARGELY DEPENDENT ON SPRINT.

We expect that our future business will primarily come from wireless customers and Sprint has acquired or controls our principal wireless customers. Accordingly, until substantial business is acquired from other domestic customers or additional international customers, our future business will be substantially dependent upon orders from Sprint. Sprint is currently using our products in connection with its initial offering of wireless Internet access services. We have only a small number of other customers.

Sprint also possesses substantial corporate governance rights. By virtue of the various agreements in connection with the purchase of $11 million in convertible debentures, Sprint may designate two

directors of the Board. Under the terms of our agreements with Sprint, we cannot issue any securities (with limited exceptions) or, in most cases, take material corporate action without Sprint's approval. Sprint has other rights and privileges, including pre-emptive rights and a right of first refusal in the case of any proposed change of control transaction, which right of first refusal is assignable by Sprint to any third party. Furthermore, if Sprint exercises all its warrants (and assuming that no other warrant holders exercise), Sprint would own as of March 31, 2001, approximately 27.9% of our common stock on a beneficial ownership basis and 19.6% of our common stock on a fully diluted basis. As a result, Sprint will have a great deal of influence on us in the future. We have no assurance that Sprint will exercise this influence in our best interests, as Sprint's interests are in many respects different than ours (e.g., in deciding whether to purchase our products, in negotiating the price and other terms of any of those purchases and in deciding whether or not to support any future investment in us or any future strategic partnering or sale opportunity).

We have entered into an equipment purchase agreement with Sprint that imposes substantial requirements on us. We must meet Sprint's schedule for the manufacture and shipment of products; we must develop certain new products and enhance existing products according to Sprint's schedule and specifications; we must perform substantial installation and maintenance services; and we have agreed to the "open architecture" principle whereby we will license our technology to qualified third parties. In addition, Sprint's obligation to purchase our products is subject to extensive testing and acceptance procedures. If we fail to meet the requirements of the agreement, we could be subject to heavy penalties, including the obligation to license our intellectual property rights to Sprint on a royalty-free basis and Sprint may gain access to key source code of our products.

CHANGES IN PLANS OR CIRCUMSTANCES OF OUR LARGEST CUSTOMERS COULD ADVERSELY AFFECT OUR SALES.

In late 2000, Sprint completed a reorganization of its operations that included the business to which we sell our products. At that time, Sprint announced that, in the residential and small business areas, it was focusing its broadband efforts on the thirteen markets where it had already deployed systems and that, once it reached a comfort level that products and services were in line with customer expectations and requirements, it would begin a nationwide deployment. In light of these plans, we expect to sell a relatively smaller amount of our higher margin head end equipment to Sprint until it commences its nationwide deployment, and our sales and gross margins could be adversely affected.

In late 2000, Look Communications, our second largest customer for that year, encountered difficulties in securing additional financing to support the continued growth of its operations. We believe that Look Communications is exploring alternatives to obtain additional financing but cannot be assured that it will succeed. We did not make any sales to Look Communications during the quarter ending March 31, 2001 and we expect to make limited sales to them during the balance of 2001.

WE HAVE NOT BEEN PROFITABLE TO DATE, AND WE MAY NEVER BE PROFITABLE. WE EXPECT CONTINUING LOSSES FOR THE FORESEEABLE FUTURE.

We have not been profitable to date, and we cannot assure that we will ever achieve or sustain profitability. We were organized in 1990 and have had operating losses every year to date. Our accumulated deficit was $129,238,000 as of March 31, 2001 and $122,964,000 as of December 31, 2000. The revenue and profit potential of our business is unproven. The market for our products has only recently begun to develop, is rapidly changing, has an increasing number of competing technologies and competitors, and many of the competitors are significantly larger than we are. We have experienced price pressure on sales of our products in the past and these pressures continue. We expect to incur losses for the foreseeable future.

WE MUST BE ABLE TO QUICKLY AND EFFECTIVELY DEVELOP NEW PRODUCTS, DEVELOP ENHANCEMENTS FOR OUR EXISTING PRODUCTS, AND DEPLOY OUR PRODUCTS ON A MUCH LARGER SCALE THAN WE HAVE IN THE PAST, AND WE MIGHT NOT BE ABLE TO MEET THESE CHALLENGES.

In order to meet the existing and future demands of the broadband wireless markets, we must develop new products and enhance our existing products. In addition, Sprint and other potential large scale customers will require us to demonstrate that our system can be successfully deployed on a much larger scale than it has been in the past. We might not be able to meet these challenges.

Sprint and other potential customers are also requesting the ability to deploy equipment that can serve subscribers who do not have a direct line-of-sight to the base station's transmit and receive tower. In some regions only 30% of the potential subscribers can be reached with line-of-sight equipment. The non line-of-sight deployments require the wireless system to operate with significantly reduced signal levels and increased signal distortions. The effect and magnitude of these factors varies widely and depends on many environmental factors. Hybrid is developing new products to operate in some non line-of-sight locations. There is no assurance that these new products will successfully solve all the non line-of-sight problems or that the wireless operators will accept these new products. If another company is successful in deploying a cost effective non line-of-sight system before we do, our business will be adversely affected.

WE ARE LARGELY DEPENDENT ON THE BROADBAND WIRELESS MARKET, AN EMERGING MARKET SUBJECT TO UNCERTAINTIES.

Prior to 2000, over half of our sales had been to cable customers. We have been, as expected, essentially shut out of the market of new installations for cable customers by the general adoption of the Data Over Cable Systems Interface Specification (DOCSIS) standard. This is a standard to which our products do not conform. The wireless industry has not adopted DOCSIS. Accordingly, the DOCSIS standard has inhibited our sales to cable customers, but it has not, to date, affected our ability to market to wireless system operators.

The market for broadband Internet access products has only recently begun to develop. In the past, the broadband wireless industry has been adversely affected by chronic under-capitalization. Recent investments by Sprint and Worldcom in wireless operators had a significant effect upon the industry. One effect has been to attract major competitors. Cisco is testing high-speed Internet access products for wireless applications using a new technology that Cisco claims will replace existing technologies, including ours. It is a variant of Orthogonal Frequency Division Multiplex (OFDM). We face other major competition in the wireless market as well.

The wireless industry also competes with other technologies such as cable and DSL, to provide high-speed Internet access. Cable companies providing Internet access and telephone companies providing Internet access through DSL service are expanding into areas that were previously considered commercially reachable only by wireless service. The principal disadvantage of wireless is that it currently requires a direct line-of-sight between the wireless operator's antenna and the customer's location. Physical interruptions such as buildings, trees or uneven terrain can interfere with reception, thus limiting broadband wireless system operators' customer bases. In addition, wireless customers face a number of licensing and regulatory restrictions.

Conditions in the wireless market could change rapidly and significantly as a result of technological changes, and the development and market acceptance of alternative technologies could decrease the demand for our products or render them obsolete. There can be no assurance that the wireless industry market will grow or that our products will be accepted in the emerging market.

EVOLVING INDUSTRY STANDARDS, COMPETING TECHNOLOGIES, AND TECHNOLOGICAL CHANGES MAY HURT OUR BUSINESS.

Our products are not in compliance with the DOCSIS standard that has been adopted by cable operators or with the Digital Audio Visual Council (DAVIC) standard that is supported in Europe. The emergence of these standards has impacted our cable business, and an adoption of wireless industry standards in the future could also have a similar adverse effect.

The market for high-speed Internet access products is characterized by rapidly changing technologies and short product life cycles. The rapid development of new competing technologies increases the risk that our products could be rendered non-competitive. Future advances in technology may not be beneficial to, or compatible with, our business and products, and we might not be able to respond to the changes in technology, or our response might not be timely or cost-effective. Market acceptance of new technologies and our failure to develop and introduce new products and enhancements to keep pace with technological developments could impact our business.

Some firms that are developing broadband wireless systems and products are much larger than we are. These firms and other smaller firms are not all using the same technological base and approach. In order to promote their products, these competing firms are seeking to develop consortia and other alliances to promote their technology as the industry standard. If technologies other than the approach we are pursuing are adopted as the standard, our products could lose acceptance in the marketplace and our growth would be seriously impaired.

WE FACE SIGNIFICANT COMPETITION, INCLUDING COMPETITION FROM LARGE COMPANIES.

Our market is intensely competitive, and we expect even more competition in the future. Most of our competitors are substantially larger and have greater financial, technical, marketing, distribution, customer support, and other resources, as well as greater name recognition and access to customers, than we have. One of our principal competitors, Cisco, has recently announced that it has a competitive wireless technology that will provide superior cost/benefit performance and will operate successfully in environments in which it is difficult to obtain a clear line-of-sight as well as environments with multi-path interference (around buildings, flat roofs and water, for example). Although we believe Cisco has not yet installed a commercially operating system using this technology, we cannot assure you that it will not do so or that Cisco's system will not provide benefits superior to ours. We believe that other companies also have products under development to mitigate line-of-sight limitations.

We are primarily engaged in the market for fixed broadband wireless (FBBW) high-speed Internet access equipment. In addition, our customers compete with other forms of high-speed Internet access including DSL and cable. While we believe our products and services are competitive with or superior to those of our competitors, our product development may be adversely affected by the lack of engineering resources. Conditions in our market could change rapidly and significantly as a result of technological changes, and the development and market acceptance of alternative technologies could decrease the demand for our products or render them obsolete. Similarly, the continued emergence or evolution of industry standards or specifications may put us at a disadvantage in relation to our competitors. There can be no assurance that we will be able to compete successfully in the future.

We have agreed with Sprint that in the future we will allow third parties to license our technology and offer products in competition with ours, using our technology. This could generate significant new competitive challenges for us. It might also not meet our objective of creating a defacto standard for working systems.

Our business depends upon the technical success and working relationships of our allies producing other parts of the system. As an example, one transceiver must be installed for each Hybrid Wireless Broadband Router. California Amplifier has the major share of the transceiver market in Sprint and

many other accounts and our customer sales would be limited if California Amplifier fails to meet their needs. Three vendors produce transmitters and the vendor is often chosen because their product already matches the transmitters in place when the spectrum is acquired. Two transmitter producers, Thomcast and EMCEE, resell Hybrid products. Many of the Sprint deployments use transmitters produced by ADC, a competitor to Hybrid. The head end down-converters and antennas are produced by this same group of companies. Andrew Corporation supplies transmitter antennas. The effective alliances in place that support free sales of our products may not continue to provide this support.

To be successful, we must respond promptly and effectively to the challenges of new competitive products and tactics, alternate technologies, technological changes and evolving industry standards. We must continue to develop products with improved performance over two-way wireless transmission facilities. There can be no assurance that we will meet these challenges.

WE FACE LITIGATION RISKS.

We may be exposed to litigation in the future. Litigation may be necessary in the future to enforce our intellectual property rights, to determine the validity and scope of our patents, and to determine the validity and scope of the proprietary rights of others. Such litigation might result in substantial costs as well as a diversion of managerial resources and attention. Furthermore, our business activities may infringe upon the proprietary rights of others, and they may claim that our products infringe upon their proprietary rights. Any such claims, with or without merit, could result in significant litigation costs and diversion of management attention, as well as harm to our business, including having to enter into royalty and license agreements that may have terms that are disadvantageous to us. If litigation is successful against us, it could result in the invalidation of our proprietary rights and our incurring liability for damages, which could have a harmful effect on our business. We initiated one patent infringement litigation to enforce our patent rights, and it resulted in a settlement in which we granted licenses to the defendants containing terms that are in some respects favorable to them, including a right of first refusal to purchase our patents that we granted to one defendant (Com21, Inc.) in the event that we propose in the future to sell our patents (whether separately or together with our other assets) to any third party. Nonetheless, we may find it necessary to institute further infringement litigation in the future and third parties may institute litigation against us challenging the validity of our patents. We may also face litigation over other aspects of our business, including employment or other commercial matters that, if concluded in a manner adverse to us, could adversely affect our operating results and financial condition.

MARKET PRESSURE TO REDUCE PRICES HAS HURT OUR BUSINESS AND THE PRESSURE IS LIKELY TO INCREASE.

Historically, the market has demanded increasingly lower prices for our products and we expect downward pressure on the prices of our products to continue and increase. Our products are relatively expensive for the consumer electronics and the small office or home office markets. For example, customers who purchase one of our modems must usually also purchase an Ethernet adaptor. Market acceptance of our products, and our future success, will depend, in significant part, on reductions in the unit cost of our client modems. Sprint and other large-scale customers have increased the downward pressure on our prices. Our ability to reduce our prices has been limited by a number of factors, including our reliance on a single manufacturer of our modems and on single-sources for certain components of our products. One of the principal objectives of our research and development efforts has been to reduce the cost of our products through design and engineering changes. We have no assurance that we will be able to redesign our products to achieve substantial cost reductions or that we will otherwise be able to reduce our manufacturing and other costs, or that any reductions in cost will be sufficient to improve our gross margins, which have historically been negative and which must substantially improve in order for us to operate profitably.

WE RELY ON A SINGLE MANUFACTURER FOR OUR END-USER PRODUCTS AND ON SINGLE-SOURCE COMPONENTS, AND SOME OF THE COMPONENTS ARE BECOMING OBSOLETE.

We configure, test, and perform quality assurance procedures on the final product at the Hybrid facility. We outsource manufacturing of the product modules to third parties, while maintaining a limited in-house manufacturing capability for pre-production assembly and testing.

Our Series 2000 client routers are manufactured by Sharp Corporation through an agreement we have had since early 1997 with Sharp and its distributor, Itochu Corporation. We have not developed an alternative manufacturing source given the quality of the Sharp product and our limited volumes. We continue cost reduction efforts in response to market pressures to reduce our prices. Given that Sharp remains our only manufacturing source of our routers and production rates remain level, our ability to reduce the manufacturing costs may be limited.

Our CyberManager 2000 is built on the Ultra 10/Solaris platform by installing our proprietary network subscriber and network management software. Our CyberMaster Downstream Router and CyberMaster Upstream Router are built on Intel's Pentium-based PCI/ISA-based computer cards installed in a standard rack-mounted chassis from Industrial Computer Source. Our proprietary software, Hybrid OS, is overlaid on a standard Berkeley Systems operating system for the CMD and CMU.

We are dependent upon these and other key suppliers for a number of components within our Series 2000 products. The WBR series routers use a Texas Instrument chip set for the 64-QAM demodulator. Hitachi is the sole supplier of the processors used in our routers. Intel is currently the sole supplier for certain components used in our products. There can be no assurance that these and other single-source components will continue to be available to us, or that deliveries to us will not be interrupted or delayed (due to shortages or other factors). Having single-source components also makes it more difficult for us to reduce our costs for these components and makes us vulnerable to price increases by the component manufacturer. Any significant interruption or delay in the supply of components for our products or any increase in our costs for components, or our inability to reduce component costs, could adversely affect our business.

OUR LONG SALES CYCLE MAKES IT DIFFICULT FOR US TO FORECAST REVENUES, REQUIRES US TO INCUR HIGH SALES COSTS AND AGGRAVATES FLUCTUATIONS IN QUARTERLY OPERATING RESULTS. OUR SALES CYCLE MAY GET LONGER.

The sale of our products typically involves a great deal of time and expense. Customers usually want to engage in significant technical evaluation before making a purchase commitment. There are often delays associated with our customers' internal procedures to approve the large capital expenditures that are typically involved in purchasing our products. This makes it difficult for us to predict revenue. In addition, since we incur sales costs before we make a sale or recognize related revenues, the length and uncertainty of our sales cycle increases the volatility of our operating results because we may have high costs without offsetting revenues.

Over the last year, the marketplace has consolidated so that our principal customers and potential customers are large service providers including telecommunications companies. This consolidation has greatly increased our selling expenses and lengthened our sales cycle.

INTERNATIONAL SALES COULD INVOLVE GREATER RISKS.

Although we have primarily sold our products in the United States and Canada, we are pursuing opportunities in other countries. Although international sales were less than 1% of our gross sales in the first quarter of 2001, we believe that they may represent an increasingly greater proportion of our

annual sales in the future. In 2000, international sales accounted for 24% of our gross sales, compared to 5% in 1999. To the extent that we sell our products internationally, such sales will be subject to a number of risks, including longer payment cycles, export and import restrictions, foreign regulatory requirements, greater difficulty in accounts receivable collection, potentially adverse tax consequences, currency fluctuations, political and economic instability and reduced intellectual property protection. To increase our international coverage we rely on value added resellers (VARs) or integrators. These VARs may not remain exclusive Hybrid distributors and will attempt rather to meet the needs of their customers. They also compete with each other in some areas so it may be difficult for Hybrid to protect its international distribution channels. In addition, the frequency spectrum and amount of spectrum available internationally varies from country to country. We will be dependent on our VARs to develop compliant transceivers and transmitters, which may slow deployment in some international markets.

WE DEPEND ON KEY PERSONNEL AND HIRING AND RETAINING QUALIFIED EMPLOYEES IS DIFFICULT.

Our success depends in significant part upon the continued services of our key technical, sales and management personnel. Any officer or employee can terminate his or her relationship with us at any time. Our future success will also depend on our ability to attract, train, retain and motivate highly qualified technical, marketing, sales and management personnel. We are in an extremely tight labor market, and competition for such personnel is intense. There can be no assurance that we will be able to attract and retain key personnel. The loss of the services of one or more of our key personnel or our failure to attract additional qualified personnel could prevent us from meeting our product development goals and could have an extremely adverse effect on our business.

WE MAY BE UNABLE TO PROTECT OUR INTELLECTUAL PROPERTY.

We rely on a combination of patent, trade secret, copyright and trademark laws in addition to contractual restrictions to establish and protect our intellectual property rights. We cannot assure that our patents will cover all the aspects of our technology that require patent protection or that our patents will not be challenged or invalidated, or that the claims allowed in our patents will be of sufficient scope or strength to provide meaningful protection or commercial advantage to us. We have initiated one patent infringement lawsuit to enforce our patent rights, and it resulted in a settlement in which we granted licenses to the defendants containing certain terms that are in some respects favorable for them, including a right of first refusal to purchase our patents that we granted to one defendant (Com21, Inc.) in the event that in the future we propose to sell our patents (separately or together with our other assets) to any third party. We do not know whether we will bring litigation in the future in an effort to assert our patent rights, or whether other companies will bring litigation challenging our patents. Any such litigation could be time consuming and costly and could result in our patents being held invalid or unenforceable. Furthermore, even if the patents are upheld or are not challenged, third parties might be able to develop other technologies or products without infringing any such patents.

We have entered into confidentiality and invention assignment agreements with our employees, and we enter into non-disclosure agreements with certain of our suppliers, distributors, and customers, in order to limit access to and disclosure of our proprietary information. There can be no assurance that these contractual arrangements or the other steps we take to protect our intellectual property will prove sufficient to prevent misappropriation of our technology or deter independent third-party development of similar technologies. The laws of certain foreign countries may not protect our products or intellectual property rights to the same extent, as do the laws of the United States.

We have in the past received, and may in the future receive, notices from certain persons claiming that our products, software or asserted proprietary rights infringe the proprietary rights of such persons.

We expect that developers of wireless and cable modems will be increasingly subject to infringement claims as the number of products and competitors in our market grows. While we are not currently subject to any such claim, any future claim, with or without merit, could be time consuming, result in costly litigation, cause product shipment delays or require us to enter into royalty or licensing agreements. Such royalty or licensing agreements might not be available on terms acceptable to us if at all.

In the future, we may also file lawsuits to enforce our intellectual property rights, to protect our trade secrets or to determine the validity and scope of the proprietary rights of others. Such litigation, whether successful or not, could result in substantial costs and diversion of management resources. As indicated above, we were engaged during 1998 in an infringement lawsuit that we brought against two alleged infringers. In 1999, in order to stop the diversion of resources caused by the litigation, we entered into a settlement pursuant to which the defendants obtained licenses to our products on terms that in certain respects were favorable to the defendants. Nonetheless, we may find it necessary to institute further infringement litigation in the future.

DEFECTS IN OUR PRODUCTS COULD CAUSE PRODUCT RETURNS AND PRODUCT LIABILITY.

Products as complex as ours frequently contain undetected errors, defects or failures, especially when first introduced or when new versions are released. In the past, such errors have occurred in our products and there can be no assurance that errors will not be found in our current and future products. The occurrence of such errors, defects or failures could result in product returns and other losses. They could also result in the loss of or delay in market acceptance of our products.

GOVERNMENT REGULATION MAY ADVERSELY AFFECT OUR BUSINESS.

We are subject to varying degrees of governmental, federal, state and local regulation. For instance, the jurisdiction of the FCC extends to high-speed Internet access products such as ours. The FCC has promulgated regulations that, among other things, prescribe the installation and equipment standards for communications systems. Furthermore, regulation of our customers may adversely affect our business.

VOLATILITY OF OUR STOCK PRICE.

The factors referred to in this "Risk Factors" section tend to cause our operating results to vary substantially from quarter to quarter. These fluctuations have adversely affected the prices of our common stock in the past and may adversely affect such prices in the future.

Our common stock was delisted from The Nasdaq Stock Market and did not trade on Nasdaq between mid-June 1998 and July 6, 2000. The market price of our common stock has fluctuated in the past and is likely to fluctuate in the future.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

Not applicable.

PART II. OTHER INFORMATION

II.: OTHER INFORMATION

Item 2. Changes in Securities and Use of Proceeds

Please see the description of our sale of convertible subordinated debentures and warrants to Halifax Fund L.P. in February 2001 provided above in Item 1. Financial Statements, under Notes to Unaudited Condensed Financial Statements—Convertible Debentures, and in Item 2., Management's Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources, which descriptions are incorporated herein by this reference. This sale was made to a single accredited investor in a private transaction pursuant to the exemption from registration provided by Section 4(2) of the Securities Act of 1933 and Rule 506 of Regulation D.

Item 6. Exhibits and Reports on Form 8-K

(a): Exhibits

The following exhibits are filed as part of this report:

Exhibit No.		Description of Exhibit
4.01		Securities Purchase Agreement between Halifax Fund and the Registrant dated as of February 16, 2001 (1)
4.02		Form of 6% Convertible Debenture due 2003 (1)
4.03		Form of Common Stock Purchase Warrant dated as of February 16, 2001 (1)
4.04		Form of Adjustment Warrant dated as of February 16, 2001 (1)
4.05		Registration Rights Agreement dated as of February 16, 2001 (1)

(1): Incorporated by reference to the Exhibit with the same number in the Company's current report on Form 8-K filed February 22, 2001.
(b): Reports on Form 8-K

The following Current Reports on Form8-K and 8-R/K have been filed by the Company during the quarter for which this report is filed:

1.: On February 22, 2001, the Company reported under Item 5 "Other Events" that it had entered into an agreement with a fund of the Palladin Group LP that would provide the Company with up to $15 million in cash to fund future operations.

HYBRID NETWORKS, INC.
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.

Date: April 27, 2001		HYBRID NETWORKS, INC.
		/s/ MICHAEL D. GREENBAUM Michael D. Greenbaum Chief Executive Officer
		/s/ JUDSON W. GOLDSMITH Judson W. Goldsmith Chief Financial Officer (Principal Accounting Officer)

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HYBRID NETWORKS, INC. INDEX
PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

HYBRID NETWORKS, INC. UNAUDITED CONDENSED BALANCE SHEETS (in thousands, except per share data)
HYBRID NETWORKS, INC. UNAUDITED CONDENSED STATEMENTS OF OPERATIONS (in thousands, except per share data)
HYBRID NETWORKS, INC. UNAUDITED CONDENSED STATEMENTS OF CASH FLOWS (in thousands)

HYBRID NETWORKS, INC. NOTES TO UNAUDITED CONDENSED FINANCIAL STATEMENTS

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

PART II. OTHER INFORMATION

Item 2. Changes in Securities and Use of Proceeds

Item 6. Exhibits and Reports on Form 8-K

HYBRID NETWORKS, INC. SIGNATURES