-----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, BAMRvthXcVTK7dHDt0t25cRB3oWnL4Y3ngcx4IzxqeRxwdkkMiZo6ZqWPcOqIAe4 Yp1qaN2GFj4BPRe5dKAaGg== 0001047469-99-023980.txt : 19990615 0001047469-99-023980.hdr.sgml : 19990615 ACCESSION NUMBER: 0001047469-99-023980 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 8 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990614 FILER: COMPANY DATA: COMPANY CONFORMED NAME: HYBRID NETWORKS INC CENTRAL INDEX KEY: 0000900091 STANDARD INDUSTRIAL CLASSIFICATION: [] IRS NUMBER: 770250931 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-23289 FILM NUMBER: 99645374 BUSINESS ADDRESS: STREET 1: 6409 GUADALUPE MINES ROAD CITY: SAN JOSE STATE: CA ZIP: 95120 BUSINESS PHONE: 4083236500 MAIL ADDRESS: STREET 1: 6409 GUADALUPE MINES ROAD CITY: SAN JOSE STATE: CA ZIP: 95120 10-K 1 10-K UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Year Ended December 31, 1998, or [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _____ to_________. COMMISSION FILE NUMBER: 0-23289 HYBRID NETWORKS, INC. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) DELAWARE 77-0252931 (STATE OF OTHER JURISDICTION OF (I.R.S. EMPLOYER IDENTIFICATION NO.) INCORPORATION OR ORGANIZATION) 6409 Guadalupe Mines Road San Jose, California, 95120 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE) REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (408) 323-6500 Securities registered pursuant to Section 12(b) of the Exchange Act: None Securities registered pursuant to Section 12(g) of the Exchange Act: Common Stock, par value $0.001 per share Indicate by check mark whether the Registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months(or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes /X/ No / / (Such reports are filed concurrently herewith.) Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-B is not contained herein, and will not be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K / / As of May 28, 1999, there were outstanding 10,517,399 shares of the Registrant's Common Stock, $0.001 par value per share. As of that date, the aggregate market value of the shares of voting common stock held by non-affiliates of the Registrant, based on the average bid and ask prices of such stock as of such date on the pink sheets (although the Registrant disclaims that such prices accurately reflect the fair market value of such stock), was approximately $15,770,432. This excludes shares of common stock held by directors, officers and stockholders whose ownership exceeded ten percent of the shares outstanding. Exclusion of shares held by any person should not be construed to indicate that such person possesses power, direct or indirect, to direct or cause the direction of the management or policies of the Registrant, or that such person is controlled by or is under common control with the Registrant. 1 HYBRID NETWORKS, INC. Annual Report on Form 10-K For the fiscal year ended December 31, 1998 TABLE OF CONTENTS
PAGE ---- PART I ITEM 1 Business 4 ITEM 2 Properties 12 ITEM 3 Legal Proceedings 12 ITEM 4 Submission of Matters to a Vote of Security Holders 14 PART II ITEM 5 Market for the Registrants Common Equity and Related Stockholder Matters 15 ITEM 6 Selected Financial Data 17 ITEM 7 Management's Discussion and Analysis of Financial Condition and Results of Operations 18 ITEM 7A Quantitative and Qualitative Disclosures About Market Risk 35 ITEM 8 Financial Statements and Supplementary Data 36 ITEM 9 Changes in and Disagreements With Accountants on Accounting and Financial Disclosure 62 PART III ITEM 10 Directors and Executive Officers of the Company 63 ITEM 11 Executive Compensation 66 ITEM 12. Security Ownership of Certain Beneficial Owners and Management 69 ITEM 13 Certain Relationships and Related Transactions 70 ITEM 14 Exhibits, Financial Statements Schedules and Reports on Form 8-K 71 Signatures 74 Exhibits
As used in this report on Form 10-K, unless the context otherwise requires, the terms "we," "us," or, "the Company" and "Hybrid" refer to Hybrid Networks, Inc., a Delaware corporation. 2 PART I THIS REPORT ON FORM 10-K CONTAINS FORWARD-LOOKING STATEMENTS RELATING TO FUTURE EVENTS OR FINANCIAL RESULTS, SUCH 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, YEAR 2000 COMPLIANCE, 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 FORM 10-K. RESTATEMENT OF OUR FINANCIAL STATEMENTS On May 18, 1998 and June 1, 1998, we were engaged with our independent accountants, Coopers & Lybrand LLP (which later became PricewaterhouseCoopers LLP and is referred to herein as "PwC"), in a review of our financial statements for 1997 and the first quarter of 1998. On June 18, 1998, we announced that PwC had notified us that its audit reports on our 1997 financial statements should no longer be relied upon and that we were continuing our review of financial statements. On July 9, 1998, PwC resigned as our independent accountants, stating that it believed our 1997 financial statements should be restated but that, although there had been no disagreements between PwC and us on any matter of our accounting principles or practices, financial statement disclosure or auditing procedure, PwC would not continue as our independent accountants to address the restatement. In August 1998, we retained Arthur Andersen LLP ("AA") as our independent accountants. After extensive work in connection with our 1997 financial statements, AA resigned as our independent accountants on November 24, 1998. AA informed us that, in AA's view, material weaknesses existed in our internal controls of a nature that prevented AA from being able to form an opinion on our conclusions as to the appropriate timing and amount of revenue recognition for the purposes of our 1997 financial statements. AA also stated that during the course of its work, it had reached the conclusion that it needed to expand significantly the scope of its audit, which it did with our approval and cooperation, and that, while AA did not complete its audit, it concluded that our 1997 financial statements were materially misstated. AA confirmed that there had been no disagreements between AA and us on any matter of our accounting principles and practices, financial statement disclosure or auditing procedure. In December 1998, we engaged Hein + Associates LLP ("Hein") as our independent accountants. During the review of our financial statements in conjunction with Hein (and, earlier, with PwC and AA), we became aware of errors and irregularities that caused our financial statements for 1997 and the first quarter of 1998 to be misstated, particularly with respect to the timing and amount of our sales in 1997 and the first quarter of 1998. We also concluded that the financial effects of warrants issued by us in 1997 had not been properly reflected in our financial statements. Our financial statements for 1997 and the first quarter of 1998 have been restated to correct these errors. As indicated in Note 1 to the financial statements in Item 8 of this report, as a result of the restatement net sales for 1997 were reduced from $14,270,000 to $4,120,000 (resulting in gross loss of $4,799,000 rather than gross profit of $2,012,000), net loss increased from $13,590,000 to $21,602,000 and accumulated deficit increased from $30,932,000 to $38,944,000. Our basic and diluted loss per share increased from $3.84 to $6.10. For additional information regarding the restatement, see Note 1 to the financial statements in Item 8 of this report. In June 1999, Hein completed its audit of our 1997 and 1998 financial statements. Those financial statements, and Hein's audit report on them are included in this report (The financial statements included in Item 8 of this report are referred to as the "Financial Statements"). 3 Our inability to issue audited financial statements during the last 12 months has had serious consequences for our business. As a result, the Nasdaq National Market suspended trading in our Common Stock from June 18, 1998 to December 1, 1998, at which time our Common Stock was delisted from the Nasdaq National Market. Primarily due to our announcements regarding the need to restate our financial statements, a number of class action litigations were brought in June, July and August 1998, and the Securities and Exchange Commission initiated a formal investigation in October 1998. We believe these actions hurt our business during the latter part of 1998, made it more difficult for us to attract and retain employees, disrupted our management, sales and marketing, engineering and research and development staffs, contributed to our inability to complete the restatement of our financial statements during 1998 and adversely affected the sales of our products and services. ITEM 1. BUSINESS OVERVIEW We are a broadband access equipment company that designs, develops, manufactures and markets wireless and cable systems that provide high-speed broadband access to the Internet and corporate intranets for both businesses and consumers. Our products remove the bottleneck over the local connection to the end-user which causes slow response time for those accessing bandwidth-intensive information. Customers include broadband wireless system operators, cable system operators, internet service providers ("ISPs"), resellers and other companies that provide broadband networking solutions or services to business and residential users. Our Series 2000 product line consists of headend routers, wireless or cable modems and management software for use with either cable TV or wireless transmission facilities. Because a majority of wireless and cable transmission facilities are not capable of two-way transmissions, the Series 2000 has been designed to utilize a variety of return paths, including the public switched telephone network. The Series 2000 is capable of supporting a combination of speeds, media and protocols in a single wireless or cable system, providing system operators with flexible, scalable and upgradeable solutions that allow them to offer cost-effective broadband access to their subscribers. PRODUCTS, TECHNOLOGY AND SERVICES Our Series 2000 product line provides broadband wireless system operators, cable system operators, ISPs and other businesses with a cost-effective, high speed Internet and intranet access solution. Our products include headend routers, wireless and cable modems and management software for use with either wireless transmission facilities or cable TV transmission facilities. Our headend products are used by broadband wireless system operators, cable system operators and other customers to transmit and receive data across networks and to manage networks and modems. Our client modems are used by subscribers of our customers and can be used as single-user devices or in multi-user local area networks. Our products incorporate proprietary technology that enables the same system to be deployed in either broadband wireless or cable systems. Additionally, our products support both one-way downstream transmission accompanied by upstream transmission via a telephone modem or return router or two-way wireless or cable transmission using a wireless channel or cable channel. 4 PRODUCTS The following table outlines the primary components of the Company's Series 2000:
- -------------------------------------------------------------------------------------------------------------------------- HEADEND EQUIPMENT (1)(2) PRODUCT DESCRIPTION - -------------------------------------------------------------------------------------------------------------------------- CyberManager 2000 (CMG-2000) Workstation with proprietary Hybrid software that provides subscriber and network management - -------------------------------------------------------------------------------------------------------------------------- CyberMaster Downstream Router (CMD-2000) High speed downstream RF router that supports up to 60 Mbps aggregate throughput in 12 MHz of spectrum. - -------------------------------------------------------------------------------------------------------------------------- CyberMaster Upstream Router QPSK Return Upstream receiver and demodulator for two-way (CMU 2000-14C and QDC-030-2) QPSK configuration - -------------------------------------------------------------------------------------------------------------------------- END-USER EQUIPMENT (1)(3) - -------------------------------------------------------------------------------------------------------------------------- Multi-User Modem/Router (CCM-201, CCM-202) Client modem and router that can be used in either CCM-231) wireless or cable systems. Supports up to 20 users. - -------------------------------------------------------------------------------------------------------------------------- Single-User Modem (N-201, N202) Similar to CCM-201, CCM-202 and CCM-231 but N-231) restricted to a single user. - --------------------------------------------------------------------------------------------------------------------------
(1) All products are available for use with wireless or cable systems. (2) Headend equipment typically ranges in price from $40,000 to $90,000 for a single system. (3) Modem list prices range from approximately $320 to $480 depending on features. HEADEND EQUIPMENT CYBERMANAGER 2000. The CyberManager 2000 ("CMG-2000") is our proprietary subscriber and network management workstation built on a Sun Microsystems Sparc 5. Running Hybrid software, the CMG-2000 operates as the system administrator interface to the upstream and downstream routers and other supported third party headend equipment. The CMG-2000 has a 10/100BaseT (Ethernet) interface to connect to a fast Ethernet switch in the headend. Currently, the CMG-2000 supports up to 5,000 modems. CYBERMASTER DOWNSTREAM ROUTER. The CyberMaster Downstream Router ("CMD-2000") is our rack-mounted, Pentium based, PCI/ISA bus industrial microcomputer. It supports Hybrid's proprietary SIF and QAM cards, which are used for downstream routing and for 64-quadrature amplitude modulation ("64-QAM") downstream modulation. The CMD-2000 has a 10/100BaseT interface to connect to a fast Ethernet switch within the headend. The CMD-2000 supports up to six independent 10 Mbps downstream channels normally feeding two TV channels or transmitters. Each 10 Mbps channel occupies 2 MHz of either wireless or cable spectrum. CYBERMASTER UPSTREAM ROUTER QPSK RETURN. The Cybermaster upstream router is our rack mounted, Pentium based, PCI/ISA bus industrial microcomputer. The product houses dual quadrature phase-shift keying ("QPSK") receiver cards which demodulate upstream QPSK signals. The CMU-2000-14C has a 10/100BaseT interface to connect to a fast Ethernet switch at the headend. The CMU supports up to 28 upstream ports each with a 256 Kbits per second (Kbps) to 5 Mbits per second (Mbps) data rate. It is usually configured to support up to 2,400 wireless or cable modem subscribers. 5 END-USER EQUIPMENT MULTI-USER MODEM/ROUTER. The Multi-User Modem/Router supports 10 Mbps, 64-QAM downstream data transmission on both wireless and cable systems and upstream transmission via phone modem, router or wireless or cable return. The router includes the CCM-201, a phone return with external modem, the CCM-202 phone return with internal modem, and the CCM-231, for phone, wireless or cable. Each CCM-201 includes routing capability to support up to 20 networked devices (PC, Macintosh or workstation). The CCM-201 has a number of security features including system authentication and user ID. SINGLE-USER MODEM. The Single-User Modems are similar to the Multi-User Modem/Routers (CCM-201, CCM-202 and CCM231, respectively) but support only one client device which can be a PC, Macintosh or workstation. All modems are available in a version which supports DES encryption. TECHNOLOGY The Series 2000 product line is a proprietary, integrated broadband access system. The Series 2000 is media independent, allowing the same system components to be deployed in either wireless or cable systems. It utilizes proprietary asymmetric networking technology that allows for optimal use of available frequencies. The Series 2000 supports both asymmetric two-way transmission on a wireless or cable system and asymmetric telephone- or router-return on either a broadband wireless or cable system using the same wireless transmitter or downstream TV channel. Our proprietary sub-channelization technology splits a standard 6 MHz channel into three 2 MHz slices for downstream transmission, providing greater flexibility and minimizing the effects of multipath interference in wireless systems. By providing 2 MHz sub-channelization, our products are also positioned to serve the new WCS frequencies, which are 5 MHz wide. The Series 2000 provides for downstream transmission over wired cable in the interference prone "rolloff" channels that are unsuitable for video broadcast, preserving scarce channels for the cable system operator. The Series 2000 is expandable from an entry-level system to large systems that serve more than 5,000 modems. SERVICES Our product support services include consulting, systems engineering, systems integration, installation, training and technical support. Network operations engineers, who combine radio frequency and TCP/IP networking expertise, provide network consulting to support the sales force, assisting sales representatives and customers in defining the specifications for the system to be installed. Our network operations group also works with the customer during site preparation to aid in systems engineering, system integration, installation and acceptance testing to ensure a successful system start-up. Each customer is required to enroll, for a fee, at least one person in our one-week training course; enrollment for multiple employees from the customer organization is encouraged and supported with a discounted fee schedule. These training courses are tailored to specific implementations of our products and cover the installation, operation and maintenance of our headend and client modem products in a network operating environment. We typically provide a one-year warranty on our hardware products that includes factory and on-site repair service as needed. Customer support also includes telephone support, maintenance releases and technical bulletins covering all of our software and firmware products that contain application code. We provide support after expiration of the warranty period as a purchase option, including on-site field support. CUSTOMERS Our customers include broadband wireless system operators, cable system operators, ISPs, resellers and other businesses. A small number of customers has accounted for a large portion of our net sales. In 1998, RCN Corporation and Knology Holdings, Inc. accounted for 25% and 13% of our net sales. In 1997, RCN 6 Corporation and Jones Intercable accounted for 13% and 12% of our net sales. In 1996, AT&T Corporation and Intel Corporation accounted for 41% and 21% of our net sales. During 1998, 58% of our net sales were attributable to cable system applications and the balance to broadband wireless applications. A number of cable operators have adopted a standard for products used in transmitting data over cable systems called Data Over Cable System Interface Specification ("DOCSIS"). Our products do not meet this standard, and the adoption of the standard by cable operators has adversely affected our sales to cable customers and is likely to continue to do so in the future. SALES, MARKETING AND DISTRIBUTION We market and sell our products in the United States through our own field sales force and sales support organization. We also sell our products through distributors, VARs and OEMs. We have field sales offices in Atlanta, Georgia and Tinton Falls, New Jersey. 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 customers' internal procedures to complete the evaluation and to approve the large capital expenditures that are typically involved in purchasing our products. The sales cycle for our products has been lengthy, generally lasting three to nine months, and is subject to a number of significant risks, including customers' budgetary constraints and internal acceptance reviews. Because our sales cycle may be long and uncertain, and because we depend on a relatively few customers who place relatively large orders, any delay or loss of an order that is expected to be received 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. We have a limited backlog of orders. We believe this is not necessarily an indication of our future sales, because our customers typically demand prompt delivery after placing an order and because most of our orders are booked and shipped in the same quarter. Our marketing efforts are targeted at broadband wireless system operators, cable system operators, local and long-distance telephone service companies (LECs and IXCs) and existing ISPs. In the past, we devoted considerable time and effort to educating potential customers on the business opportunity of providing high speed Internet and intranet access (through white papers, prototype customer business models, industry speaking engagements, product and system demonstrations and direct customer presentations). We have tried to maintain an industry presence by exhibiting at industry tradeshows and speaking at conferences and seminars. During the latter part of 1998, constraints in our financial resources have limited our sales and marketing efforts. By the end of the year, our principal focus has been on supplying and supporting our existing customers. 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. If we are unable to continue to reduce costs, our profitability will be adversely affected. Our profitability is 7 also affected by the sales mix of headends and modems. Our single user modems generally have lower margins than our multi-user modems, both of which have lower margins than our headend routers. Due to current customer demand, we anticipate that the sales mix of modems will be weighted toward lower-margin single-user modems in the foreseeable future. As a result, gross margins, and our business, could be adversely affected. In order to market and sell our products internationally, we had entered into several distribution relationships. European interest in the DOCSIS standard has adversely affected our distribution arrangements. We had no international sales in 1998. MANUFACTURING Our manufacturing strategy is to perform system integration, testing and quality inspection internally and to outsource the manufacturing of the product modules to third parties. We maintain a limited in-house manufacturing capability for performing system integration and testing on headend products and for manufacturing small quantities of modems at our headquarters in San Jose. During 1998, we used our in-house manufacturing capability largely for (i) pilot production of new modem designs, (ii) configuration changes to adjust inventory to customer volume requirements for various models and (iii) sample testing of products received from volume modem manufacturers. Our Series 2000 client modems 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. Our inability to develop alternative manufacturing sources has adversely affected our ability to reduce the manufacturing costs of our modems despite competitive pressures that have caused us to reduce our selling prices. We expect downward pressure on the prices of our products to continue. In order for us to compete effectively in the sale of modems, we will need to reduce our prices, and the underlying costs, of our modems. As long as Sharp is the only manufacturing source of our modems, our ability to reduce the manufacturing costs of our modems may be limited. We have subcontractors for the standard components and subassemblies for our products. Standard components include the Sun Microsystems Sparc 5 workstation and its Sun Operating System (OS); and Intel's Ethernet cards and Pentium-based PCI processor cards. Our CyberManager 2000 Router is built on the Sparc 5/Sun OS platform by installing our proprietary network subscriber and network management software, HybridWare. Our CyberMaster Downstream Router ("CMD") and CyberMaster Upstream Router ("CMU") are built on Intel's Pentium-based PCI/ISA-based computer cards installed in standard rack-mounted backplanes from Industrial Computer Source that are configured to our specifications. Our proprietary software, Hybrid OS, is overlaid on a standard Berkeley Systems operating system for the CMD and CMU. We are dependent upon certain key suppliers for a number of the components for our 64-QAM products. For example, we have only one vendor, BroadCom Corporation, for the 64-QAM demodulator semiconductors that are used in our client modem products, and in past periods these semiconductors have been in short supply. In 1997, BroadCom announced a program whereby certain of its technological and product enhancements may be made available to certain of our competitors before making them available to us, thereby giving us a competitive disadvantage. Hitachi is the sole supplier of the processors used in certain of our modems. Stanford Telecom, which is a competitor for at least one of our broadband wireless products, is currently the sole supplier for certain components used in our products and has indicated that they might stop supplying these components to us, although it has not yet done so. There can be no assurance that these and other single-source components will continue to be available to us, or that deliveries of them 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 8 components for our products or any increase in our costs for components, or our inability to reduce component costs, could hurt our business. Our products generally carry a one-year warranty for replacement of parts. Although we have not experienced any significant product liability claims to date, we could be subjected to such claims in the future. RESEARCH AND DEVELOPMENT As of December 31, 1998, our research and development staff consisted of 22 full-time employees. As of April 30, 1999, our research and development staff had been reduced to 8 full-time employees, due primarily to a reduction in workforce that we implemented in the first quarter of 1999. To supplement our research and development efforts, we have hired a consulting firm in India to work on various projects. Our agreement with the firm is to provide up to 20 engineers as consultants depending upon the project needs. In addition, we have hired consultants in California to work on various projects. Our total research and development expenses for 1998, 1997 and 1996 were $7,771,000, $7,831,000 and $5,076,000, respectively, but they have declined substantially in 1999 due to lack of resources. Our research and development during 1998 was directed primarily towards (i) increasing the performance and improving the scalability of our broadband systems and (ii) reducing the cost of our modems. We are currently enhancing our QPSK return product software in cooperation with certain of our wireless customers to improve performance as the customers introduce antenna sectorization to increase return path capacity. Developments now being tested would, if successful, increase the capacity of the manager to 20,000 modems and extend the CCM-231 multi-user modem to serve 60 computers. We are continuing our efforts to reduce the cost of manufacturing client modems significantly through design and engineering changes. There can be no assurance that we will be successful in these efforts. The market for high speed Internet access products is characterized by rapidly changing and competing technologies, evolving industry standards and frequent new product introductions leading to short product life cycles. There can be no assurance that we will be able to keep up with these changes. COMPETITION Our market is intensely competitive, and we expect even more competition in the future. The principal competitive factors in this market include: - product performance and features including both downstream and upstream transmission capabilities, - reliability and stability of operation, - breadth of product line, - sales and distribution capability, - technical support and service, - relationships with cable and broadband wireless system operators and ISPs, - meeting standards compliance and - general industry and economic conditions. While we believe our products and services are competitive with or superior to those of our competitors, we have been hampered by a lack of resources, by disruptions resulting from management and personnel changes, uncertainties caused by our financial reporting difficulties referred to at the beginning of this report and by our competitors having established relationships with principal cable companies, wireless 9 operators, and ISPs, including @Home. Although our products have been particularly well received in the broadband wireless market, financial difficulties among our wireless customers have limited our sales to and collections from these customers. In addition, 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. In general, our competitors are producers of asymmetric cable modems and other types of cable modems and other broadband access products. 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. Many of our competitors are in a better position to withstand any significant reduction in capital spending by cable or broadband wireless system operators. CABLE MODEM COMPETITORS Our competitors in the cable modem market include Cisco Systems, Com21, Terayon, GI, Nortel Networks, Motorola, General Instrument and 3Com and its subsidiary U.S. Robotics. Other cable modem competitors include Phasecom, Scientific-Atlanta, Toshiba and Zenith Electronics, as well as a number of smaller, more specialized companies. Certain competitors have established relationships in the cable industry and with @Home, which is the ISP for a number of major cable operators, and have more experience than we have in selling two-way cable transmission products. Some of these competitors have entered into partnerships with computer networking companies and with @Home that may give such competitors greater visibility in this market. A number of competitors have already introduced or announced high speed connectivity products that are priced lower than ours, and certain other competitors are more focused on and experienced in selling and marketing two-way cable transmission products. Certain of our competitors have established relationships with cable system operators and telephone companies ("telcos"), and ISPs, including @Home, and, based on these relationships, may have more direct access to the decision-makers of such cable system operators and telcos. In addition, we could face potential competition from certain of our suppliers, such as Sharp, if it were to launch or license competitive modems for sale to others. The adoption of the DOCSIS cable standard by large cable operators has adversely affected our ability to sell to cable customers, particularly new customers. Further, our products are not compatible with headend equipment and modems of other suppliers of broadband Internet access products, including DOCSIS products, and, as a result, potential customers who wish to purchase broadband Internet access products from multiple suppliers may be reluctant to purchase our products. WIRELESS CABLE COMPETITIORS Our principal competitors in the wireless MMDS market include Nortel Networks (which is active in Canada), Cisco Systems (which has proprietary products under development due to its acquisition of Clarity Wireless, Inc.), COM21 (which is attempting to adapt its proprietary cable systems for wireless), Phasecom and other vendors that may be attracted by recent investments by MCI Worldcom and Sprint in wireless operations. Stanford Telecommunications (which manufactures QPSK products) is providing wireless Internet connectivity over LMDS frequencies and has added telephone service, which is potentially attractive to new operators. Stanford Telecom is the sole supplier for certain components used in our products and has indicated that they might stop shipping these components to us. Our products have been more widely accepted in the broadband wireless market than in the cable market partly because the adoption of the DOCSIS standard has not had a significant effect on wireless customers. We believe that products meeting the present DOCSIS standard will not perform well over wireless. This belief is based in part on the performance of the adaptive equalizer in the modem in the presence of multiple signals, the 10 power required from the transceiver in the return path and the probable disruption of the TDMA return path in the presence of noise or multi-path propagation. However, there can be no assurance that improvements in integrated circuit technology, transceiver output power levels or changes in the DOCSIS TDMA protocol will not allow systems developed for cable to perform effectively over wireless. One of the DOCSIS compliant vendors might also modify the DOCSIS equipment to a proprietary non-standard form to work over wireless. OTHER COMPETITION Broadband wireless and cable system operators face competition from providers of alternative high speed connectivity systems. In the wireless high speed access market, broadband wireless system operators are in competition with satellite TV providers. In telephony networks, Digital Subscriber Line ("xDSL") technology enables digitally compressed video signals to be transmitted through existing telephone lines to the home. Market acceptance of xDSL, or other wired technologies such as Integrated Services Digital Network ("ISDN"), or satellite technologies such as DBS, could decrease the demand for our products. Recently, several companies, including Compaq, Intel, Microsoft, 3Com, Alcatel, Lucent, several RBOCs, MCI and others announced the formation of a group focused on accelerating the pace of ADSL ( a form of xDSL) service. Further, if any competing architecture or technology were to limit or halt the deployment of coaxial or hybrid fiber-coax ("HFC") systems, our business could be materially adversely affected. 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. INTELLECTUAL PROPERTY PATENTS We rely on a combination of patent, trade secret, copyright and trademark laws and contractual restrictions to establish and protect proprietary rights in our products. We have received five patents from the U.S. Patent and Trademark Office: 5,586,121; 5,818,845; 5,828,655; 5,859,852; and RE 35,774, which is a re-issuance of our earlier U.S. Pat. 5,374,304. These patents are directed to various aspects of cable and wireless modems and headend systems. In addition, the U.S. Patent and Trademark Office has issued formal notices of allowances for nine pending patent applications which are also directed to cable and wireless modems and headend systems, as well as various modulation and transmission schemes used in cable modem systems. We have other patent applications pending before the U.S. Patent and Trademark Office. We have patent applications pending in a number of foreign jurisdictions as well. We do not know whether any pending or foreign patent applications will result in the issuance of patents. We cannot assure you 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 litigation 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 (See Item 3 "Legal Proceedings"). 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 for us 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. 11 SOFTWARE PROTECTION 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. INFRINGEMENT We have in the past, received, and may in the future receive, notices from third parties claiming that our products, software or asserted proprietary rights infringe the proprietary rights of third parties. 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 or 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 resources. As indicated above, we were engaged during 1998 in an infringement lawsuit that we brought against two third parties. 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 (See "--Patents" above and Item 3 "Legal Proceedings" below). Nonetheless, we may find it necessary to institute further infringement litigation in the future. EMPLOYEES As of December 31, 1998, we had 87 full-time employees. None of our employees is represented by a collective bargaining unit with respect to his or her employment, and we have never experienced an organized work stoppage. As of April 30, 1999, the number of full- time employees had been reduced to 32, due primarily to the reduction in workforce we implemented during the first quarter of 1999. We used consultants heavily to supplement our workforce and as of April 30, 1999 we had 14 consultants in various areas. ITEM 2. PROPERTIES We currently sublease approximately 55,000 square feet of office, research and development and manufacturing space in San Jose, California. The sublease expires in April 2004, and we have an option to extend the term of the lease through October 2009. We also lease approximately 900 square feet of office space in Tinton Falls, New Jersey and approximately 1,000 square feet of office space in Atlanta, Georgia. Both leases expire in 1999. We believe our facilities are in excess of our needs. As of May 1999, our San Jose facility was significantly underutilized, and attempts to sublease the excess space have been unsuccessful. ITEM 3. LEGAL PROCEEDINGS CLASS ACTION LITIGATION In June 1998, five class action lawsuits were filed in San Mateo County Superior Court, California against us, our five directors (one of whom is an officer), two former officers and one former director. The 12 lawsuits were brought on behalf of purchasers of our Common Stock during the class period commencing November 12, 1997 (the date of our initial public offering) and ending June 1, 1998. In July 1998, a sixth class action lawsuit was filed in the same court against the same defendants, although the class period was extended to June 18, 1998. All six lawsuits also named as defendants the underwriters in our initial public offering, but the underwriters have since been dismissed from the cases. The complaints in these lawsuits claim that we and the other defendants violated the anti-fraud provisions of the California securities laws, alleging that the financial statements we used in connection with our initial public offering and the financial statements we issued subsequently during the class period, as well as related statements made on our behalf during the initial public offering and subsequently regarding our past and prospective financial condition and results of operations, were false and misleading. The complaints also allege that we and the other defendants caused these misrepresentations to be made in order to inflate the price of our stock for the initial public offering and during the class period. We and the other defendants denied the charges of wrongdoing. In March 1999, the parties entered into an agreement in principle to settle these lawsuits, as indicated below. In July and August 1998, two class action lawsuits were filed in the U.S. District Court for the Northern District of California. Both of these federal class action lawsuits were brought against the same defendants as the six state court class actions referred to above, except that the second federal class action lawsuit also named as a defendant PwC, our former independent auditors. (The underwriters in our initial public offering were named as defendants in the first federal class action lawsuit but were subsequently dismissed.) The class period for the first federal class action lawsuit is from November 12, 1997 to June 1, 1998, and the class period in the second class action lawsuit extends to June 17, 1998. The complaints in both federal class action lawsuits claim that we and the other defendants violated the anti-fraud provisions of the federal securities laws, on the basis of allegations that are similar to those made by the plaintiffs in the state class action lawsuits. We and the other defendants denied these charges of wrongdoing. We believe that the state and federal class action lawsuits hurt our business during the latter part of 1998, made it more difficult for us to attract and retain employees, disrupted our management, sales and marketing, engineering and research and development staffs, contributed to our inability during the year to complete the restatement of our financial statements and adversely affected the sales of our products and services. In March 1999, we and the other parties to the state class action lawsuits and the federal class action lawsuits (other than PwC) reached an agreement in principle to settle the lawsuits. The agreement is subject to the parties' entering into a binding stipulation of settlement and approval by the U.S. District Court for the Northern District of California. Under the agreement in principle, (i) our insurers would pay $8.8 million on our behalf (and on behalf of the other officer and director defendants), (ii) we would issue 3.0 million shares of our Common Stock to the plaintiffs (the number of shares would be increased proportionately to the extent that there are more than 10.5 million shares of our Common Stock outstanding on the date of distribution so that, as of such date, the plaintiffs would hold approximately 22.6% of all of the shares of our Common Stock that are then outstanding), (iii) if we are acquired within nine months after March 9, 1999, the date of the agreement in principle, then, in addition to the consideration referred to in (i) and (ii), we would pay to the plaintiffs an amount equal to 10% of the consideration received by our stockholders in the acquisition. As a result of the agreement in principle and a related agreement between us and our insurers, we have paid, and will not be reimbursed by our insurers for, $1.2 million in attorney's fees and other litigation expenses that would otherwise be covered by our insurance, and we will not have insurance coverage for the attorney's fees and expenses relating to the settlement that we incur in the future. 13 SEC INVESTIGATION In October 1998, the Securities and Exchange Commission began a formal investigation of us and unidentified individuals with respect to our financial statements and public disclosures. We have been producing documents in response to the Securities and Exchange Commission's subpoena and are cooperating with the investigation. A number of current and former officers and employees and outside directors have testified or may testify before the Securities and Exchange Commission's staff. PATENT LITIGATION In January 1998, we brought a lawsuit in the U.S. District Court for the Eastern District of Virginia against Com21, Inc. and Celestica, Inc. in which we alleged that the defendants infringed our patents. In response to our lawsuit, Com21 initiated a declaratory judgment action six days later in the U.S. District Court for the Northern District of California to obtain a declaration that our patents are invalid and unenforceable and that in any event Com21 did not infringe them. In February 1998, the action in the Eastern District of Virginia was transferred to the Northern District of California, and the two actions were consolidated. Pre-trial discovery continued in the consolidated action until September 1998 when the parties agreed to stay the proceedings while they attempted to reach a settlement. In January 1999, the parties entered into a settlement agreement and the actions were dismissed. Pursuant to the settlement, we granted Com21 and Celestica a nonexclusive license on our patents under which they may be required to pay royalties in the event that they sell certain products in the future, subject to certain contingencies, and we granted Com21 a right of first refusal to purchase our patents 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. The Company has agreed to pay its legal counsel in this action, as a partial contingency fee (in return for such counsel's acceptance of reduced current legal fees), an amount equal to 50% of any royalties that the Company receives from its license with the defendants in the litigation (but not in excess of $3,000,000). To date the Company has received virtually no royalties from the license. SUBSEQUENT LAWSUIT: FILED BY PACIFIC MONOLITHICS In March 1999, Pacific Monolithics, Inc. (which had filed a voluntary petition under Chapter 11 of the U.S. Bankruptcy Code and is suing as debtor-in-possession) filed a lawsuit in Santa Clara County Superior Court, California against us, our five directors (one of whom is an officer), a former director (who was subsequently dismissed), a former officer and PwC. The lawsuit concerns an agreement which we entered into in March 1998 to acquire Pacific Monolithics through a merger, which acquisition was never consummated. The complaint alleges that we induced Pacific Monolithics to enter into the agreement by providing it with our financial statements, and by making other representations concerning our financial condition and results of operations, which were false and misleading, and further alleges that we wrongfully failed to consummate the acquisition. The complaint claims the defendants committed breach of contract and breach of the implied covenant of good faith and fair dealing, as well as fraud and negligent misrepresentation. The complaint seeks compensatory and punitive damages according to proof, plus attorneys' fees and costs. The plaintiff has attempted to initiate discovery, which defendants have opposed on the basis that the plaintiff and the Company had agreed that any disputes would be submitted to arbitration. The defendants have filed a motion to compel arbitration and to stay the court action. The Company does not believe, based on current information (which is only preliminary, since discovery has not commenced in the litigation), that the outcome of this litigation will have a material adverse impact on the Company's financial statements. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS There were no matters submitted to a vote of our security holders during 1998. 14 PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS MARKET INFORMATION FOR COMMON STOCK Our Common Stock was traded on the Nasdaq National Market under the symbol "HYBR" during the period from our initial public offering on November 12, 1997 through June 16, 1998. The high and low closing sales prices indicted below are as reported on the Nasdaq National Market.
HIGH LOW -------- ------- Fourth Quarter 1997 $24 1/4 $9 1/4 First Quarter 1998 $13 $4 1/8 Second Quarter 1998 (through June 16, 1998) $ 8 $2 3/16
On June 17, 1998, trading in our Common Stock was suspended by the Nasdaq National Market in response to our independent auditors, PwC, withdrawing their reports on our 1997 financial statements. The suspension continued until December 1, 1998, when our Common Stock was delisted by the Nasdaq National Market due to continuing noncompliance with listing requirements. Since December 1, 1998, our stock has been traded, without our consent or approval, in the over-the-counter market on the Pink Sheets. During December 1998, the high and low closing prices of our Common Stock on the Pink Sheets was $3/4 and $1/8, respectively. On June 1, 1999, the closing price of our Common Stock on the Pink Sheets was $2 1/8. STOCKHOLDERS As of February 27, 1998, there were approximately 183 holders of record of our Common Stock DIVIDENDS We have not paid any cash dividends on our capital stock to date. We currently anticipate that we will retain any future earnings for use in our business and do not anticipate paying any dividends in the foreseeable future. The terms of a $5.5 million senior secured convertible debenture (the "$5.5 Million Debenture") prohibit us from paying any cash dividends for so long as the $5.5 Million Debenture remains outstanding. RECENT SALES OF UNREGISTERED SECURITIES We did not sell any of our securities within 1998 which were not registered under the Securities Act, except for the following issuances of shares of our Common Stock upon the exercise of stock options that were made under exemptions provided under Rule 701 under the Securities Act: A total of 94,968 shares of Common Stock were issued, 43,000 to former officers. USE OF INITIAL PUBLIC OFFERING PROCEEDS The Form S-1 Registration Statement (SEC File No. 333-36001) related to our initial public offering of Common Stock was declared effective by the SEC on November 11, 1997. A total of 3,105,000 shares of 15 Common Stock was registered with the SEC, which consisted of 2,836,053 shares registered on our behalf (with an aggregate offering price of $39,705,000) and 268,947 shares registered on behalf of certain of our stockholders (with an aggregate offering price of $3,765,000). The offering took place on November 12, 1997, and all 2,836,053 and 268,947 shares of Common Stock being offered by us and certain stockholders of ours, respectively, were sold at the offering price through a syndicate of underwriters managed by NationsBanc Montgomery Securities and UBS Securities. We and the selling stockholders paid to the underwriters an underwriting discount totaling $2,779,000 and $264,000, respectively, in connection with the offering. We estimate that we incurred additional expenses of approximately $1,184,000 in connection with the offering. Thus the net offering proceeds to us and the selling stockholders were approximately $35,737,000 and $3,502,000, respectively. The underwriting discount and the other offering expenses were not made directly or indirectly to any of our directors or officers (or their associates), or to persons owning 10% or more of any class of equity securities or to any other affiliates of ours. Through December 31, 1998 the net offering proceeds to us have been utilized as follows:
Direct or indirect payments to directors, officers or their associates; to persons owning ten percent or more of any class of our equity securities; Direct or indirect Use and to our affiliates payments to others - ------------------------- ------------------------------ ------------------- Construction of plant, -- -- building and facilities Purchase and installation of -- $ 3,817,000 machinery and equipment Purchase of real estate -- -- Acquisition of other business(es) -- -- Repayment of indebtedness $ 1,371,000 $ 5,627,000 Working capital -- $20,960,000 Temporary investment in -- $ 3,962,000 Alex. Brown Investment Account and General Bank Account Other purposes -- --
16 ITEM 6. SELECTED FINANCIAL DATA The following selected financial data should be read in conjunction with the Company's financial statements and related notes thereto and "Management's Discussion and Analysis of Financial Condition and Results of Operations" included elsewhere in this Form 10-K.
Year Ended December 31, -------------------------------------------------------------------- 1998 1997(1) 1996 1995 1994 ------------ ------------ ------------ ------------ ------------ STATEMENT OF OPERATIONS DATA: Net sales $ 12,418 $ 4,120 $ 2,962 $ 630 $ 668 Cost of sales 14,046 8,899 3,130 761 1,362 -------- -------- -------- -------- -------- Gross profit (1,628) (4,779) (168) (131) (694) -------- -------- -------- -------- -------- Operating expenses: Research and development 7,771 7,831 5,076 3,862 1,251 Sales and marketing 3,642 4,678 1,786 390 348 General and administrative 8,933 2,964 1,714 748 533 Asset impairment charge 1,250 - - - - Write off of technology license 1,283 - - - - -------- -------- -------- -------- -------- Total operating expenses 22,879 15,473 8,576 5,000 2,132 -------- -------- -------- -------- -------- Loss from operations (24,507) (20,252) (8,744) (5,131) (2,826) Interest income and other expense, net 779 316 257 166 30 Interest expense (897) (1,666) (28) (304) (101) -------- -------- -------- -------- -------- Net loss $(24,625) $(21,602) $ (8,515) $ (5,269) $ (2,897) -------- -------- -------- -------- -------- -------- -------- -------- -------- -------- Basic and diluted net loss per share $ (2.37) $ (6.10) $ (3.36) $ (2.37) $ (1.30) -------- -------- -------- -------- -------- -------- -------- -------- -------- -------- Shares used in basic and diluted per share calculation (2) 10,410 3,541 2,535 2,223 2,226 -------- -------- -------- -------- -------- -------- -------- -------- -------- -------- December 31, ------------------------------------------------------------ 1998 1997(1) 1996 1995 1994 ---------- ---------- ---------- ---------- ------------ BALANCE SHEET DATA: Cash, cash equivalents and short-term investments $ 3,966 $ 27,143 $ 6,886 $ 3,353 $ 1,426 Working capital (812) 23,795 6,944 3,149 1,129 Total assets 15,420 39,065 10,539 4,586 1,892 Long-term debt 419 654 472 228 2,108 Total stockholders' equity (deficit) 2,702 27,303 7,709 3,661 (708)
17 (1) See Note 1 of Notes to Financial Statements for information concerning the restatement of our financial statements. All financial data presented in the table above as of and for the year ended December 31, 1997 reflect such restatement. (2) See Note 2 of Notes to Financial Statements for an explanation of the number of shares used to compute basic and diluted net loss per share. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS THE DISCUSSION IN THIS ITEM 7 SHOULD BE READ IN CONJUNCTION WITH THE FINANCIAL STATEMENTS AND THE NOTES THERETO INCLUDED IN ITEM 8 OF THIS REPORT ON FORM 10-K. THE DISCUSSION IN THIS ITEM 7 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, YEAR 2000 COMPLIANCE, 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-K. OVERVIEW GENERAL We are a broadband access equipment company that designs, develops, manufactures and markets wireless and cable systems that provide high speed access to the Internet and corporate intranets for both businesses and consumers. Our products remove the bottleneck over the local connection to the end-user which causes slow response time for those accessing bandwidth-intensive information. Our Series 2000 product line consists of secure headend routers, wireless and cable modems and management software for use with either wireless transmission or cable TV facilities. From our inception in June 1990 until September 1996, we focused on the design, development, manufacturing and market introduction of the first two generations of Hybrid's Series 1000 product line. These product generations offered 5 and 10Mbps access speeds for downstream data. In October 1996, we introduced our third generation product line, the Series 2000, which provides 30Mbps downstream access speeds. During the three years ended December 31, 1997, we sold a limited number of points of presence headend equipment ("headends") and cable modems from both product series. We expect to generate substantially all of our future sales from our Series 2000 products, enhancements to these products, new products and related support and networking services. To date, net sales include principally product sales and, to a lesser extent, support and networking services. We sell our products primarily in the United States. Our customers include broadband wireless system operators, cable system operators, ISPs, resellers and certain distributors and communications equipment resellers. Historically, a small number of customers has accounted for a substantial portion of our net sales, and we expect the 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, generally lasting three to nine months, and is subject to a number of significant risks, including customers' budgetary constraints and internal acceptance reviews. Because our 18 sales cycle may be long and uncertain, and because we depend on relatively few customers who place relatively large orders, any delay or loss of an order that is expected to be received 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 and product obsolescence, and evolving industry standards. Our ability to develop and offer competitive products on a timely basis that satisfy industry demands, such as for two-way QPSK, or industry standards such as DOCSIS, could have a material effect on our business. In addition, 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. If we are unable to continue to reduce costs quickly enough, our profitability will be adversely affected. Our profitability is also affected by the sales mix of headends and modems. Our single-user modems generally have lower margins than our multi-user modems, both of which have lower margins than our headend routers. Due to current customer demand, we anticipate that the sales mix of modems will be weighted toward lower-margin single-user modems in the foreseeable future. As a result, our gross margins, and our business, could be adversely affected. RESTATEMENT OF OUR FINANCIAL STATEMENTS In May and June 1998, we and PwC, our independent auditors, engaged in a review of our financial statements for 1997 and the first quarter of 1998. On June 18, 1998, we announced that PwC had notified us that its audit reports on our 1997 financial statements should no longer be relied upon and that we and they were continuing to review those financial statements. On July 9, 1998, PwC resigned as our independent auditors, stating that it believed our 1997 financial statements should be restated but that, although there had been no disagreements between PwC and us on any matter of our accounting principles, or practices, financial statement disclosure or auditing procedure, PwC would not continue as our independent auditors to address the restatement. In August 1998, we retained AA as our independent auditors. After extensive work in examining our 1997 financial statements, AA resigned as our independent auditors on November 24, 1998. AA informed us that, in its view, material weaknesses existed in our internal controls of a nature that prevented AA from being able to form an opinion on our conclusions as to the appropriate timing and amount of revenue recognition for the purposes of our 1997 financial statements. AA also stated that, during the course of its work, it had reached the conclusion that it needed to expand significantly the scope of its audit, which it did with our approval and cooperation, and that, while AA did not complete its audit, it concluded that our 1997 financial statements were materially misstated. AA confirmed that there had been no disagreements between AA and us on any matter of our accounting principles and practices, financial statement disclosure or auditing procedure. 19 In December 1998, we engaged Hein as our independent auditors. During the review of our financial statements in conjunction with Hein (and earlier with PwC and AA), we became aware of errors and irregularities that caused our financial statements for 1997 and the first quarter of 1998 to be misstated, particularly with respect to the timing and amount of our sales in 1997 and the first quarter of 1998. We also concluded that the financial effects of warrants issued by us in 1997 had not been properly reflected in our financial statements. Our financial statements for 1997 and the first quarter of 1998 have been restated to correct these errors. As indicated in Note 1 to the Financial Statements in Item 8 of this report, as a result of the restatement net sales for 1997 were reduced from $14,270,000 to $4,120,000 (resulting in gross loss of $4,799,000 rather than gross profit of $2,012,000), net loss increased from $13,590,000 to $21,602,000 and accumulated deficit increased from $30,932,000 to $38,944,000. Our basic and diluted loss per share increased from $3.84 to $6.10. For additional information regarding the restatement, see Note 1 to the Financial Statements in Item 8 of this report. In June 1999, Hein completed its audit of our 1997 and 1998 financial statements. Those financial statements, and Hein's audit report on them are included in the Financial Statements and the Notes thereto which appear in Item 8 of this report. Our inability to issue audited financial statements during the last 12 months has had serious consequences for our business. As a result, the Nasdaq National Market suspended trading in our Common Stock from June 18, 1998 to December 1, 1998, at which time our Common Stock was delisted from the Nasdaq National Market. Primarily due to our announcements regarding the need to restate our financial statements, a number of class action litigations were brought in June, July and August 1998, and the Securities and Exchange Commission initiated a formal investigation in October 1998. We believe these actions hurt our business during the latter part of 1998, made it more difficult for us to attract and retain employees, disrupted our management, sales and marketing, engineering and research and development staffs, contributed to our inability to complete the restatement of our financial statements during 1998 and adversely affected the sales of our products and services. REVENUE RECOGNITION We normally ship our products based upon a bona fide Purchase Order and Volume Purchase Agreement. The Company generally recognizes its revenue at the time a transaction is shipped and collection of the resulting account receivable is probable. Shipments on customer orders with either acceptance criteria, installation criteria, or rights of return are recognized as revenue only when the criteria are satisfied according to the contract. Revenue related to shipments to distributors is normally recognized upon sell through which is generally signified by receipt of payment for such transactions. For the Cybermanager 2000, the hardware and software sales are generally bundled with upgrades, maintenance and system support and service, and sold for a period of three years. Revenue attributed to hardware is recognized upon shipment. Revenue attributed to software is recognized over the three year maintenance, system support and service period. When a maintenance contract is sold separately, the revenue is recognized ratably over the term of the maintenance contract, generally on a straight-line basis. Where maintenance revenue is not separately invoiced, it is unbundled from hardware and software license revenue and deferred for revenue recognition purposes. Other service revenue, primarily training and consulting, is generally recognized at the time the service is performed. WARRANTY COSTS We accrue for estimated warranty costs when the related sales revenue is recognized. Our modem manufacturer, Sharp Corporation, provides a 15 month warranty on all cable modems manufactured by it. The warranty period begins on the date the modems are completely assembled. We provide a 12 month warranty on all headend equipment sold. Actual warranty costs incurred have not differed materially from those provided. 20 NET LOSSES We incurred net losses for the years ended December 31, 1998, 1997 and 1996 of $24,625,000, $21,602,000 and $8,515,000, respectively. As a result, we had an accumulated deficit of $63,569,000 as of December 31, 1998. If we are able to raise additional capital, we would expect to increase in the future our capital expenditures, as well as our research and development and other operating expenses, in order to support and expand our operations. There can be no assurance that we will be able to raise additional capital. Whether or not we raise such capital, we expect to incur losses for the foreseeable future, although we may not be able to continue as a going concern without that additional financing. DEFERRED TAXES As of December 31, 1998, we had approximately $27.6 million in gross deferred tax assets comprised primarily of net operating loss carryforwards and capitalized research expenditures. We believe that we might not be able to realize our deferred tax assets, due to uncertainties regarding our future, our history of net losses and our lack of capital resources. In addition, the utilization of net operating loss carry forwards may be subject to a substantial annual limitation due to the "change in ownership" provisions of the Internal Revenue Code of 1986 and similar state provisions. We will continue to assess the realizability of the deferred tax assets based on actual and forecasted operating results. See Note 12 of Notes to Financial Statements. 21 RESULTS OF OPERATIONS The following table sets forth the percentage of net sales represented by the items in our statements of operations for the periods indicated:
Year Ended December 31, --------------------------------------- 1998 1997(1) 1996 ---- ------- ---- Net sales 100.0% 100.0% 100.0% Cost of sales 113.1% 216.0% 105.7% ----- ----- ----- Gross loss -13.1% -116.0% -5.7% ----- ----- ----- Operating expenses: Research and development 62.6% 190.1% 171.4% Sales and marketing 29.3% 113.5% 60.3% General and administrative 71.9% 72.0% 57.8% Asset impairment charge 10.1% - - Write off technology license 10.3% - - ----- ----- ----- Total operating expenses 184.2% 375.6% 289.5% ----- ----- ----- Loss from operations -197.3% -491.6% -295.2% Interest income and other expenses, net 6.2% 7.7% 8.7% Interest expense -7.2% -40.4% -1.0% ----- ----- ----- Net loss -198.3% -524.3% -287.5% ----- ----- ----- ----- ----- -----
(1) See Note 1 of Notes to Financial Statements for information concerning the restatement of our financial statements. All financial data in the table above as of and for the year ended December 31, 1997 presented reflect such restatement. YEAR ENDED DECEMBER 31, 1998 COMPARED TO YEAR ENDED DECEMBER 31, 1997. NET SALES. Net sales for 1998 were $12,418,000, compared to net sales of $4,120,000 for 1997. The growth in net sales was primarily due to increased unit shipments of the Series 2000 product line offset in part by price declines on certain products in connection with volume purchases. In 1998, cable systems operators accounted for approximately 57% of net sales, broadband wireless systems operators accounted for 38% of net sales, with ISPs accounting for 5% of net sales. During 1997, broadband wireless system operators accounted for approximately 59% of net sales, cable system operators accounted for 39% of net sales, with ISPs accounting for 2% of net sales. There were no international sales in 1998. International sales accounted for 13.5% of net sales in 1997. We had two customers that individually accounted for 25% and 13% of net sales during 1998. We had two customers that individually accounted for 13% and 12% of net sales during 1997. GROSS PROFIT. Gross margin was negative 13.1% and negative 116.0%, in 1998 and 1997, respectively. Gross margin in 1997 reflected an increase in the inventory provision included in cost of sales by $2.6 million as compared to 1996, largely related to excess inventory levels and to shipments being made during 1997 in 22 transactions that were not recognized as sales (due to restatement of our financial statements). Such a large inventory provision relative to sales was not made in 1998, and is not anticipated in future periods. Excluding this nonrecurring inventory charge, gross margin for 1997 would have been a negative 40%. The remaining increase in gross margin from 1997 was primarily due to efficiencies resulting from increased unit shipments and to decreased cost per unit. RESEARCH AND DEVELOPMENT. Research and development expenses include ongoing headend, software and cable modem development expenses, as well as design expenditures associated with product cost reduction programs and improving manufacturability of our existing products. Research and development expenses were $7,771,000 and $7,831,000 during the years ended December 31, 1998 and 1997, respectively, representing 62.6% and 190.1% of net sales, respectively. If we are able to obtain additional financing (see "--Liquidity and Capital Resources" below), we would expect to increase our investment in research and development programs in future periods, focusing on wireless technologies, cost improvement and software enhancements. SALES AND MARKETING. Sales and marketing expenses consist primarily of salaries and related payroll costs of sales and marketing personnel, commissions, advertising, promotions and travel. Sales and marketing expenses were $3,642,000 and $4,678,000 during the years ended December 31, 1998 and 1997, respectively, representing 29.3% and 113.5% of net sales, respectively. The decrease in sales and marketing expenses in absolute dollars was principally due to decreased headcount and related payroll costs and marketing and promotion costs incurred in 1997 in connection with our Series 2000 product line. If we are able to obtain additional financing (see "--Liquidity and Capital Resources" below), we would expect sales and marketing expenses to increase in the future. GENERAL AND ADMINISTRATIVE. General and administrative expenses consist primarily of executive personnel salaries, provision for doubtful accounts, travel expenses, legal fees and costs of outside services. General and administrative expenses were $8,933,000 and $2,964,000 during the years ended December 31, 1998 and 1997, respectively, representing 71.9% and 72.0% of net sales, respectively. The increase in absolute dollars in 1998 was due to increased legal costs and reserves in connection with the various litigations in which we were engaged during 1998, including the accrual of $1,547,000 related to the class action settlement (see Item 3 "Legal Proceedings"), and to support our patent program, increased headcount and related payroll costs and increased expenses for professional and other fees required of a publicly traded company and to support the aforementioned restatement of our financial statements. OTHER CHARGES. Due to the underutilization of our San Jose headquarters, operating expenses include a fourth quarter charge of $1,250,000 reflecting the impairment of leasehold improvements and office furniture and fixtures. Operating expenses also include a nonrecurring charge of $1,283,000 relating to the write off of the rights to certain technology acquired in November 1997. INTEREST INCOME (EXPENSE) AND OTHER EXPENSE, NET. We incurred net interest expense during 1998 and 1997 of $118,000 and $1,350,000, respectively. Net interest expense incurred in 1998 decreased in comparison to 1997 due (i) to interest income on increased average cash and cash equivalents resulting primarily from our initial public offering of Common Stock in November 1997, and (ii) to noncash interest expense of $870,000 incurred in the fourth quarter of 1997 related to issuance of warrants with respect to certain loans obtained in September 1997. YEAR ENDED DECEMBER 31, 1997 COMPARED TO YEAR ENDED DECEMBER 31, 1996. NET SALES. The restated Net sales for the year ended December 31, 1997, were $4,120,000, compared to net sales of $2,962,000 for the same period in 1996. The growth in net sales was primarily due to 23 increased unit shipments as a result of the introduction of the Series 2000 product line in October 1996 offset in part by price declines on certain products in connection with volume purchases. GROSS PROFIT. Gross margin was negative 116.0% and negative 5.7%, in 1997 and 1996, respectively. The inventory provision included in cost of sales increased by approximately $2.6 million in 1997 compared to 1996, largely related to excess inventory levels and to shipments being made during 1997 in transactions that were not recognized as sales (due to restatement of our financial statements). Excluding this nonrecurring charge, gross margin for 1997 would have approximated a negative 40%. The remaining decrease in gross margin from 1996 was primarily due to decreases in average selling prices due to volume purchase arrangements and other promotions. RESEARCH AND DEVELOPMENT. Research and development expenses were $7,831,000 and $5,076,000 during the years ended December 31, 1997 and 1996, respectively, representing 190.1% and 171.4% of net sales, respectively. Research and development expenses grew in absolute dollars as a result of increased staffing and associated engineering costs related to new and existing product development. SALES AND MARKETING. Sales and marketing expenses were $4,678,000 and $1,786,000 during the years ended December 31, 1997 and 1996, respectively, representing 113.5% and 60.3% of net sales, respectively. The increase in sales and marketing expenses in absolute dollars was principally due to increased headcount and related payroll costs and increased costs for marketing and promoting the Company's Series 2000 product line, as well as increased product demonstration costs. GENERAL AND ADMINISTRATIVE. General and administrative expenses were $2,964,000 and $1,714,000 during the years ended December 31, 1997 and 1996, respectively, representing 72.0% and 57.8% of net sales, respectively. The increase in absolute dollars was due to increased legal costs to support the Company's patent program and increased headcount and related payroll costs. INTEREST INCOME (EXPENSE) AND OTHER EXPENSE, NET. We incurred net interest expense during 1997 of $1,350,000 and earned net interest income of $229,000 during 1996. Net interest expense incurred during 1997 was the result of (i) our use of capital lease financing to fund a majority of our capital expenditures and (ii) interest expense (including non cash expense of $870,000 incurred in the fourth quarter of 1997 related to issuance of warrants with respect to certain loans obtained in September 1997) incurred on loans obtained to support working capital requirements. Net interest income earned during 1996 was primarily due to higher cash balances as a result of Preferred Stock financings in December 1995 and June 1996, offset in part by the interest expense incurred on outstanding capital lease obligations. LIQUIDITY AND CAPITAL RESOURCES We have historically financed our operations primarily through a combination of debt, equity and equipment lease financing. Despite our initial public offering in November 1997 and other debt and equity financing during 1997 in which we raised $42,507,000 in net proceeds, by December 31, 1998, our cash, cash equivalents and short-term investments had been reduced to $3,451,000 (from $27,148,000 as of December 31, 1997), our working capital was negative $812,000, and we are in violation of a covenant (not involving payment of interest or principal) under the terms of the $5.5 Million Debenture pursuant to which the holder of the debenture has the right to declare a default. Net cash used in operating activities was $19,302,000, $21,677,000 and $8,577,000 during 1998, 1997 and 1996, respectively. The net cash used in operating activities in 1998 was primarily due to our net loss of $24,625,000, partially offset by non-cash charges of $6,336,000 and a decrease in net current assets related to operating activities of $1,013,000. Net cash used in operations in 1997 was primarily the result of our net loss of $21,602,000 and an increase of $8,086,000 in inventories to support increased sales, shipments and 24 orders expected in the fourth quarter of 1997 that were not received, offset by non-cash charges of $4,966,000 and by increases in accrued liabilities and accounts payable of $3,062,000 resulting from increased inventory purchases and operating expenditures. Net cash used in operating activities during 1996 was primarily due to our net loss of $8,515,000. Net cash used in investing activities was $3,014,000 and $1,559,000 during 1998 and 1997, respectively. Cash provided by investing activities in 1996 was $143,000. Aggregate capital expenditures for property and equipment, primarily computers, leasehold improvements, furniture, fixtures and engineering test equipment were $3,907,000, $629,000 and $321,000 during 1998, 1997 and 1996, respectively. The significant increase in capital expenditures in 1998 was primarily due to leasehold improvements. The Company purchased short-term investments of $893,000 in 1997 and $11,772,000 in 1998. All short-term investments were liquidated in 1998. We have funded a substantial portion of our property and equipment expenditures from direct vendor leasing programs and third party commercial lease arrangements. At December 31, 1998, we had no material commitments for capital expenditures. Net cash used in financing activities of $391,000 in 1998 was primarily the result of payment of $478,000 on capital lease obligations, partially offset by net proceeds of $87,000 from issuance of common stock. Net cash provided by financing activities was $42,508,000 and $12,457,000 during 1997 and 1996, respectively. Net cash provided by financing activities during 1997 was primarily due to our initial public offering and to the debt and Preferred Stock financings totaling $42,741,000 referred to above and to the exercise of stock options of $94,000. Cash provided by financing activities during 1996 resulted from the issuance of convertible debentures and Preferred Stock. At December 31, 1998, our only source of liquidity consisted of cash and cash equivalents of $3,451,000. We had no available line of credit or other source of borrowings or financing. As indicated above, we were (and are) not in compliance with certain of the terms of the $5.5 Million Debenture and, as a result, the holder of the debenture has the right to declare a default under the debenture at any time. Our obligations under the $5.5 Million Debenture are collateralized by a security interest in substantially all our assets. We will need to raise additional capital promptly in order to offset our expected future operating losses. To fund our operations during 1999 and continue as a going concern, we are seeking to raise additional capital through debt or equity financing, but there is no assurance that we will be able to do so. If we do obtain additional financing, it may be on terms that would be unfavorable to us and may hurt our ability to raise further capital in the future. 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-K BEFORE INVESTING IN OUR COMMON STOCK. THE RISKS DESCRIBED BELOW ARE NOT THE ONLY ONES WE FACE. ADDITIONAL RISKS THAT WE ARE 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. WE WILL NEED ADDITIONAL CAPITAL SOON TO CONTINUE IN BUSINESS. Although we raised over $35 million in net proceeds from our initial public offering in November 1997, our capital resources are now largely depleted. We are not in compliance with certain terms of the $5.5 Million Debenture, and, as a result, the holder of the debenture may declare a default under the debenture at any time. We currently do not have the capital resources to make such payment. Should we fail to make payment on demand, the debenture holder may elect, subject to certain restrictions and limitations, to exercise its security interest in all our assets, which may involve the seizure and sale of our assets. In 25 addition to meeting our obligations under the debenture, we need to raise additional capital in order to continue in operation. Our ability to raise additional capital has been limited by a number of factors, including (i) our noncompliance with certain terms of the $5.5 Million Debenture, (ii) our not having audited financial statements for 1997 or 1998 or a quarterly report for the first quarter of 1999, (iii) our Common Stock being delisted from the Nasdaq National Market and not traded on any other public market (except for a small number of sales on the Pink Sheets which have occurred without our consent), (iv) the state and federal class action litigation and the Securities and Exchange Commission investigation that are pending against us (although we have agreed in principle to settle the class action litigation, that agreement is not yet final), (v) uncertainty which the foregoing has caused regarding our financial condition and results of operations, (vi) the adverse effect which the foregoing has had on sales to our customers, (vii) the disruption in our management and our employees caused by the foregoing, including the substantial reduction in force we implemented in February 1999, (viii) our history of heavy losses and (ix) the other risk factors referred to herein. We can give no assurance that, within a short period of time, we will be able to raise the additional capital we need 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. IT IS NOT CLEAR THAT WE WILL BE ABLE TO RECOVER FROM THE ADVERSE EFFECTS OF HAVING TO RESTATE OUR FINANCIAL STATEMENTS. The adverse effects of having to restate our financial statements have been severe, and there can be no assurance that we will not suffer additional adverse consequences in the future. The restatement and related issues have resulted in the resignation of two successive audit firms that were hired by us, in our continuing for 12 months as a public company without having audited financial statements, in the multiple class action lawsuits, the Securities and Exchange Commission investigation and the Pacific Monolithics litigation referred to in Item 3 "Legal Proceedings" above and in the other adverse consequences referred to in the preceding paragraph. We do not know whether additional litigation will arise in the future, or whether other adverse developments will result, from the difficulties we have encountered in connection with our financial statements. OUR LIMITED OPERATING HISTORY AND HEAVY LOSSES MAKE OUR BUSINESS DIFFICULT TO EVALUATE. We were organized in 1990 and have had operating losses each year since then. Our accumulated deficit was $63,569,000 as of December 31, 1998. 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 had negative gross margins in the past and the price pressures on sales of our products continues. We expect to incur losses for the foreseeable future. WE FACE LITIGATION RISKS. As indicated in Item 3 "Legal Proceedings," there are a number of lawsuits pending against us. The principal lawsuits are the class action lawsuits referred to on pages 12 and 13. Although we have reached an agreement in principle to settle these lawsuits, the agreement is subject to the parties' entering into a binding stipulation of settlement, which has not yet occurred, and upon the subsequent approval of the settlement by the court in a hearing at which any persons opposing the settlement will have an opportunity to be heard. If the settlement is not consummated, we could be subjected to lengthy, expensive and potentially damaging class action litigation. It is difficult for us to evaluate what the outcome of the Securities and Exchange Commission investigation (referred to page 14) will be. Responding to the investigation has been, and probably will be, expensive and time-consuming for us. We do not know whether the results of the investigation will be damaging for us. 26 The Pacific Monolithics litigation referred to on page 14 is in its early stages and is difficult for us to evaluate at this point. It is possible that we may be exposed to further litigation in the future, particularly in light of the restatement of our financial statements, and the adverse developments that have occurred partly as a result of the restatement (see the two risk factors immediately above). In addition, litigation may be necessary in the future to enforce our intellectual property rights or to determine the validity and scope of our patents or of the proprietary rights of others. Such litigation might result in substantial costs and diversion of resources and management attention. Furthermore, our business activities may infringe upon the proprietary rights of others, and in the past third parties have claimed, and may in the future claim, infringement by our software or products. Any such claims, with or without merit, could result in significant litigation costs and diversion of management attention, and could require us to enter into royalty and license agreements that may be disadvantageous to us or suffer other harm to our business. If litigation is successful against us, it could result in invalidation of our proprietary rights and 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 we separately or together with our other assets) to any third party. (See Item 3 "Legal Proceedings--Patent Litigation.") Nonetheless, we may find it necessary to institute further infringement litigation in the future. RECENT REDUCTIONS IN OUR EXPENDITURES AND IN THE NUMBER OF OUR EMPLOYEES COULD HURT OUR BUSINESS. Commencing in the latter part of 1998, we began to reduce our expenditures on research and development and on other aspects of our business. We also began to reduce the number of our employees. During the first quarter of 1999 we implemented a reduction in force that reduced the number of full-time employees to 32, as compared to 87 full-time employees at December 31, 1998. We used consultants heavily to supplement our workforce and as of April 30, 1999 we had 14 consultants in various areas. While we believe these reductions were necessary to conserve our remaining capital resources, they have limited and delayed the enhancement of our products and our development of new products, and our sales and marketing efforts have been adversely affected. These limitations on our activities, (together with the other factors referred to above and elsewhere herein), have hurt us competitively and may continue to harm our business in the future. We do not know whether we will be successful in obtaining sufficient capital resources to expand our business in the future. MARKET PRESSURE TO REDUCE PRICES MAY HURT OUR BUSINESS. The market has historically demanded increasingly lower prices for our products, and we expect downward pressure on the prices of our products to continue. The list prices for our Series 2000 client modems currently range from approximately $320 to $480, depending upon features and volume. Customers wishing to purchase client modems generally must also purchase an Ethernet adapter for their computer. These prices make our products relatively expensive for the consumer electronics and the small office or home office markets. Market acceptance of our products, and our future success, will depend in significant part on reductions in the unit cost of our client modems. In a number of instances, the prices of our competitors' products are lower than ours. 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 of the 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, although, as indicated above, we have recently had to reduce the scope of our research and development efforts due to lack of capital resources. We have no 27 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. We expect that the market price pressure to reduce the prices on our products will continue to exert downward pressure on our gross margins. Our gross margins are also affected by the sales mix of our headends and modems. Our single-user modems generally have lower margins than our multi-user modems, both of which have lower margins than our headends. We anticipate that, due to customer demand, the sales mix of our products will continue to be weighted toward lower-margin single-user modems. WE RELY ON A SINGLE MANUFACTURER FOR OUR MODEMS AND ON SINGLE-SOURCE COMPONENTS. Our Series 2000 client modems 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. Our inability to develop alternative manufacturing sources has adversely affected our ability to reduce the manufacturing costs of our modems despite competitive pressures that have caused us to reduce our selling prices. We expect downward pressure on the prices of our products to continue. In order for us to compete effectively in the sale of modems, we will need to reduce our prices, and the underlying costs, of our modems. As long as Sharp is the only manufacturing source of our modems, our ability to reduce the manufacturing costs of our modems may be limited. We are dependent upon certain key suppliers for a number of the components for our 64QAM products. For example, we have only one vendor, BroadCom Corporation, for the 64QAM demodulator semiconductors that are used in our client modem products, and in past periods these semiconductors have been in short supply. In 1997, BroadCom announced a program whereby certain of its technological and product enhancements may be made available to certain of our competitors before making them available to us, thereby giving us a competitive disadvantage. Hitachi is the sole supplier of the processors used in certain of our modems. Stanford Telecom, which is a competitor for at least one of our broadband wireless products, is currently the sole supplier for certain components used in our products and has indicated that they might stop supplying these components to us, although it has not yet done so. There can be no assurance that these and other single-source components will continue to be available to us, or that deliveries of them 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 cost 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 hurt our business. WE ARE IN AN INTENSELY COMPETITIVE MARKET, AND WE COMPETE WITH MUCH LARGER COMPANIES. Our market is intensely competitive, and we expect even more competition in the future. The principal competitive factors in this market include: - product performance and features including both downstream and upstream transmission capabilities, - reliability and stability of operation, - breadth of product line, - sales and distribution capability, - technical support and service, - relationships with cable and broadband wireless system operators and ISPs, 28 - meeting standards compliance and - general industry and economic conditions. While we believe our products and services are competitive with or superior to those of our competitors, we have been hampered by a lack of resources, by disruptions resulting from management and personnel changes, by uncertainties caused by our financial reporting difficulties referred to at the beginning of this report, and by our competitors having established relationships with principal cable companies, wireless operators, and ISPs, including @Home. Although our products have been particularly well received in the broadband wireless market, financial difficulties among our wireless customers have limited our sales to and collections from these customers until recently. In addition, 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 its competitors. There can be no assurance that we will be able to compete successfully in the future. In general, our competitors are producers of asymmetric cable modems and other types of cable modems and other broadband access products. 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. Many of our competitors are in a better position to withstand any significant reduction in capital spending by cable or broadband wireless system operators. CABLE MODEM COMPETITORS. Our competitors in the cable modem market include Cisco Systems, Com21, Terayon, Nortel Networks, Motorola, General Instrument and 3Com and its subsidiary U.S. Robotics. Other cable modem competitors include Phasecom, Scientific-Atlanta, Toshiba and Zenith Electronics, as well as a number of smaller, more specialized companies. Certain competitors have established relationships in the cable industry and with @Home, which is the ISP for a number of major cable operators, and have more experience than we have in selling two-way cable transmission products. Some of these competitors have entered into partnerships with computer networking companies and with @Home that may give such competitors greater visibility in this market. A number of competitors have already introduced or announced high speed connectivity products that are priced lower than ours, and certain other competitors are more focused on and experienced in selling and marketing two-way cable transmission products. Certain of our competitors have established relationships with cable system operators and telephone companies ("telcos"), and ISPs, including @Home, and, based on these relationships, may have more direct access to the decision-makers of such cable system operators and telcos. In addition, we could face potential competition from certain of our suppliers, such as Sharp, if it were to launch or license competitive modems for sale to others. The adoption of the DOCSIS cable standard by large cable operators has adversely affected our ability to sell to cable customers, particularly new customers. Further, our products are not compatible with headend equipment and modems of other suppliers of broadband Internet access products, including DOCSIS products, and, as a result, potential customers who wish to purchase broadband Internet access products from multiple suppliers may be reluctant to purchase our products. WIRELESS CABLE COMPETITORS. Our principal competitors in the wireless broadband wireless market include Nortel Networks (which is active in Canada), Cisco Systems (which has proprietary products under development due to its acquisition of Clarity Wireless, Inc.), COM21 (which is attempting to adapt its proprietary cable systems for wireless), Phasecom and other vendors that may be attracted by recent investments by MCI Worldcom and Sprint in wireless operations. Stanford Telecommunications (which manufactures QPSK products) is providing wireless Internet connectivity over LMDS frequencies and has 29 added telephone service, which is potentially attractive to new operators. Stanford Telecom is the sole supplier for certain components used in our products and has indicated that they might stop shipping these components to us. Our products have been more widely accepted in the broadband wireless market than in the cable market partly because the adoption of the DOCSIS standard has not had a significant effect on wireless customers. We believe that products meeting the present DOCSIS standard will not perform well over wireless. This belief is based on the performance of the adaptive equalizer in the modem in the presence of multiple signals, the power required from the transceiver in the return path and the probable disruption of the TDMA return path in the presence of noise or multi-path propagation. However, there can be no assurance that improvements in integrated circuit technology, transceiver output power levels or changes in the DOCSIS TDMA protocol will not allow systems developed for cable to perform effectively over wireless. One of the DOCSIS compliant vendors might also modify the DOCSIS equipment to a proprietary non-standard form to work over wireless. OTHER COMPETITION. Broadband wireless and cable system operators face competition from providers of alternative high speed connectivity systems. In the wireless high speed access market, broadband wireless system operators are in competition with satellite TV providers. In telephony networks, xDSL technology enables digitally compressed video signals to be transmitted through existing telephone lines to the home. Market acceptance of xDSL, or other wired technologies such as ISDN, or satellite technologies, such as DBS, could decrease the demand for our products. Recently, several companies, including Compaq, Intel, Microsoft, 3Com, Alcatel, Lucent, several RBOCs, MCI and others announced the formation of a group focused on accelerating the pace of ADSL service. Further, if any competing architecture or technology were to limit or halt the deployment of coaxial or HFC systems, our business could be materially adversely affected. 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. 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 a number of large cable operators, and this has adversely affected our ability to sell to cable customers, particularly new customers. Further, our products are not compatible with headend equipment and modems of other suppliers of broadband Internet access products, including DOCSIS products, and, as a result, potential customers who wish to purchase broadband Internet access products from multiple suppliers may be reluctant to purchase our products. Our products are not in compliance with the DAVIC specifications that are supported in Europe. The emergence of these standards has hurt our business, and the adoption of other industry standards in the future could have a further adverse effect. There are a number of competing technologies for providing high speed internet access. Alternative high speed connectivity technologies include wired technologies such as xDSL and ISDN. As indicated in "Competition" above, several large companies have announced the formation of a group to accelerate the pace of ADSL service. To the extent that customers view these or other alternative technologies as providing faster access or greater reliability or cost-effectiveness, sales of our products would be adversely affected. 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 the competitiveness of our products could be adversely affected. 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 advances, or our response might not be timely or cost-effective. Market acceptance of new technologies and 30 our failure to develop and introduce new products and enhancements to keep pace with technological developments could hurt our business. OUR MARKET IS NEW AND DEVELOPING, AND WE MUST DEPEND UPON CABLE AND WIRELESS OPERATORS. The market for broadband Internet access products has only recently begun to develop and is characterized by an increasing number of market entrants and competing technologies. Our success will depend primarily on our ability to sell our cable and wireless modem systems to cable system operators and broadband system operators and on their sales of our client modems to end-users. In selling to cable system operators, we face a number of difficulties. Our products are not in compliance with the DOCSIS standard that has been adopted by a number of large cable operators and which is preferred by @Home, which has adversely affected our sales. Also, our products are not compatible with the headend equipment or modems of other suppliers. Many cable system operators and their customers may be reluctant to adopt and commit to a technology such as ours which has not gained wide acceptance among their industry peers. Certain of our competitors have already established relationships in the cable market and with @Home, further limiting our ability to sell products to penetrate the market. The cable industry has undergone evolution and reorganization, which has adversely affected certain of our customer relationships. Moreover, the extent to which (and the manner in which) cable system operators will commit to providing broadband Internet access remains uncertain. Cable system operators have a limited number of programming channels over which they can offer services, and there can be no assurance that they will choose to provide Internet access. Cable service operators have little experience in providing Internet networks or launching, marketing and supporting Internet services, and providing such services will involve substantial capital expenditures. To the extent that cable service operators elect to provide Internet access, there is no assurance that they will choose to do so through our cable modem systems. We have become increasingly dependent on sales to broadband wireless system operators and distributors. Our net sales to customers in the broadband wireless industry increased from $2.4 million in 1997 to $4.7 million in 1998. The adoption of the DOCSIS standard, which has adversely affected our sales to cable system operators, has not had a significant effect on wireless customers. We believe that products meeting the present DOCSIS standard will not perform well over wireless, but this could change in the future as a result of modifications in the DOCSIS TDMA protocol, improvements in technology or other developments. Many broadband wireless system companies are in the early stage of development or are in need of capital to upgrade and expand their services in order to compete effectively with cable system operators, satellite TV and telcos. The weak financial condition of many wireless customers has adversely affected our sales to these customers and their ability to pay for the products we have shipped to them. The principal disadvantage of wireless cable is that it requires a direct line of sight between the wireless cable system operator's antenna and the customer's location and the installation of an antenna at the customer premises. Therefore, despite a typical range of up to 35 miles, a number of factors, such as buildings, trees or uneven terrain, can interfere with reception, thus limiting broadband wireless system operators' customer bases. We estimate that there were only approximately 1.0 million wireless video cable customers in the United States as of March 1998. In addition, current technical and legislative restrictions have limited the number of analog channels that wireless cable companies can offer in the most commonly used frequency bands to 33. In order to better compete with cable system operators, satellite TV and telcos, broadband wireless system operators have begun to examine the implementation of digital TV and/or Internet access to create new revenue streams. To the extent that such operators choose to invest in digital TV, such decisions will limit the amount of capital available for investment in deploying other services, such as Internet access. To the extent wireless operators choose to provide Internet access, there is no assurance that they will not select technologies other than our high speed modem system to do so (such as Internet plus telephony, or new equipment standards such as DOCSIS with which our products are not compatible). Moreover, broadband wireless system operators will require substantial capital to introduce and market Internet access products. There can be no assurance that broadband wireless system operators will have the capital to supply Internet services in a competitive environment. While many broadband wireless system operators 31 are currently utilizing telephone return for upstream data transmission, we believe that wireless operators will demand two-way wireless transmission as more of these entities obtain licenses for additional frequencies under the new FCC two-way authorization for MMDS frequencies released in September 1998. Currently, we are attempting to refine our products so as to satisfy the two-way transmission needs of broadband wireless system operators, and our customers have six headend installations in place to do this. But, there can be no assurance that we or our customers will be successful in our efforts to make this a commercially viable alternative to two-way cable. The failure of our products to gain market acceptance would hurt our business. WE DEPEND UPON A SMALL NUMBER OF CUSTOMERS. A small number of customers has accounted for a large portion of our net sales, and we expect this trend to continue. Our headend equipment and modems do not operate with other companies' headend equipment or modems, and, as a result, we are typically the sole source provider to our customers. The fact that our customer base is highly concentrated increases our risk of loss as a result of the loss of any of our principal customers. In 1998, RCN Corporation and Knology Holdings, Inc. accounted for 25% and 13% of our net sales, respectively. In 1997, RCN Corporation and Jones Intercable accounted for 13% and 12% of our net sales, respectively In 1998, Jones Intercable was sold to Comcast and ceased purchasing our products, which adversely affected our business. There is no assurance that RCN or Knology will continue as our customers. The loss of either of these customers or any of our other principal customers would hurt our business. THE SALES CYCLE FOR OUR PRODUCTS IS LENGTHY AND UNCERTAIN AND OUR OPERATING RESULTS FLUCTUATE WIDELY. 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 customers' internal procedures to complete the evaluation and to approve the large capital expenditures that are typically involved in purchasing our products. The sales cycle for our products has been lengthy, generally lasting three to nine months, and is subject to a number of significant risks, including customers' budgetary constraints and internal acceptance reviews. Because our sales cycle may be long and uncertain, and because we depend on a relatively few customers who place relatively large orders, any delay or loss of an order that is expected to be received 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. These factors, together with the other 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. 32 WE DEPEND ON KEY PERSONNEL. 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. Competition for such personnel is intense, and 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 have a material adverse effect on our business, operating results and financial condition. We carry a $1.5 million key-person life insurance policy on Mr. Ledbetter, our Chief Executive Officer. WE MAY BE UNABLE TO PROTECT OUR INTELLECTUAL PROPERTY. We rely on a combination of patent, trade secret, copyrights and trademark laws and contractual restrictions to establish and protect our intellectual property rights. We cannot assure you 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. (See Item 3 "Legal Proceedings.") 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 for us 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 third parties claiming that our products, software or asserted proprietary rights infringe the proprietary rights of third parties. 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 or 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 resources. As indicated above we were engaged during 1998 in an infringement lawsuit that we brought against two third parties. 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. (See "Patents" above and Item 3 "Legal Proceedings" below.) Nonetheless, we may find it necessary to institute further infringement litigation in the future. 33 DEFECTS IN OUR PRODUCTS COULD CAUSE PRODUCT RETURNS AND PRODUCT LIABILITY. Products as complex as those offered by us 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, set installation and equipment standards for communications systems. Further, regulation of our customers may adversely affect our business. VOLATILITY OF OUR STOCK PRICE. Our Common Stock has been delisted from the Nasdaq National Market and has not traded on Nasdaq since mid-June 1998. Until the filing of this report, there has not been current information regarding our business and financial condition for over one year, and our previous financial statements have been restated. As a result, it is difficult to estimate based on current information what the price for our Common Stock will be if and when our stock is actively traded on a public market. In addition, the market price of our Common Stock has fluctuated in the past and is likely to fluctuate in the future. INTERNATIONAL SALES COULD INVOLVE GREATER RISKS. To date, sales of our products outside of the United States have represented an insignificant portion of our net sales. 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 and political and economic instability. RISKS RELATED TO THE YEAR 2000 ISSUE. BACKGROUND. The "Year 2000 Issue" refers generally to the problems that some software, including firmware embedded in the Company's products, may have in determining the correct century for the year. For example, software with date-sensitive functions that is not Year 2000 compliant may not be able to distinguish whether "00" means 1900 or 2000, which may result in failures or the creation of erroneous results. OUR READINESS PLAN. We have developed a Year 2000 readiness plan for the current versions of our products. The plan includes development of corporate awareness, assessment, implementation (including remediation, upgrading and replacement of certain product versions), validation testing and contingency planning. We continue to respond to customer concerns about prior versions of our products on a case-by-case basis because we believe most products that could be affected have been withdrawn from service. We have largely completed our plan, except for contingency planning, with respect to the current versions of all of our products in an effort to assure that they are Year 2000 compliant. As a result of our readiness plan, substantially all of the current versions of each of our products currently offered for sale are Year 2000 compliant (with the exception of final quality assurance and customer network testing), when configured and used in accordance with the related documentation, and provided that the underlying operating system of the host machine and any other software used with or in the host machine or our products are also Year 34 2000 compliant. In some cases, our products require an upgrade which is either sold as a complete substitute or as a kit for in-service systems to be Year 2000 Compliant. We consider our products to be Year 2000 compliant if they have the ability to: (i) correctly handle date information needed for the December 31, 1999 to January 1, 2000 date change; (ii) function according to the product documentation provided for this date change without changes in operation resulting from the advent of a new century, assuming correct configuration; (iii) where appropriate, respond to two-digit date input in a way that resolves the ambiguity as to century in a disclosed, defined, and predetermined manner; and (iv) recognize year 2000 as a leap year. RISKS. Despite our testing and testing by our current customers, and any assurances from developers of products incorporated into our products, our products may contain undetected errors or defects associated with Year 2000 date functions. Also, certain prior versions of our products are not fully Year 2000 compliant and may remain in service. Known or unknown errors or defects in our products could result in delay or loss of revenue, diversion of development resources, damage to our reputation, or increased service and warranty costs, any of which could materially adversely affect our business. We do not currently have any information concerning the Year 2000 compliance status of our customers. If our customers suspend or defer investments in system enhancements or new products to address Year 2000 compliance problems, our business could be materially adversely affected. Some commentators have predicted significant litigation regarding Year 2000 compliance issues. Because this type of litigation lacks precedent, it is uncertain whether or to what extent we may be affected by it. We have an ongoing program in an effort to prevent any adverse effects caused by the Year 2000 Issue with regard to our mission critical internal information systems (including the third-party software for our management information systems, networks and desktop applications, and our hardware telecommunications technology). We expect to complete this program before the end of 1999. COSTS. We have funded our Year 2000 efforts from operating cash. While we do not expect such costs to be material, additional costs will be incurred related to Year 2000 programs for administrative personnel to manage our readiness plans, technical support for our product engineering and customer satisfaction. Although we are not currently aware of any material operational issues or costs associated with preparing our internal information systems for the Year 2000, we may experience material unanticipated problems and costs caused by undetected errors or defects in the technology used in our information systems. We can give no assurance that other material problems and costs will not arise in connection with Year 2000 compliance or that these problems and costs will not adversely affect our business. CONTINGENCY PLANNING. We have not developed a comprehensive contingency plan to address situations that may result if we are unable to achieve Year 2000 readiness of our critical operations. The cost of developing and implementing such a plan may itself be material. We are also subject to external forces that might generally affect industry and commerce, such as utility or transportation company Year 2000 compliance failures and related service interruptions. Were we to experience an unanticipated Year 2000 interruption, business operations could be seriously impaired for an indefinite period of time until remedial efforts could be achieved. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Not applicable. 35 ITEM 8. FINANCIAL STATEMENTS INDEX TO FINANCIAL STATEMENTS Independent Auditors Reports 37-38 Balance Sheets as of December 31, 1998 and 1997 39 Statements of Operations for the Years Ended December 31, 1998, 1997 and 1996 40 Statements for Stockholders' Equity for the Years Ended December 31, 1998, 1997 and 1996 41 Statements of Cash Flows for the Years Ended December 31, 1998, 1997 and 1996 42 Notes to Financial Statements 43 Schedule II - Valuation and Qualifying Accounts 76
36 INDEPENDENT AUDITORS REPORT The Stockholders and Board of Directors Hybrid Networks, Inc. San Jose, California We have audited the accompanying balance sheets of Hybrid Networks, Inc. as of December 31, 1998 and 1997, and the related statements of operations, stockholders' equity and cash flows for the years then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Hybrid Networks, Inc. as of December 31, 1998 and 1997, and the results of its operations and its cash flows for the years ended December 31, 1998 and 1997, in conformity with generally accepted accounting principles. The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 3 to the financial statements, the Company has suffered recurring losses from operations and has an accumulated deficit of $63,569,000, that raise substantial doubt about the Company's ability to continue as a going concern. Management's plans with regard to these matters are also described in Note 3. The financial statements do not include any adjustments relating to the recoverability and classification of reported asset amounts or the amounts and classification of liabilities that might result from the outcome of this uncertainty. As discussed in Note 1 to the financial statements, the Company has restated its 1997 financial statements for the application of revisions to its revenue recognition policy and for revisions in the valuation of warrants. /s/ HEIN + ASSOCIATES LLP HEIN + ASSOCIATES LLP Certified Public Accountants Orange, California April 23, 1999, except for the last two paragraphs of Note 16 which are as of May 5, 1999 37 REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors and Stockholders Hybrid Networks, Inc.: We have audited the balance sheet of Hybrid Networks, Inc. as of December 31, 1996 and the related statements of operations, stockholders' equity (deficit) and cash flows for the year ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Hybrid Networks, Inc. as of December 31, 1996 and the results of its operations and its cash flows for the year ended, in conformity with generally accepted accounting principles. PricewaterhouseCoopers LLP San Jose, California August 28, 1997 38 HYBRID NETWORKS, INC. BALANCE SHEETS (in thousands, except per share data)
December 31, --------------------------- 1998 1997 ----------- ----------- (restated - See Note 1) ASSETS Current assets: Cash and cash equivalents $ 3,451 $ 26,158 Restricted cash 515 - Short-term investments - 985 Accounts receivable, net of allowance for doubtful accounts of $200 in 1998 and $0 in 1997 1,433 1,128 Inventories 5,224 6,270 Prepaid expenses and other current assets 864 362 -------- -------- Total current assets 11,487 34,903 Property and equipment, net 3,438 1,808 Intangibles and other assets 495 2,354 -------- -------- Total assets $ 15,420 $ 39,065 -------- -------- -------- -------- LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Convertible debenture $ 5,500 $ 5,500 Current portion of capital lease obligations 465 410 Accounts payable 2,063 2,285 Accrued liabilities and other 4,271 2,913 -------- -------- Total current liabilities 12,299 11,108 Capital lease obligations, less current portion 365 618 Other long-term liabilities 54 36 -------- -------- Total liabilities 12,718 11,762 -------- -------- Commitments and contingencies ( Notes 3,7,9, 10 and 16) Stockholders' equity: Convertible preferred stock, $.001 par value: Authorized: 5,000 shares; Issued and outstanding: no shares in 1998 or 1997 - - Common stock, $.001 par value: Authorized: 100,000 shares; Issued and outstanding: 10,473 shares in 1998 and 10,345 shares in 1997 10 10 Additional paid-in capital 66,261 66,145 Unrealized gain on available-for-sale securities - 92 Accumulated deficit (63,569) (38,944) -------- -------- Total stockholders' equity 2,702 27,303 -------- -------- Total liabilities and stockholders' equity $ 15,420 $ 39,065 -------- -------- -------- --------
The accompanying notes are an integral part of these financial statements. 39 HYBRID NETWORKS, INC. STATEMENTS OF OPERATIONS (in thousands, except per share data)
Year Ended December 31, ---------------------------------------------- 1998 1997 1996 -------- -------- -------- (restated - See Note 1) Net sales $ 12,418 $ 4,120 $ 2,962 Cost of sales 14,046 8,899 3,130 -------- -------- -------- Gross loss (1,628) (4,779) (168) -------- -------- -------- Operating expenses: Research and development 7,771 7,831 5,076 Sales and marketing 3,642 4,678 1,786 General and administrative 8,933 2,964 1,714 Asset impairment charge 1,250 - - Write off of technology license 1,283 - - -------- -------- -------- Total operating expenses 22,879 15,473 8,576 -------- -------- -------- Loss from operations (24,507) (20,252) (8,744) Interest income and other expenses, net 779 316 257 Interest expense (897) (1,666) (28) -------- -------- -------- Net loss $(24,625) $(21,602) $ (8,515) -------- -------- -------- -------- -------- -------- Basic and diluted loss per share $ (2.37) $ (6.10) $ (3.36) -------- -------- -------- -------- -------- -------- Shares used in basic and diluted per share calculation 10,410 3,541 2,535 -------- -------- -------- -------- -------- --------
The accompanying notes are an integral part of these financial statements. 40 HYBRID NETWORKS, INC. STATEMENTS OF STOCKHOLDERS' EQUITY (in thousands)
Preferred Stock Common Stock Additional ---------------- ---------------- Paid-in Shares Amount Shares Amount Capital ------- ------ ------ ------ ---------- Balances, January 1, 1996 8,363 $ 8 2,497 $ 2 $ 12,478 Exercise of common stock options - - 65 - 34 Repurchase of common stock - - (42) - (9) Issuance of Series B preferred stock upon net exercise of warrants 248 - - - - Issuance of Series G preferred stock for cash and conversion of notes payable, net of issuance costs of $704 3,458 4 - - 12,534 Net loss - - - - - Comprehensive loss ------- ---- ------ ---- -------- Balances, December 31, 1996 12,069 12 2,520 2 25,037 Exercise of common stock options - - 150 - 94 Repurchase of common stock - - (12) - (7) Grant of stock bonus awards - - 13 - 26 Issuance of common stock for services rendered - - 9 - 181 Issuance of Series H preferred stock 494 1 1,999 Issuance of warrants in connection with convertible subordinated notes - - - - 870 Issuance of warrants in connection with technology support and development agreement - - - - 2,200 Issuance of common stock, net of issuance costs of $1,185 - - 2,836 3 35,737 Conversion of preferred stock to common stock (12,563) (13) 4,653 5 8 Issuance of common stock upon net exercise of warrants - - 176 - - Unrealized gain on investments - - - - - Net loss - - - - - Comprehensive loss - - - - - ------- ---- ------ ---- -------- Balances, December 31, 1997 - - 10,345 10 66,145 Exercise of common stock options - - 127 - 87 Grant of stock bonus awards - - 1 5 Charge due to acceleration of options - - - - 24 Reclassification for gains included in net loss - - - - - Net loss - - - - - Comprehensive loss - - - - - ------- ---- ------ ---- -------- Balances, December 31, 1998 - $ - 10,473 $ 10 $ 66,261 ------- ---- ------ ---- -------- ------- ---- ------ ---- -------- Accumulated Other Comprehensive Accumulated Comprehensive Income(loss) Deficit Total Loss -------------- ----------- --------- ------------- (restated - See Note 1) Balances, January 1, 1996 $ - $ (8,827) $ 3,661 Exercise of common stock options - - 34 Repurchase of common stock - - (9) Issuance of Series B preferred stock - upon net exercise of warrants - - - Issuance of Series G preferred stock - for cash and conversion of notes payable, - net of issuance costs of $704 - - 12,538 Net loss - (8,515) (8,515) $ (8,515) -------- Comprehensive loss $ (8,515) ----- -------- -------- -------- -------- Balances, December 31, 1996 - (17,342) 7,709 Exercise of common stock options - - 94 Repurchase of common stock - - (7) Grant of stock bonus awards - - 26 Issuance of common stock for - services rendered - - 181 Issuance of Series H preferred stock - - 2,000 Issuance of warrants in connection - with convertible subordinated notes - - 870 Issuance of warrants in connection - with technology support and development agreement - - 2,200 Issuance of common stock, net of - issuance costs of $1,185 - - 35,740 Conversion of preferred stock - to common stock - - - Issuance of common stock upon net - exercise of warrants - - - Unrealized gain on investments 92 - 92 $ 92 Net loss - (21,602) (21,602) (21,602) -------- Comprehensive loss - - - $(21,510) ----- -------- -------- -------- -------- Balances, December 31, 1997 92 (38,944) 27,303 Exercise of common stock options - - 87 Grant of stock bonus awards - - 5 Charge due to acceleration of options - - 24 Reclassification for gains included in net loss (92) - (92) $ (92) Net loss - (24,625) (24,625) (24,625) -------- Comprehensive loss - - - $(24,717) ----- -------- -------- -------- -------- Balances, December 31, 1998 $ - $(63,569) $ 2,702 ----- -------- -------- ----- -------- --------
The accompanying notes are an integral part of these financial statements. 41 HYBRID NETWORKS, INC. STATEMENTS OF CASH FLOWS (in thousands)
Year Ended December 31, ----------------------------------- 1998 1997 1996 ---------- ---------- ---------- (restated - See Note 1) Cash flows from operating activities: Net loss $(24,625) $(21,602) $ (8,515) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization 1,883 1,130 322 Asset impairment charge 1,250 - - Provision for doubtful accounts 200 - - Provision for excess and obsolete inventory 1,691 2,759 126 Common stock issued for services rendered - 181 - Stock bonus 5 26 - Charge for accelerated vesting of options 24 - - Interest related to issuance of warrant in connection with convertible subordinated note - 870 - Write off technology license 1,283 - - Change in assets and liabilities: Restricted cash (515) - - Accounts receivable (505) 220 (1,061) Inventories (645) (8,086) (873) Prepaid expenses and other current assets (502) (237) (115) Accounts payable (222) 861 1,144 Accrued liabilities 1,376 2,201 395 -------- -------- -------- Net cash used in operating activities (19,302) (21,677) (8,577) -------- -------- -------- Cash flows from investing activities: Purchase of property and equipment (3,907) (629) (321) Disposal of property and equipment 74 - - Change in other assets (74) (37) (26) Purchase of short-term investments (11,772) (893) - Proceeds from disposal of short-term investments 12,665 - 490 -------- -------- -------- Net cash provided by (used in) investing activities (3,014) (1,559) 143 -------- -------- -------- Cash flows from financing activities: Repayment of capital lease obligations (478) (320) (106) Net proceeds from issuance of preferred stock - 2,000 9,378 Net proceeds from issuance of common stock 87 35,835 34 Repurchase of common stock - (7) (9) Proceeds from issuance of convertible subordinated note payable and related common stock warrants - 6,882 - Repayment of convertible subordinated note payable and related common stock warrants - (6,882) Net proceeds from issuance of convertible debenture - 5,000 3,160 -------- -------- -------- Net cash provided by (used in) financing activities (391) 42,508 12,457 -------- -------- -------- Increase (Decrease) in cash and cash equivalents (22,707) 19,272 4,023 Cash and cash equivalents, beginning of period 26,158 6,886 2,863 -------- -------- -------- Cash and cash equivalents, end of period $ 3,451 $ 26,158 $ 6,886 -------- -------- -------- -------- -------- -------- SUPPLEMENTAL SCHEDULE OF NONCASH FINANCING ACTIVITIES: Conversion of notes payable into preferred stock $ - $ - $ 3,160 Property and equipment acquired under capital leases 280 688 472 Issuance of warrants in connection with technology support and development agreement - 2,200 - SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: Interest paid 802 718 28 Income taxes paid 1 1 1
The accompanying notes are an integral part of these financial statements. 42 HYBRID NETWORKS, INC. NOTES TO FINANCIAL STATEMENTS 1. RESTATEMENT OF FINANCIAL STATEMENTS Subsequent to the filing of its Annual Report on Form 10-K for the year ended December 31, 1997 with the Securities and Exchange Commission, the Company became aware of errors and irregularities that ultimately affected the timing and dollar amount of reported sales from product shipments in 1997 and the first quarter of 1998. The Company undertook and completed extensive procedures related to product sales in 1997 and the first quarter of 1998. As a result of these findings and other relevant information now known or disclosed, the Company has determined that a significant number and dollar amount of product shipments were improperly reported as sales in the aforementioned periods. The Company has determined that revenue is earned and should be recorded only after any related obligations have been satisfied (i.e. when there are no longer any significant remaining uncertainties related to the earnings process). This revenue recognition policy has been followed for all transactions with customers reflected in these financial statements. Additionally, during 1998 the Company became aware that warrants to purchase common stock issued and outstanding in 1997 had not been properly valued, resulting in an understatement of operating expenses and interest expense. These warrants have now been properly valued and reflected in the financial statements. 43 As a result of the above, the statement of operations for the year ended December 31, 1997 has been restated as follows:
1997 ------------------------------ Previously Restated Reported ------------- ------------ Net sales $ 4,120 $ 14,270 Cost of sales 8,899 12,258 -------- -------- Gross profit (loss) (4,779) 2,012 -------- -------- Operating expenses: Research and development 7,831 7,108 Sales and marketing 4,678 4,319 General and administrative 2,964 3,606 -------- -------- Total operating expenses 15,473 15,033 -------- -------- Loss from operations (20,252) (13,021) Interest income and other expenses, net 316 399 Interest expense (1,666) (968) -------- -------- Net loss $(21,602) $(13,590) -------- -------- -------- -------- Basic and diluted loss per share $ (6.10) $($3.84) -------- -------- -------- -------- Shares used in basic and diluted per share calculation 3,541 3,541 -------- -------- -------- --------
2. FORMATION AND BUSINESS OF THE COMPANY The Company, which was incorporated in Delaware on June 6, 1990, is a broadband access equipment company that designs, develops, manufactures and markets wireless and cable systems that provide high speed access to the Internet and corporate intranets for both businesses and consumers. The Company's products remove the bottleneck over the local connection to the end user which causes slow response time for those accessing bandwidth intensive information. 3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES BASIS OF PRESENTATION The accompanying financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. As shown in the 44 financial statements, during 1998, 1997 and 1996, the Company incurred net losses of approximately $24,625,000, $21,602,000 and $8,515,000, respectively. Additionally, the Company had accumulated deficits of $63,569,000 and $38,944,000 at December 31, 1998 and 1997, respectively, and is highly dependent on its ability to obtain sufficient additional financing in order to fund the current and planned operating levels. Additionally, the Company is subject to a number of lawsuits involving substantial dollar amounts, and is subject to an official investigation by the Securities and Exchange Commission regarding its financial reporting practices (See Note 10). These factors among others raise substantial doubt about the ability of the Company to continue as a going concern for a reasonable period of time. The financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts or the amounts and classification of liabilities that might be necessary should the Company be unable to continue as a going concern. The Company's continuation as a going concern is dependent upon its ability to obtain additional financing to continue its product development and marketing plans and to fund other general operating expenses, achievement of a financially satisfactory resolution to outstanding litigation and the SEC investigation, and ultimately is dependent upon its ability to obtain sufficient customer demand to attain profitable operations. No assurance can be given that the Company will be successful in these efforts. CHANGE IN FISCAL YEAR In 1997, the Company changed its fiscal year end from March 31, to December 31, effective January 1, 1992. USE OF ESTIMATES The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The Company's financial statements are based upon a number of significant estimates, including the estimated useful lives selected for property and equipment, accrued liabilities related to product warranties and litigation, and valuation allowances for accounts receivable, inventory and property and equipment. Due to uncertainties inherent in the estimation process, it is at least reasonably possible that these estimates will be further revised in the near term and such revisions could be material. FAIR VALUE OF FINANCIAL INSTRUMENTS, BUSINESS RISKS AND CREDIT CONCENTRATION The carrying amounts of certain of the Company's financial instruments including cash and cash equivalents, short-term cash investments, accounts receivable, accounts payable, capital leases, convertible debenture and other accrued liabilities' approximate fair value due to their short maturities. The Company sells its products primarily to cable system operators, broadband wireless system operators, Internet Service Providers, third party distributors and other companies that provide broadband networking systems or services, principally in North America. The Company performs ongoing credit evaluations of its customers and does not require collateral. The Company also maintains allowances for potential losses on collectability of accounts receivable, as needed, and such losses have been within Management's expectations. 45 The Company operates in the intensely competitive and rapidly changing communications industry which has been characterized by rapid technological change, evolving industry standards and federal, state and local regulation which may impede the Company's penetration of certain markets. The Company currently operates with one product line. The Company's future success depends upon its ability to develop, introduce and market new products, its ability to obtain components from key suppliers, obtaining sufficient manufacturing capacity, and the success of the broadband access business. The Company may experience future fluctuations in operating results and declines in selling prices. CASH AND CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS Cash equivalents consist of highly liquid investment instruments with a maturity at the time of purchase of three months or less. Instruments with a maturity at the time of purchase of greater than three months but less than one year from the date of purchase are included in short-term investments. The Company's cash and cash equivalents as of December 31, 1997 included corporate commercial paper which was classified as available for sale. Accordingly, the investments were carried at fair value and unrealized holding gains of $92,000 were recorded in stockholders' equity. INVENTORIES Inventories are stated at the lower of cost (first-in, first-out basis) or market. PROPERTY AND EQUIPMENT Property and equipment are recorded at cost. Depreciation is computed on a straight-line basis over the estimated useful lives of two to five years. Leasehold improvements are amortized over the lesser of their estimated useful lives or the lease term. The cost of normal maintenance and repairs is charged to operations as incurred. Material expenditures which increase the life of an asset are capitalized and depreciated over the estimated remaining useful life of the asset. The cost of fixed assets sold, or otherwise disposed of, and the related accumulated depreciation or amortization is removed from the accounts, and any gains or losses are reflected in current operations. INTANGIBLES AND OTHER ASSETS Intangibles and other assets include deferred financing costs relating to fees incurred in connection with the issuance of a senior convertible debenture in April 1997 and, at December 31, 1997, the value assigned to the purchase of certain technologies relating to a technology support and development agreement signed in November 1997. In connection with entering into the technology support and development agreement, the Company issued a five-year warrant to purchase 458,295 shares of Common Stock at an exercise price of $10.91 per share. The amount attributed to the value of the warrants was $2,200,000. The deferred financing costs are amortized over the five year life of the debenture (see Note 7). The unamortized value of the technologies of approximately $1,283,000 was charged to expense in the second quarter of 1998 as it was determined to be of no further value to the Company. Total accumulated amortization as of December 31, 1998 and 1997 was $178,000 and $408,000, respectively. The Company periodically assesses the recoverability of intangible assets by determining whether the amortization of the asset balance over the remaining life can be recovered through undiscounted future operating cash flows. The amount of impairment, if any, is measured based on projected discounted future operating cash flows and is recognized as a write down of the asset to a net realizable value. REVENUE RECOGNITION The Company normally ships its products based upon a bona fide Purchase Order and Volume Purchase Agreement. The Company generally recognizes its revenue at the time a transaction is shipped and 46 collection of the resulting account receivable is probable. Shipments on customer orders with either acceptance criteria, installation criteria, or rights of return are recognized as revenue only when the criteria are satisfied according to the contract. Revenue related to shipments to distributors is normally recognized upon sell-through which is generally signified by receipt of payment for such transactions. For Cybermanager 2000, the hardware and software sales are generally bundled with upgrade, maintenance and system support and service and sold for a period of three years. Revenue attributed to hardware is recognized upon shipment. Revenue attributed to software is recognized over the three year maintenance, system support and service period. When a maintenance contract is sold separately, the revenue is recognized ratably over the term of the maintenance contract, generally on a straight-line basis. Where maintenance revenue is not separately invoiced, it is unbundled from hardware and software license revenue and deferred for revenue recognition purposes. Other service revenue, primarily training and consulting, is generally recognized at the time the service is performed. The Company accrues for estimated warranty costs when the related sales revenue is recognized. The Company's third party manufacturer provides a fifteen month warranty period on all cable modems manufactured by them. The warranty period begins on the date the modems are completely assembled. The Company provides a twelve month warranty on all headend equipment sold. Actual warranty costs incurred have not differed materially from those estimated and accrued by the Company. PRODUCT DEVELOPMENT COSTS Costs related to research, design and development of products are charged to research and development expenses as incurred. Software development costs are included in research and development and are expensed as incurred. Statement of Financial Accounting Standards No. 86 (SFAS 86) requires the capitalization of certain software development costs from when technological feasibility is established, which the Company defines as completion of a working model, to when the software is available for sale to the Company's customers. The capitalized cost is then amortized on a straight-line basis over the estimated product life, or on the ratio of current revenues to total projected product revenues, whichever is greater. To date, the period between achieving technological feasibility and the general availability of such software has been short and software development costs qualifying for capitalization have been insignificant. Accordingly, the Company has not capitalized any software development costs. STOCK-BASED COMPENSATION The Company has elected to follow Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25") and related interpretations in accounting for its employee stock options. In accordance with Statement of Financial Accounting Standards No. 123 (SFAS. 123), "Accounting for Stock-Based Compensation," the Company will disclose the impact of adopting the fair value accounting of employee stock options. Transactions in equity instruments with non-employees for goods or services have been accounted for using the fair value method prescribed by SFAS 123. 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. COMPREHENSIVE INCOME (LOSS) 47 Effective January 1, 1998, the Company adopted Statement of Financial Accounting Standards No. 130 (SFAS No. 130), "Reporting Comprehensive Income." SFAS No. 130 requires that all items recognized under accounting standards as comprehensive income be reported in an annual financial statement that is displayed with the same prominence as other annual financial statements. Comprehensive income (loss) includes all changes in equity (net assets) during a period from nonowner sources. Examples of items to be included in comprehensive income, which are excluded from net income (loss), include foreign currency translation adjustments and unrealized gain/loss on available-for-sale securities. The Company has presented comprehensive income (loss) for each period presented within the Statements of Stockholder's Equity. NEW ACCOUNTING PRONOUNCEMENTS In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS 133"). The new standard requires companies to record derivatives on the balance sheet as assets or liabilities, measured at fair value. Under SFAS 133, gains or losses resulting from changes in the values of derivatives are to be reported in the statement of operations or as a deferred item, depending on the use of the derivatives and whether they qualify for hedge accounting. The key criterion for hedge accounting is that the derivative must be highly effective in achieving offsetting changes in fair value or cash flows of the hedged items during the term of the hedge. The Company is required to adopt SFAS 133 in the first quarter of 2000. The Company currently transacts substantially all of its revenues and costs in U.S. dollars and to date has not entered into any material amounts of derivative instruments. Accordingly, management does not currently expect adoption of this new standard to have a significant impact on the Company. Statement of Financial Accounting Standards No. 132, "Employers Disclosures about Pensions and Other Postretirement Benefits" and Statement of Financial Accounting Standards No. 134, "Accounting for Mortgage-Backed Securities Retained after the Securitization of Mortgage Loans Held for Sale by a Mortgage Banking Enterprise" were issued in 1998 and are not expected to impact the Company's future financial statement disclosures, results of operations or financial position. RECLASSIFICATIONS Certain reclassifications have been made to the 1997 and 1996 financial statements in order to conform to the 1998 presentation. Such reclassifications had no effect on the previously reported net loss. 4. INVENTORIES Inventories are comprised of the following (in thousands):
December 31, ------------------------ 1998 1997 ----------- ----------- (restated) Raw materials $1,371 $2,175 Work in progress 386 229 Finished goods 3,467 3,866 ------ ------ $5,224 $6,270 ------ ------ ------ ------
48 The allowance for excess and obsolete inventory was $3,135,000 and $3,015,000 at December 31, 1998 and 1997, respectively. The provision for excess and obsolete inventory included in cost of sales was $1,691,000, $2,759,000 and $126,000 for the years ended December 31, 1998, 1997 and 1996, respectively. 5. PROPERTY AND EQUIPMENT Property and equipment consist of the following (in thousands):
December 31, ------------------------ 1998 1997 ----------- ----------- Machinery and equipment $ 3,048 $ 2,780 Office furniture and fixtures 737 164 Leasehold improvements 1,914 110 ------- ------- 5,699 3,054 Less accumulated depreciation and amortization (2,261) (1,246) ------- ------- $ 3,438 $ 1,808 ------- ------- ------- -------
Furniture and equipment under capital leases included in the above table total $1,691,000 and $920,000, net of accumulated amortization of $1,005,000 and $541,000 as of December 31, 1998 and 1997, respectively. Depreciation and amortization expense related to property and equipment was $1,233,000, $687,000 and $162,000 for the years ended December 31, 1998, 1997, and 1996, respectively. Due to the underutilization of the Company's San Jose headquarters, the 1998 financial statements include a fourth quarter charge of $1,250,000 reflecting the impairment of leasehold improvements and office furniture and fixtures. 6. CONVERTIBLE SUBORDINATED NOTE PAYABLE In September 1997, the Company entered into a Convertible Subordinated Promissory Note Purchase Agreement to issue $6,882,000 of subordinated notes at 10% interest (increasing to 18% after March 30, 1998 under certain circumstances). The principal amount of the notes was payable at the earlier of September 30, 1998 or the effective date of an initial public offering of the Company's common stock. In connection with the Convertible Subordinated Note Purchase Agreement, the Company issued warrants to purchase 252,381 shares of its common stock at $10.91 per share. The warrant was exercisable at the earlier of 180 days after issuance or the effective date of an initial public stock offering and expires in five years. The amount attributed to the value of the warrants was $870,000 which was charged to interest expense upon repayment of the notes. At December 31, 1997 no amount was outstanding under the convertible subordinated note payable. 49 7. CONVERTIBLE DEBENTURE On April 30, 1997, the Company issued a senior convertible secured debenture in the amount of $5,500,000, bearing interest at 12% per annum, payable quarterly, and maturing on April 30, 2002. An arrangement fee of $500,000 was paid by the Company. The debenture is convertible, at the option of the holder, at any time, into common stock at $10.71 per share. If the Company issues any shares (with certain exceptions for employee stock options and the like) for consideration less then $10.71 per share, any such issuance would be subject to certain "weighted average" antidilution provisions. The debenture is collaterized by certain of the Company's assets. The Company may not make any plant or fixed capital expenditures in excess of $1,500,000, $2,500,000, $5,500,000 and $11,000,000 during the twelve months ending March 31, 1998, 1999, 2000 and 2001, respectively. Additionally, the Company may, among other things, not declare dividends, retire any subordinated debt other than in accordance with its terms, or distribute its assets to any stockholder as long as the debenture remains outstanding. The Company's capital expenditures have exceeded the maximum capital expenditures allowed for the twelve months ending March 31, 1999. Consequently, the debt has been classified as a current liability in the accompanying financial statements as the holder has the right to declare a default under the convertible debenture at any time. 8. ACCRUED LIABILITIES AND OTHER Accrued liabilities and other consists of the following (in thousands):
December 31, ------------------------ 1998 1997 ----------- ----------- (restated) Accrued payroll and related accruals $ 385 $ 954 Accrued class action settlement and related legal expenses 1,946 - Deferred revenue and customer deposits 1,381 1,448 Other liabilities 559 511 ------ ------ $4,271 $2,913 ------ ------ ------ ------
50 9. LEASE OBLIGATIONS The Company entered into certain non-cancelable operating and capital lease commitments which expire at various dates through April 2004. Capital leases bear interest at rates ranging from 7.6% to 10.1%. Future minimum lease payments under all non-cancelable leases are as follows (in thousands):
Capital Operating Leases Leases --------- --------- 1999 $ 516 $ 839 2000 352 899 2001 30 899 2002 - 950 2003 - 975 Thereafter - 406 ------- ------- 898 $ 4,968 Less amount representing interest (68) ------- ------- ------- 830 Less current portion (465) ------- $ 365 ------- -------
Rent expense for 1998, 1997 and 1996 was approximately $955,000, $494,000 and $263,000, respectively. The Company's only long-term operating lease is for approximately 55,000 square feet of office, research and development and manufacturing space in San Jose, CA. This sublease expires in April 2004. 10. CONTINGENCIES CLASS ACTION LITIGATION In June 1998, five class action lawsuits were filed in San Mateo County Superior Court, California against the Company, its five directors (one of whom is an officer), two former officers and one former director. The lawsuits were brought on behalf of purchasers of the Company's Common Stock during the class period commencing November 12, 1997 (the date of the Company's initial public offering) and ending June 1, 1998. In July 1998, a sixth class action lawsuit was filed in the same court against the same defendants, although the class period was extended to June 18, 1998. All six lawsuits also named as defendants the underwriters in the Company's initial public offering, but the underwriters have since been dismissed from the cases. The complaints in these lawsuits claim that the Company and the other defendants violated the anti-fraud provisions of the California securities laws, alleging that the financial statements used in connection with the Company's initial public offering and the financial statements issued subsequently during the class period, as well as related statements made on behalf of the Company during the initial public offering and subsequently regarding the Company's past and prospective financial condition and results of operations, were false and misleading. The complaints also allege that the Company and the other defendants made 51 these misrepresentations in order to inflate the price of the Company's Common Stock stock for the initial public offering and during the class period. The Company and the other defendants denied the charges of wrongdoing. In July and August 1998, two class action lawsuits were filed in the U.S. District Court for the Northern District of California. Both of these federal class action lawsuits were brought against the same defendants as the six state court class actions referred to above, except that the second federal class action lawsuit also named as a defendant PwC, the Company's former independent accountants. (The underwriters in the Company's initial public offering were named as defendants in the first federal class action lawsuit but were subsequently dismissed.) The class period for the first federal class action lawsuit is from November 12, 1997 to June 1, 1998, and the class period in the second class action lawsuit extends to June 17, 1998. The complaints in both federal class action lawsuits claim that the Company and the other defendants violated the anti-fraud provisions of the federal securities laws, on the basis of allegations that are similar to those made by the plaintiffs in the state class action lawsuits. The Company and the other defendants denied these charges of wrongdoing. In March 1999, the Company and the other parties (other than PwC) to the state class action lawsuits and the federal class action lawsuits reached an agreement in principle to settle the lawsuits. The agreement is subject to the parties' entering into a binding stipulation of settlement and approval by the U.S. District Court for the Northern District of California. Under the agreement in principle, (i) the Company's insurers would pay $8.8 million on the Company's behalf (and on behalf of the other officer and director defendants), (ii) the Company would issue 3.0 million shares of Common Stock to the plaintiffs (the number of shares would be increased proportionately to the extent that there are more than 10.5 million shares of Common Stock outstanding on the date of distribution so that, as of such date, the plaintiffs would hold approximately 22.6% of all of the shares of the Company's Common Stock that are then outstanding), (iii) if the Company is acquired within nine months after March 9, 1999, the date of the agreement in principle, then, in addition to the consideration referred to in (i) and (ii), the Company would pay to the plaintiffs an amount equal to 10% of the consideration received by the Company's stockholders in the acquisition. As a result of the agreement in principle and a related agreement between the Company and its insurers, it has paid, and will not be reimbursed by its insurers for, $1.2 million in attorneys fees and other litigation expenses that would otherwise be covered by its insurance, and the Company will not have insurance coverage for the attorneys fees and expenses relating to the settlement that it incurs in the future. As of December 31, 1998 the Company has accrued $1,547,000 for the value of the 3,000,000 shares to be issued in the settlement. SEC INVESTIGATION In October 1998, the Securities and Exchange Commission began a formal investigation of the Company and unidentified individuals with respect to the Company's financial statements and public disclosures. The Company has been producing documents in response to the Securities and Exchange Commission's subpoena and is cooperating with the investigation. A number of current and former officers and employees and outside directors have testified or may testify before the Securities and Exchange Commission's staff. The Company does not believe, based on current information, that this investigation will have a material adverse impact on the Company's financial statements. PATENT LITIGATION In January 1998, the Company brought a lawsuit in the U.S. District Court for the Eastern District of Virginia against Com21, Inc. and Celestica, Inc. in which the Company alleged that the defendants infringed the Company's patents. In response to the Company's lawsuit, Com21 initiated a declaratory judgment action six days later in the U.S. District Court for the Northern District of California to obtain a declaration that the Company's patents are invalid and unenforceable and that in any event Com21 did not infringe them. In February 1998, the action in the Eastern District of Virginia was transferred to the Northern 52 District of California, and the two actions were consolidated. Pre-trial discovery continued in the consolidated action until September 1998 when the parties agreed to stay the proceedings while they attempted to reach a settlement. In January 1999, the Company entered into a settlement agreement with Com21, Inc. and Celestica, Inc. whereby the patent lawsuits were settled. Pursuant to the agreements, the Company granted Com21 and Celestica a nonexclusive license on the Company's patents under which they may be required to pay royalties in the event that they sell certain products in the future, subject to certain contingencies, and the Company granted to Com21 a right of first refusal to purchase the patents in the event that the Company should propose in the future to sell its patents (whether separately or together with the Company's other assets to any third party). The Company has agreed to pay its legal counsel in this action, as a partial contingency fee (in return for such counsel's acceptance of reduced current legal fees), an amount equal to 50% of any royalties that the Company receives from its license with the defendants in the litigation (but not in excess of $3,000,000). To date the Company has received virtually no royalties from the license. 11. STOCKHOLDERS' EQUITY REVERSE STOCK SPLIT In September 1997, the Company's Board of Directors approved a 1-for-2.7 reverse split of the Company's common stock and a corresponding change in the preferred stock conversion ratios. All common and preferred stock and per share amounts in these financial statements have been adjusted retroactively to give effect to the split. In addition, the Company's Board of Directors approved an Amended and Restated Certificate of Incorporation which eliminated the existing convertible preferred stock and changed the number of authorized shares of preferred stock to 5,000,000 shares, $0.001 par value, and increased the shares of common stock authorized to 100,000,000 shares. In October 1997, the stockholders of the Company approved the 1- for -2.7 reverse split of the Company's common stock and a corresponding change in the preferred stock conversion ratios. PREFERRED STOCK The Board of Directors has authorized the issuance of up to 5,000,000 shares of undesignated preferred stock and the Board has the authority to issue the undesignated preferred stock in one or more series and to fix the rights, preferences, privileges and restrictions thereof. No preferred stock was outstanding as of December 31, 1998 INITIAL PUBLIC OFFERING AND CONVERSION OF PREFERRED STOCK In November 1997, the Company filed a registration statement with the Securities and Exchange Commission permitting the Company to sell shares of its common stock to the public. The offering was completed on November 12, 1997. In connection with the Initial Public Offering, all outstanding shares of Preferred Stock were converted into shares of common stock. WARRANTS The Company has historically issued warrants in connection with its various rounds of financing, equipment lease lines, and transfers of technology. Warrants have been valued using the Black-Scholes Option Pricing Model. In connection with the issuance of Series G preferred stock in July 1996, and the 1996 equipment lease line, the Company issued warrants to purchase 58,021 and 5,802 shares of common stock, respectively, at $10.34 per share. These warrants are exercisable at any time and expire in July 2001 and August 2006, 53 respectively. The Company has reserved 63,823 shares of common stock for issuance upon exercise of these warrants. In connection with the issuance of convertible promissory notes in June 1996, which were later converted into Series G preferred stock, the Company issued warrants to purchase 167,037 shares of common stock at $4.73 per share. In connection with the issuance of Series D preferred stock May 1995, the Company issued warrants, at $.001 per warrant, to purchase 592,593 shares of common stock at $4.73 per share. In December 1997, a warrant to purchase 132,225 shares was exercised for a net exercise of 99,850 shares of common stock. The remaining warrants are exercisable at any time and expire in June 2001. The Company has reserved 627,405 shares of common stock for issuance upon exercise of these warrants. During 1996, the Company issued warrants, at $.001 per warrant, to purchase 76,245 shares of Common stock at $4.73 per share. In connection with technology transfered and the 1995 equipment lease line, the Company issued warrants to purchase 169,259 and 8,466 shares of common stock, respectively, at $4.73 per share. During 1996, a warrant to purchase 169,259 shares was exercised for a net exercise of 91,921 shares of common stock. The remaining warrants are exercisable at any time and expire in June 2001 and August 2005, respectively. The Company has reserved 84,710 shares of common stock for issuance upon exercise of these warrants. In September 1997, the Company issued warrants to purchase 252,381 shares of common stock in connection with the convertible subordinated notes payable, at an exercise price of $10.91. In October 1997, the Company issued warrants to purchase 2,659 shares of common stock in connection with obtaining a bank credit facility at an exercise price of $10.91. These warrants are exercisable at any time and expire in September and October 2002. In November 1997, warrants to purchase 151,267 shares of common stock were exercised for a net exercise of 76,096 shares of common stock. In November 1997, the Company issued a five year warrant to purchase 458,295 shares of common stock at an exercise price of $10.91 per share, in connection with a technology support and development arrangement. A summary of outstanding warrants as of December 31, 1998 follows:
Number Exercise Expiration Outstanding Price Date ----------- --------- ---------- 703,629 $4.73 June 2001 58,021 10.34 July 2001 458,295 10.91 November 2002 103,764 10.91 July 2002 8,466 4.73 August 2005 5,802 10.34 August 2006 --------- 1,337,977 --------- ---------
54 STOCK OPTION PLANS In September 1997, the Company adopted the 1997 Equity Incentive Plan and reserved a total of 1,750,000 shares for issuance to employees, officers, directors, consultants, independent contractors, and advisors. The number of shares outstanding will increase automatically by 5% of the outstanding shares each year unless waived by the Board of Directors. In addition, any shares that, upon the effective date of the 1997 plan, were available for the grant of options under earlier plans were rolled over and are available for issuance under the 1997 plan; also, any shares that subsequently become available under the earlier plans, roll over and become available for issuance under the 1997 plan. The 1997 Equity Incentive Plan expires in September 2007. Also in September 1997, the Company adopted the 1997 Directors' Stock Option Plan under which 100,000 shares of common stock have been reserved for issuance. The Directors' Plan provides for the grant of nonstatutory stock options to non-employee directors of the Company and expires in September 2007. In December 1996, the Company adopted the 1996 Equity Incentive Plan and reserved 185,185 shares of common stock for issuance to employees, officers, directors, consultants, independent contractors and advisors. In June 1997, the Company increased the number of shares reserved for issuance under the 1996 Equity Incentive Plan by 222,222. The 1996 Equity Incentive Plan expires in December 2006. In December 1995, the Company adopted the Executive Officer Incentive Plan and reserved 370,370 shares of common stock for issuance to the Company's chief executive officer and other senior executive officers. In 1996 and 1997, the Company increased the number of shares reserved under this plan by 129,630 and 62,963, respectively. In the event of a merger, consolidation, liquidation or similar change of control transaction as a result of which the participants' responsibilities and position with the Company are materially diminished, options granted under this plan become fully exercisable and remain so for one year thereafter. This plan will expire in December 2005. In October 1993, the Company adopted the 1993 Equity Incentive Plan, and reserved 185,185 shares of common stock for issuance to employees, officers, directors, consultants and advisors. In 1995, 1996 and 1997, the Company increased the number of shares reserved for issuance under the 1993 Equity Incentive Plan by 351,851, 425,925 and 66,340 shares, respectively. The 1993 Equity Incentive Plan expires in October 2003. Options, under all of the above plans, may be granted at prices not less than fair market value at the date of grant, as determined by the Board of Directors, in case of incentive options (110% in certain instances), and not less than 85% of fair market value at the date of grant, as determined by the Board of Directors, in case of nonqualified options, restricted stock awards and stock bonus awards (100% in certain instances). Options and stock awards generally vest 12.5% six months from date of grant and 2.0833% per month thereafter; stock options expire three months after termination of employment and five years from date of grant. 55 Activity under the Plans is set forth below (in thousands, except per share data):
Weighted Value of Average Shares Options Options Exercise Available Outstanding Outstanding Price --------- ----------- ----------- -------- Balances, January 1, 1996 696 309 $ 146 $ 0.47 Additional shares reserved 741 - - - Options granted (1,267) 1,267 865 0.68 Stock repurchased 11 - - - Options canceled 32 (32) (14) 0.44 Options exercised - (65) (34) 0.65 ------ ----- ------- Balances, December 31, 1996 213 1,479 963 0.65 Additional shares reserved 2,409 - - - Options granted (862) 862 5,332 6.19 Stock bonus awards (13) - - - Stock repurchased 12 - - - Options canceled 265 (265) (316) 1.19 Options exercised - (150) (94) 0.13 ------ ----- ------- Balances, December 31, 1997 2,024 1,926 5,885 3.06 Options granted (1,445) 1,445 4,527 3.13 Stock bonus award (1) - - - Options canceled 511 (511) (1,871) 3.66 Options exercised (125) (87) 0.70 ------ ----- ------- Balances, December 31, 1998 1,089 2,735 $ 8,454 $ 3.09 ------ ----- ------- ------ ----- -------
For the years ended December 31, 1998, 1997 and 1996, the weighted average fair value of options granted was $2.34, $1.40 and $0.81 per share, respectively. 56 As of December 31, 1998, the stock options outstanding were as follows (in thousands, except per share data):
Weighted Average Weighted Weighted Range of Remaining Average Average Exercise Number Contractual Exercise Number Exercise Prices Outstanding Life (Years) Price Exercisable Price --------------- --------------- --------------- --------------- --------------- --------------- $0.27 to $0.54 790 2.16 $ 0.54 558 $ 0.54 $1.08 to $2.19 1,136 4.52 2.08 72 1.34 $2.70 to $5.13 304 4.90 3.98 101 3.76 $5.31 to $9.75 283 3.89 7.04 111 6.72 $11.04 to $11.05 223 3.73 11.04 75 11.04 ----------- -------- 2,736 3.75 $ 3.09 917 $ 2.56 ----------- -------- ----------- --------
As of December 31, 1997 and 1996, options to purchase 539,000 and 294,000 shares were exercisable at an average weighted exercise price of $0.76 and $0.54 per share, respectively. The Company has elected to continue to follow the provisions of APB No.25, "Accounting for Stock Issued to Employees," for financial reporting purposes and has adopted the disclosure-only provisions of SFAS No.123 ("SFAS No.123"). Accordingly, no compensation cost has been recognized for the Company's stock option plans. Had compensation cost for the Company's stock option plans been determined based on the fair value at the grant date for awards in years ended 1998, 1997 and 1996 consistent with the provisions of SFAS No.123, the Company's net loss and net loss per share for 1998, 1997, and 1996 would have been increased to the pro forma amounts indicated below (in thousands, except per share amounts):
Year Ended December 31, ------------------------------------------------- 1998 1997 1996 ------------ ------------ ------------ Net loss as reported $(24,625) $(21,602) $ (8,515) -------- -------- -------- -------- -------- -------- Net loss - pro forma $(25,109) $(21,670) $ (8,548) -------- -------- -------- -------- -------- -------- Net loss per share - as reported $ (2.37) $ (6.10) $ (3.36) -------- -------- -------- -------- -------- -------- Net loss per share - pro forma $ (2.41) $ (6.12) $ (3.37) -------- -------- -------- -------- -------- --------
57 The above pro forma disclosures are not necessarily representative of the effects on reported net income or loss for future years. In accordance with the provisions of SFAS No. 123, the fair value of each option is estimated using the following weighted average assumptions for grants during 1998, 1997 and 1996: dividend yield of 0%, volatility of 0% for options issued prior to the Company's Initial Public Offering, 75% thereafter in 1997, and 113% in 1998, risk-free interest rates of 5.5% to 6.7% at the date of grant and an expected term of four years. EMPLOYEE STOCK PURCHASE PLAN In September 1997, the Company's Board of Directors approved an Employee Stock Purchase Plan. Under this plan, employees of the Company can purchase Common Stock through payroll deductions. A total of 225,000 shares have been reserved for issuance under this plan. As of December 31, 1998, no shares had been purchased and all employees have withdrawn from the plan. 12. INCOME TAXES Temporary differences which gave rise to significant portions of deferred tax assets are as follows (in thousands):
December 31, ------------------------ 1998 1997 ---------- ---------- Current deferred assets: Inventory reserves $ 1,307 $ 1,260 Unearned revenue 281 108 Accrued liabilities 1,355 500 -------- -------- Total current deferred assets 2,943 1,868 Valuation allowance (2,943) (1,868) -------- -------- $ - $ - -------- -------- -------- -------- Long-term deferred assets: Net operating loss carryforwards $ 18,205 $ 10,027 Capitalized research expenditures 4,128 4,641 Tax credit carryforwards 1,905 1,365 Depreciation and amortization 411 (100) -------- -------- Total long-term deferred assets 24,649 15,933 Valuation allowance (24,649) (15,933) -------- -------- $ - $ - -------- -------- -------- --------
In accordance with generally accepted accounting principles, a valuation allowance must be established for a deferred tax asset if it is uncertain that a tax benefit may be realized from the asset in the future. Management believes that, based on a number of factors, the available objective evidence creates sufficient uncertainty regarding the realizability of the deferred tax assets such that a full valuation allowance has 58 been recorded. These factors include the Company's history of losses, recent increases in expense levels, the fact that the market in which the Company competes is intensely competitive and characterized by rapidly changing technology, the lack of carry back capacity to realize deferred tax assets, and the uncertainty regarding market acceptance of the Company's products. The Company will continue to assess the realizability of the deferred tax assets in future periods. The valuation allowance increased by $9,790,000, and $9,285,000 in 1998 and 1997, respectively. The Company had federal and state net operating loss carry forwards of approximately $47,030,000 and $25,049,000, respectively, as of December 31, 1998 available to offset future regular and alternative minimum taxable income. The Company's net operating loss carry forwards expire in 1999 through 2018, if not utilized. The Company has federal and state credit carryovers as follows:
Tax Expiration Reporting Dates --------- ---------- Research and development credit $ 1,127 2007-2013 State research and development credit 656
The Company's net operating loss and tax credit carry forwards may be subject to limitation as a result of ownership changes, as defined by tax laws. 13. EMPLOYEE BENEFIT PLAN The Company adopted a defined contribution retirement plan (the "Plan"), which qualifies under Section 401(k) of the Internal Revenue Code of 1986. The Plan covers essentially all employees. Eligible employees may make voluntary contributions to the Plan up to 15% of their annual compensation and the employer is allowed to make discretionary contributions. In 1998, 1997, 1996, the Company made no employer contributions. 14. RELATED PARTY TRANSACTIONS The Company had net sales to two stockholders of $482,000 and $21,000, respectively, for the year ended December 31, 1998. The Company had net sales of $128,000 to one stockholder for the year ended December 31, 1997. The Company had net sales to two stockholders of $1,163,000 and $568,000, respectively, for the year ended December 31, 1996. In September 1997, an executive officer of the Company contributed $500,000 or 7% of the proceeds received from the issuance of the $6,882,000 convertible subordinated note payable as referred to at Note 6. 15. BUSINESS SEGMENT AND MAJOR CUSTOMERS The Company operates in a single industry segment and primarily sells its products to customers in the U.S. There were no international sales in 1998. International sales accounted for 13.5% and 10.1% of net sales for the years ended December 31, 1997 and 1996, respectively. International sales in any one geographic area were insignificant. 59 Individual customers that comprise 10% or more of the Company's net sales are as follows:
Year Ended December 31, ---------------------------------- 1998 1997 1996 ---------- ---------- ---------- RCN Corporation 25% 13% -- Knology Holdings, Inc. 13% -- -- Jones Intercable -- 12% -- AT&T Corporation -- -- 41% Intel Corporation -- -- 21%
16. SUBSEQUENT EVENTS In March 1999, Pacific Monolithics, Inc. (which had filed a voluntary petition under Chapter 11 of the U.S. Bankruptcy Code and is suing as debtor-in-possession) filed a lawsuit in Santa Clara County Superior Court, California against the Company, its five directors (one of whom is an officer), a former director (who was subsequently dismissed), a former officer and PwC. The lawsuit concerns an agreement which the Company entered into in March 1998 to acquire Pacific Monolithics through a merger, which acquisition was never consummated. The complaint alleges that the Company induced Pacific Monolithics to enter into the agreement by providing it with financial statements, and by making other representations concerning the Company's financial condition and results of operations, which were false and misleading, and further alleges that the Company wrongfully failed to consummate the acquisition. The complaint claims the defendants committed breach of contract and breach of implied covenant of good faith and fair dealing, as well as fraud and negligent misrepresentation. The complaint seeks compensatory and punitive damages according to proof, plus attorneys' fees and costs. The Company does not believe, based on current information (which is only preliminary, since discovery has not commenced in the litigation), that the outcome of this litigation will have a material adverse impact on the Company's financial statements. In January 1999, the Company entered into retention agreements with three executive officers (each of whom has since left the Company), and with an officer who has since become an executive officer. Under the agreements, as subsequently modified, each officer received an increase in salary and the right to receive a bonus if the Company is sold and the officer continues with the Company through the closing of such sale and for a short time thereafter. The bonus would be from $50,000 to $200,000, depending on the sale price. In addition, the officers received options to purchase 231,279, 262,152, 141,982 and 200,000 shares of Common Stock, respectively. Each option has an exercise price of $0.50 per share and vests over four years, except that vesting accelerates in the event of a sale of the Company. The agreements also provide for three months' severance payment in the event that an officer's employment is terminated by the Company without cause. In March 1999, the Company entered into a severance agreement with an executive officer whereby the Company paid him three months' severance pay upon the termination of his employment, and the Company agreed that he would receive the contingent bonus and accelerated vesting of stock options provided for in his retention agreement (referred to above) if the Company was acquired prior to April 1, 2000. 60 In January 1999, the Company's Board of Directors adopted the 1999 Officer Stock Option Plan (the "1999 Officer Plan") under which the Company may grant to its officers options up to 1,000,000 shares of Common Stock in the aggregate. In May 1999, the Board of Directors adopted the 1999 Stock Option Plan (the "1999 Employee Plan") under which the Company may grant its employees options to purchase up to 1,500,000 shares of Common Stock in the aggregate. Options for 929,048 and 931,817 shares have been granted and are outstanding under the 1999 Officer Plan and the 1999 Employee Plan, respectively. In May 1999, the Company granted to the executive officers additional options to purchase 40,000 and 275,000 shares of Common Stock, respectively, at $0.50 per share and vesting over four years, except that vesting accelerates in the event of a sale of the Company. 61 ITEM 9. CHANGES AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE On June 17, 1998, PwC (then Coopers & Lybrand), our independent accountants, notified us that its reports with respect to our financial statements as of December 31, 1997 and for the year then ended, and as of September 30, 1997 and for the nine months then ended, should no longer be relied upon and that PwC's consent included with our Registration Statement on Form S-4 filed with the Securities and Exchange Commission on May 7, 1998 in connection with the pending acquisition by us of Pacific Monolithics, Inc. was being withdrawn (the "Withdrawn Reports"). On July 9, 1998, PwC resigned as our independent auditors. PwC stated that it was not specifying a reason for its resignation but informed us, for the first time, that PwC was of the view that our 1997 financial statements (which PwC had audited and reported upon) needed to be restated. PwC indicated the restatement would relate to revenue recognition but did not identify the items or quantify the amounts involved. PwC further informed us that PwC believed it was not in the best interests of PwC or the Company for PwC to continue to act as our independent auditors and that PwC would not address any restatement of the Company's financial statements. PwC acknowledged that we have cooperated fully with PwC in connection with its review of our financial statements and that there were no disagreements between PwC and us on any matter of our accounting principles or practices, financial statement disclosure or auditing scope or procedure during the two most recent fiscal years and through July 9, 1998. None of the Withdrawn Reports on our financial statements contained an adverse opinion or a disclaimer of opinion or was qualified or modified as to uncertainty, audit scope or accounting principles. On August 12, 1998, with the approval of the Board of Directors, we engaged AA as our independent accountants to audit the financial statements of the Company as of December 31, 1997 and for the year then ended and to act as our independent accountants on a continuing basis. On November 24, 1998, AA resigned as our independent public accountants for the Company. AA informed us that, in AA's view, material weaknesses existed in our internal controls of a nature that prevented AA from being able to form an opinion on our conclusions as to the appropriate timing and amount of revenue recognition for the purposes of our financial statements for the year ended December 31, 1997. During the course of its work, AA had notified us and discussed with our audit committee AA's conclusion that (i) AA needed to expand significantly the scope of its audit, which it did with our approval and cooperation, and (ii) while AA did not complete an audit of our 1997 financial statements, those financial statements were materially misstated. There were no disagreements between AA and us on any matter of our accounting principles or practices, financial statement disclosure, or auditing scope or procedure. On December 22, 1998, with the approval of the Board of Directors, we engaged Hein as our independent accountants to audit our financial statements as of December 31, 1997 and for the year then ended and to act as our independent accountants on a continuing basis, which engagement included performing an audit of our financial statements as of December 31, 1998 and for the year then ended. Prior to hiring Hein, neither we nor anyone acting on our behalf consulted Hein during our two most recent fiscal years or the subsequent interim periods. 62 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY. The following table sets forth certain information regarding our officers and directors as of June 1, 1999:
Name Age Position - --------- ----- -------------- Carl S. Ledbetter 50 Chief Executive Officer and Chairman of the Board of Directors (1) Judson W. Goldsmith 60 President and Chief Operating Officer Chief Financial Officer and Secretary (1) Thara Edson 41 Corporate Controller (1) Thomas Bissett 48 Vice President, Operations Frederick Enns 48 Vice President and Chief Technology Officer John J. Wong 47 Vice President, Engineering James R. Flach (2) (3) 51 Director Stephen E. Halprin (3) 61 Director Gary M. Lauder 37 Director Douglas M. Leone (2) 41 Director
- ------------------------------------ (1) Executive Officers. (2) Member of the Compensation Committee. (3) Member of the Audit Committee. (4) Mr. Strachman ceased being a Director in February 1998. Carl S. Ledbetter joined the Company in January 1996 as its President and Chief Executive Officer, and in August 1996, he became Chairman of the Board. Prior to joining the Company, he served in various positions at AT&T from April 1993 to January 1996, most recently as President of Consumer Products. From 1991 until April 1993, Mr. Ledbetter was Vice President of Sun Microsystems and General Manager of SunSelect, Sun's PC networking business. He is also a director of Software Spectrum, Inc., a software distributor. Mr. Ledbetter holds a B.S. in Mathematics from University of Redlands, an M.A. in Mathematics from Brandeis University and a Ph.D. in Mathematics from Clark University. Judson W. Goldsmith joined the Company in November 1998 as Vice President, Finance and Administration, Chief Financial Officer and Secretary. In March 1999, he assumed the additional responsibilities of President and Chief Operating Officer. Prior to joining the Company, Mr. Goldsmith was a manager and a management consultant working with troubled technical and non-technical companies. Mr. Goldsmith holds a B.A. in Economics from Dartmouth College and an M.B.A. from the University of Washington. Thara Edson joined the Company in August 1998 as its Controller and was promoted to Corporate Controller in September 1998. Prior to joining the Company, she served as Controller for Connectware LLC (an AMP Company) and Compressent Corporation. From 1994 to January 1997, Ms. Edson served as Director of Finance with Streamlogic Corporation, a storage systems company. Ms. Edson received a 63 B.Com. in Accounting from Madras University and an M.B.A. in Finance and Accounting from the University of Nebraska. Ms. Edson is also a Certified Management Accountant. Thomas E. Bissett joined the Company in July 1996 as Director of Operations and was promoted to Vice President of Operations March of 1999. From May 1991 to July 1996, Mr. Bissett was Vice President of Operations and member of founding team of Semaphore Communications Corporation, a company that designed and manufactured network security products. Mr. Bissett holds a B.S. and M.E. in Mechanical Engineering from the University of Utah and an M.B.A from San Jose State University. Frederick Enns joined the Company in September 1994 as Senior Architect and has been Vice President and Chief Technology Officer since August 1996. From November 1992 to September 1994, he served as Director of Hardware Engineering of Hughes LAN Systems, a networking equipment manufacturer. Mr. Enns received a B.S. in Physics from the University of California, San Diego, an M.S. in Physics from the University of Washington and an M.S. in Electrical Engineering from Stanford University. John J. Wong joined the Company in August 1997 as Director of Hardware Engineering and was recently promoted to Vice President of Engineering. Prior to joining the Company, he worked for Mitsui Comtek as Director of Engineering, where he developed Internet Appliance products. From July 1988 to February 1997, Mr. Wong worked for the systems group of Macronix, Inc., which later became Current Logic Systems, an OEM manufacturer of data/fax modem products, as Vice President of Engineering and most recently as President and CEO. Mr. Wong received a B.S. in EECS from University of California, Berkeley. James R. Flach has been a director of the Company since May 1995, and he served as acting Chief Executive Officer of the Company from November 1995 to January 1996. Since September 1992, Mr. Flach has been an executive partner of Accel Partners, a venture capital firm. Since September 1992, he has also been the President of Flach & Associates, a Management Services firm, and since March 1997, he has been the Chief Executive Officer of Redback Networks, a network products company. From May 1990 to August 1992, Mr. Flach was Vice President of Intel, serving as the General Manager of Intel's Personal Computer Enhancement Division. He holds a B.S. in Physics from Rensselaer Polytechnic Institute and an M.S. in Applied Mathematics from The Rochester Institute of Technology. Stephen E. Halprin has been a director of the Company since September 1992. He has been a general partner of OSCCO Management Partners, a venture capital firm since 1984 and a general partner of OSCCO Management Partners III since 1989. He currently serves as a director of Landec Corporation, a materials science company. He holds a B.S. in Industrial Management from the Massachusetts Institute of Technology and an M.B.A. from the Stanford University Graduate School of Business. Gary M. Lauder has been a director of the Company since October 1994. Since 1986 he has been the General Partner of Lauder Partners, a venture capital partnership formed by Mr. Lauder that focuses on advanced technologies for the cable TV marketplace. Since May 1995, Mr. Lauder has been Vice-Chairman of ICTV, Inc., a developer of interactive cable television technology. Mr. Lauder holds a B.A. in International Relations from the University of Pennsylvania, a B.S. in Economics from the Wharton School and an M.B.A. from the Stanford University Graduate School of Business. Douglas M. Leone has been a director of the Company since May 1995. He has been associated with Sequoia Capital, a venture capital firm, since June 1988 and has been a general partner of that firm since April 1993. He currently serves as a director of Infinity Financial Technology, a client server software company, and International Network Services, a networking services company. Mr. Leone holds a B.S. from Cornell University, an M.S. from Columbia University and an M.S. in Management from the Massachusetts Institute of Technology. Each officer serves at the discretion of the Board of Directors. Our certificate of incorporation and bylaws provide for a classified Board of Directors. Accordingly, the terms of the office of the Board of Directors have 64 been divided into three classes. Class I and II will expire at the annual meeting of the stockholders to be held in 1999; and Class III will expire at the annual meeting of the stockholders to be held in 2000. At each annual meeting of the stockholders, beginning with the 1999 annual meeting, the successors to the directors whose terms will then expire will be elected to serve from the time of election and qualification until the third annual meeting following election and until their successors were duly elected and qualified, or until their earlier resignation or removal, if any. Messrs. Halprin and Leone were designated as Class I directors; Mr. Flach was designated as a Class II director; and Messrs. Lauder and Ledbetter were designated as Class III directors. To the extent that there is an increase in the number of directors, additional directorships resulting therefrom will be distributed among the three classes so that, as nearly as possible, each class will consist of an equal number of directors. BOARD COMMITTEES The Audit Committee of the Board of Directors consists of Mr. Flach and Mr. Halprin. The Audit Committee reviews our financial statements and accounting practices, makes recommendations to the Board regarding the selection of independent auditors and reviews the results and scope of the audit and other services provided by our independent auditors. The Compensation Committee of the Board consists of Mr. Flach and Mr. Leone. The Compensation Committee makes recommendations to the Board concerning salaries and incentive compensation for our officers and employees and administers our employee benefit plans. SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE Section 16(a) of the Exchange Act requires our directors and executive officers and persons who own more than 10% of our Common Stock ("10% Stockholders") to file with the Securities and Exchange Commission initial reports of ownership on a Form 3 and reports of changes in ownership of our Common Stock and other equity securities on a Form 4 or Form 5. Such executive officers, directors and 10% Stockholders are required by SEC regulations to furnish us with copies of all Section 16(a) forms they file. Based solely on its reviews of the copies of such forms furnished to the Company and written representations from the executive officers and directors, we believe that all of the Company's directors, executive officers and 10% Stockholders made all the necessary filings under Section 16(a) during 1998, except that Mr. Goldsmith had a late filing of Form 3. 65 ITEM 11. EXECUTIVE COMPENSATION The following table sets forth all compensation awarded to, earned by or paid for services rendered to us in all capacities during 1998 by (i) our Chief Executive Officer and (ii) our other executive officers (other than the Chief Executive Officer) who were serving as executive officers at December 31, 1998 and had salary and bonus for 1998 of $100,000 or more (three persons) and (iii) two additional individuals who were among the four most highly compensated executive officers during 1998 (other than the Chief Executive Officer) but who were not serving as executive officers at December 31, 1998 (collectively, the "Named Executive Officers"): SUMMARY COMPENSATION TABLE
LONG-TERM COMPENSATION AWARD ANNUAL COMPENSATION ----------- --------------------------------------------------------- SECURITIES OTHER ANNUAL UNDERLYING NAME AND PRINCIPAL POSITIONS YEAR SALARY BONUS COMPENSATION OPTIONS (#) - ---------------------------- ---- -------- --------- ------------ ---------- Carl S Ledbetter 1998 $209,102 -- $ 59,231(1) -- Chief Executive Officer 1997 187,500 $ 36,853 $ 77,924(1)(2) 170,000 1996 175,000 -- 61,299(1) 487,919 Jane Zeletes (3 ) 1998 153,333 27,113(4) -- 88,139 Vice President, Marketing 1997 75,889 41,197(4) 750(5) 53,843 Vishwas Godbole (6) 1998 167,208 -- -- 124,186 Vice President, Engineering 1997 77,798 30,125 5,062(5) 137,976 Daniel E. Steimle (7) 1998 89,204 75,000 68,750(8) 6,250 Vice President, Finance and 1997 68,750 86,250 -- 111,111 Administration and Chief Financial Officer William Daniher (9 ) 1998 105,385 29,300 -- 231,279 Gustavo Ezcurra (10) 1998 101,677 57,263(11) -- 20,000 Vice President, Sales 1997 126,875 97,154(11) 1,129(2) 14,815 1996 17,625 12,835(11) -- 77,876
- -------- (1) Includes temporary living expenses paid by the Company of $59,231, $72,000 and $61,299 to Mr. Ledbetter in 1998, 1997 and 1996, respectively. (2) Includes value of stock bonuses of $5,924 and $1,129 for Messrs. Ledbetter and Ezcurra, respectively. (3) Ms. Zeletes joined the Company in March 1997 and left in March 1999. (4) Commissions paid in 1998 and 1997. (5) Includes value of stock bonuses of $5,062 and $750 for Mr. Godbole and Ms. Zeletes, respectively. (6) Mr. Godbole joined the Company in May 1997 and left in April 1999. (7) Mr. Steimle joined the Company in July 1997 and left in May 1998. (8) Severance pay for Mr. Steimle. (9) Mr. Daniher joined the Company in May 1998 and left in March 1999. (10) Mr. Ezcurra joined the Company in September 1996 and left in July 1998. (11) Includes commissions of $57,268 in 1988,$94,904 in 1997 and $12,835 in 1996. 66 In November 1998, Mr. Goldsmith joined the Company as Vice President, Finance and Chief Financial Officer. Under the terms of his employment, he received a salary of $175,000 per annum and options to purchase 275,000 shares of Common Stock at $2.19 per share and vesting over four years, and he will be entitled to receive bonuses in 1999 if we meet certain corporate milestones, including completing the audit of our financial statements, filing with the Securities and Exchange Commission the annual and quarterly reports required under the Exchange Act, holding an annual stockholders meeting, resumption of trading on Nasdaq, resolving the class action lawsuits that have been brought against us, obtaining certain financing and consummating the sale of the Company within certain parameters. If all the milestones are met within the time period specified, the aggregate amount of the bonuses could be approximately $220,000. The following table sets forth further information regarding option grants during 1998 pursuant to our Executive Officer Plan and our 1996 Equity Incentive Plan to each of the Named Executive Officers. The table sets forth the hypothetical gains or "option spreads" that would exist for the options at the end of their respective five or ten year terms. These gains are based on assumed rates of annual compound stock price appreciation of 5% and 10% from the date the option was granted to the end of the option term: OPTION GRANTS IN 1998
POTENTIAL REALIZABLE NUMBER OF PERCENTAGE OF VALUE AT ASSUMED SECURITIES TOTAL OPTIONS ANNUAL RATES OF UNDERLYING GRANTED TO EXERCISE STOCK PRICE APPRECIATION OPTIONS EMPLOYEES PRICE EXPIRATION FOR OPTION TERM (2) NAME GRANTED (1) IN 1998 PER SHARE DATE 5% 10% - ---- ----------- ------------- ----------- ---------- ------- -------- Carl S. Ledbetter -- -- -- -- -- -- Jane Zeletes 10,000 0.67 $ 5.00 01/21/03 13,814 30,526 78,139 5.24 2.19 09/09/03 47,279 104,473 Vishwas Godbole 20,000 1.34 5.00 01/21/03 27,628 61,051 104,186 6.99 2.19 09/09/03 63,038 139,298 Daniel E. Steimle 6,250 0.42 5.00 01/21/03 8,634 19,078 William Daniher 75,000 5.03 6.00 05/07/03 124,326 274,729 156,643 10.50 2.19 09/09/03 94778 209,434 Gustavo Ezcurra 20,000 1.34 5.00 01/21/03 27,628 61,051
- ----------------- (1) Options granted pursuant to the Executive Officer Plan and the 1996 Equity Incentive Plan in 1998 generally have been incentive stock options or non-qualified stock options that were granted at fair market value and vest over a four-year period so long as the individual is employed by the Company. Options granted to executive officers generally expire five years from the date of grant. (2) The 5% and 10% assumed annual rates of stock price appreciation are mandated by the rules of the Securities and Exchange Commission and do not represent the Company's estimate or projection of future common stock prices. 67 The following table sets forth the number of shares acquired upon the exercise of stock options during 1998 and the number of shares covered by both exercisable and unexercisable stock options held by each of the Named Executive Officers as of December 31, 1998. Also reported are values of "in-the-money" options, which represent the positive spread between the respective exercise prices of outstanding stock options and the fair market value of our Common Stock as of December 31, 1998 ($0.50) as determined by the Board of Directors. AGGREGATED OPTION EXERCISES IN 1998 AND YEAR-END VALUES
NUMBER OF SECURITIES VALUE OF UNEXERCISED UNDERLYING UNEXERCISED IN-THE-MONEY OPTIONS SHARES OPTIONS AT YEAR-END AT YEAR-END ACQUIRED ON VALUE -------------------------------- -------------------------- NAME EXERCISE(#) REALIZED EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE - ---- ----------- -------- ----------- ------------- ----------- ------------- Carl S. Ledbetter -- -- 394,854 236,064 -- -- Jane Zeletes -- -- 21,158 120,685 -- -- Vishwas Godbole -- -- 58,823 202,392 -- -- Daniel E. Steimle -- -- 43,285 -- -- -- William Daniher -- -- 10,938 220,341 -- -- Gustavo Ezcurra 25,000 $27,750 -- -- -- --
DIRECTOR COMPENSATION Our directors do not receive cash compensation for their services as directors but are reimbursed for their reasonable expenses in attending meetings of the Board of Directors. Each director who is not an employee is eligible to participate in our 1997 Directors Stock Option Plan (the "Directors Plan"). Each eligible director who first becomes a director on or after our initial public offering in November 1997 will initially be granted an option for 15,000 shares (an "Initial Grant") on the later of the effective date of the initial public offering or the date such director first becomes a director. At each annual meeting of stockholders thereafter, each eligible director will automatically be granted an additional option to purchase 5,000 shares if such director has served continuously as a member of the Board of Directors since the date of such director's Initial Grant (or since the effective date of the initial public offering if such director did not receive an Initial Grant). All options issued under the Directors Plan will vest as to 25% of the shares on each anniversary of the date of grant, provided the optionee continues as a member of the Board of Directors or as a consultant to the Company. The exercise price of all options granted under the Directors Plan will be the fair market value of the Common Stock on the date of grant. To date, no director has been eligible to participate under the Director Plan. COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION None of the members of the Compensation Committee of the Board of Directors was an officer or employee of the Company during 1998. None of our executive officers serves as a member of the board of directors or compensation committee of any entity that has one or more executive officers serving on our Board of Directors or Compensation Committee. 68 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The following table sets forth certain information to the extent known by us with respect to beneficial ownership of our Common Stock as of December 31, 1998 by (i) each stockholder known by the Company to be the beneficial owner of more than 5% of the Company's Common Stock, (ii) each director of the Company, (iii) each of the Named Executive Officers and (iv) all executive officers and directors as a group.
NUMBER OF SHARES PERCENTAGE OF SHARES NAME OF BENEFICIAL OWNER BENEFICIALLY OWNED (1) BENEFICIALLY OWNED - ------------------------ ---------------------- -------------------- Intel Corporation (2) 1,207,020 8.0% James R. Flach Accel Partners (3) 879,562 5.8 Douglas M. Leone Sequoia Capital (4) 870,691 5.8 Strachman Family Revocable Trust (5) 834,210 5.5 Carl S. Ledbetter (6) 423,363 2.8 Gary M. Lauder (7) 276,049 1.8 Vishwas Godbole (8) 66,303 * Gustavo Ezcurra (9) 25,000 * Jane Zeletes (10) 23,950 * William Daniher (11) 14,063 * Stephen E. Halprin (12) 2,160 * Danial E. Steimle -- * All executive officers and directors as a group (10 persons) (13) 2,580,215 17.1
- ---------------- * Represents less than 1% of the Company's outstanding Common Stock. (1) Unless otherwise indicated below, the persons and entities named in the table have sole voting and sole investment power with respect to all shares beneficially owned, subject to community property laws where applicable. Shares of common stock subject to options or warrants that are currently exercisable or exercisable within 60 days of December 31, 1998, are deemed to be outstanding and to be beneficially owned by the person holding such options warrants for the purpose of computing the percentage ownership of such person but are not treated as outstanding for the purpose of computing the percentage ownership of any other person. (2) Intel's address is 2200 Mission College Boulevard, Santa Clara, CA 95052. (3) Represents ownership by the following entities associated with Accel Partners: 545,193 shares and 250,677 shares subject to warrants held by Accel IV, L.P., 25,594 shares and 11,769 shares subject to warrants held by Accel Investors '95 L.P., 13,095 shares and 6,022 shares subject to warrants held by Ellmore C. Patterson Partners, 11,309 shares and 5,202 shares subject to warrants held by Accel Keiretsu L.P. Also includes 10,701 shares subject to options exercisable within 60 days of December 31, 1998 held by Mr. Flach granted in connection with services performed by Mr. Flach for the Company. Mr. Flach, a director of the Company, is an executive partner of Accel Partners and holds no voting or dispositive power with respect to any of these shares. The address of Mr. Flach and the Accel partnerships is 428 University Ave., Palo Alto, CA 94301. (4) Represents 595,191 shares and 275,497 shares subject to warrants held by Sequoia Capital VI, 29,761 shares and 13,776 shares subject to warrants held by Sequoia Technology Partners VI, ("STP VI"), 16,932 shares and 440 shares subject to warrants held by Sequoia XXIV and 6,877 shares and 10,581 69 shares subject to warrants held by Sequoia 1995. Mr. Leone, a director of the Company, is a general partner of STP VI and of the general partner of Sequoia Capital VI. The address of Mr. Leone and the Sequoia funds is 3000 Sand Hill Road, Menlo Park, CA 94025. (5) Mr. Strachman, a trustee of the Strachman Family Revocable Trust, was a co-founder of the Company and served as its President and Chief Executive Officer from June 1990 until his resignation in July 1995. Mr. Strachman resigned as a director in February 1998. Mr. Strachman's address is c/o Ultracom Communications, Inc., 21580 Stevens Creek Blvd., Cupertino, CA 95014. (6) Includes 422,266 shares subject to options exercisable within 60 days of December 31, 1998. Mr. Ledbetter is the Chief Executive Officer and Chairman of the Board of Directors of the Company. (7) Mr. Lauder is a director of the Company. (8) Includes 65,366 shares subject to options exercisable within 60 days of December 31, 1998. Mr. Godbole was Vice President, Engineering. He left the Company in April, 1999. (9) Mr. Ezcurra was Vice President, Sales. He left the Company in July, 1998 (10) Includes 23,812 shares subject to options exercisable within 60 days of December 31, 1998. Ms. Zeletes was Vice President, Engineering. She left the Company in March, 1999. (11) Represents shares subject to options exercisable within 60 days of December 31, 1998. (12) Does not include 429,852 shares of Common Stock and 66,553 shares subject to warrants held by OSCCO III, L.P., an entity which Mr.Halprin is affiliated with. Mr. Halprin is a director of the Company. (13) Includes 573,964 shares subject to warrants and 536,208 shares subject to options exercisable within 60 days of December 31, 1998 held by executive officers and directors of the Company. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS From January 1, 1998 to the present, there has been no (and there is no currently proposed) transaction or series of similar transactions to which we were (or are to be) a party in which the amount involved exceeds $60,000 and in which any director, executive officer or holder of more than 5% of our Common Stock (or any member of the immediate family of any of the foregoing persons) had (or will have) a direct or indirect interest, (i) except for the compensation arrangements, described in Item 11 and except for the transactions described below. In January 1999, we entered into retention agreements with three executive officers, William Daniher, Vishwas Godbole and Jane Zeletes (each of whom has since left the Company), and with Thara Edson, who has since become an executive officer. Under the agreements, as subsequently modified, each officer received an increase in salary and the right to receive a bonus if the Company is sold and the officer continues with the Company through the closing of such sale and for a short time thereafter. The bonus would be from $50,000 to $200,000, depending on the sale price. In addition, Mr. Daniher, Mr. Godbole, Ms. Zeletes and Ms. Edson received options to purchase 231,279, 262,152, 141,982 and 200,000 shares of Common Stock, respectively. Each option has an exercise price of $0.50 per share and vests over four years, except that vesting accelerates in the event of a sale of the Company. The agreements also provide for three months' severance payment in the event that an officer's employment is terminated by the Company without cause. 70 In March 1999, we entered into a severance agreement with Mr. Daniher whereby we paid him three months' severance pay upon the termination of his employment, and we agreed that he would receive the contingent bonus and accelerated vesting of stock options provided for in his retention agreement (referred to above) if we are acquired prior to April 1, 2000. In May 1999, we granted to Mr. Goldsmith and Ms. Edson additional options to purchase 275,000 and 40,000 shares of Common Stock, respectively, at $0.50 per share and vesting over four years, except that vesting accelerates in the event of a sale of the Company. ITEM 14. EXHIBITS FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a) The following documents are filed as part of this Report: 1. FINANCIAL STATEMENTS -- See Index to Financial Statements and Financial Statement Schedule at Item 8 on page 36 of this Report. 2. FINANCIAL STATEMENT SCHEDULES -- See Index to Financial Statements and Financial Statement Schedule at Item 8 on page 36 of this Report. 3. EXHIBITS -- The following exhibits are filed as part of, or incorporated by reference into, this report on Form 10-K:
Exhibit Number Exhibit Title ------- ------------- 3.01 Registrant's Amended and Restated Certificate of Incorporation. (1) 3.02 Registrant's Amended and Restated Bylaws. (2) 10.01 Amended and Restated Investors Rights Agreement, dated as of September 18, 1997 between Registrant and certain investors, as amended October 13, 1997 and as amended November 6, 1997. (3) 10.02 Registrant's 1993 Equity Incentive Plan. (3)(4) 10.03 Registrant's 1996 Equity Incentive Plan. (3)(4) 10.04 Registrant's Executive Officer Incentive Plan. (3)(4) 10.05 Registrant's 1997 Equity Incentive Plan. (3)(4) 10.06 Registrant's 1997 Directors Stock Option Plan. (3) (4) 10.07 Registrant's 1997 Employee Stock Purchase Plan. (3) (4) 10.08 Form of Indemnity Agreement entered into by Registrant with each of its directors and officers. (3) 10.11 Employment Agreement between Registrant and Carl S. Ledbetter dated January 15, 1996. (3)(4) 10.12 Senior Secured Convertible $5.5 Million Debenture Purchase Agreement between Registrant and London Pacific Life & Annuity Company dated April 30, 1997 and related Senior Secured Convertible $5.5 Million Debenture Due 2002 and Security Agreement and Senior Secured Convertible $5.5 Million Debenture Due. (3) 10.15 Collaboration Agreement among Registrant, Sharp Corporation and Itochu Corporation dated November 25, 1996 and Addendum No. 1 thereto dated November 25, 1996. (3)
71 10.16 Sales and Purchase Agreement between Registrant and Itochu Corporation dated January 10, 1997. (3)(5) 10.21 Warrant Purchase Agreement by and between Registrant and Alcatel dated as of November 3, 1997. (3) 10.22 Employment Letter between Registrant and Dan E. Steimle dated July 27, 1997. (4)(6) 10.24 Separation Agreement and General Release between the Registrant and Dan E. Steimle dated May 30, 1994. (4) 10.25 Sublease between the Rigistrant and Viking Freight, Inc. dated February 9, 1998. (7) 10.26 Employment Letter from the Registrant to Judson Goldsmith dated November 12, 1998. (4) 10.27 Product Purchase Agreement between the Registrant and RCN Operating Services, Inc. dated June 30, 1997 23.01 Consent of Independent Auditors for 1998 and 1997 23.02 Consent of Independent Accountants for 1996 27.01 Financial Data Schedule. 27.02 Restated 1997 Financial Data Schedule.
- ----------- (1) Incorporated by reference to Exhibit 3.03 to the Registrant's Registration Statement on Form S-1, File No. 333-36001, declared effective by the SEC on November 11, 1997 (the "Form S-1"). (2) Incorporated by reference to Exhibit 3.05 to the Form S-1. (3) Incorporated by reference to the Exhibit with the same number in the Form S-1. (4) Represents a management contract or compensatory plan. (5) Confidential treatment has been granted with respect to certain portions of this agreement. Such portions have been omitted from the filing and have been filed separately with the SEC. (6) Incorporated by reference to Exhibit 10.21 to the Registrant's Annual Report on Form 10-K for the Year Ended December 31, 1997. (7) Incorporated by reference to Exhibit 10.24 to the Registrant's Registration Statement on Form S-4, File No. 333-52083 (filed on May 7, 1998 (b) Reports on Form 8-K. The following Current Reports on Form 8-K were filed by the Company during the last three quarters of 1998: 1. On June 19, 1998, the Company reported under Item 5. "Other Events" that Coopers & Lybrand, the Company's independent accountants at that time, had notified the Company that their reports with respect to the financial statements of the Company as of December 31, 1997, and for the year then ended, and as of September 30, 1997, and for the nine months then ended, should no longer be relied upon. 2. On July 16, 1998, the Company reported under Item 4. "Changes In Registrant's Certifying Accountant" and Item 7. "Exhibits" that PricewaterhouseCoopers LLP (successor entity to Coopers & Lybrand) had resigned as the independent accountants of Hybrid Networks, Inc. 3. On August 17, 1998, the Company reported under Item 4. "Changes In Registrant's Certifying Accountant" that the Company had engaged Arthur Andersen LLP as the Company's independent 72 accountants to audit the financial statements of the Company as of December 31, 1997 and for the year then ended and to act as the Company's independent accountants on a continuing basis. 4. On November 17, 1998, the Company reported under Item 5. "Other Events" that Judson W. Goldsmith had been appointed Vice President, Finance and Chief Financial Officer. 5. On December 2, 1998, the Company reported under Item 4. "Changes In Registrant's Certifying Accountant" and Item 7. "Exhibits" that Arthur Andersen LLP had resigned as the independent accountants of Hybrid Networks, Inc. Additionally, the Company reported under Item 5. "Other Events" that the Company's securities would be delisted from the NASDAQ Stock Market effective with the close of business December 1, 1998. 6. On December 23, 1998, the Company reported under Item 4. "Changes In Registrant's Certifying Accountant" that the Company had engaged Hein + Associates LLP as the Company's independent accountants to audit the financial statements of the Company as of December 31, 1997 and for the year then ended and to act as the Company's independent accountants on a continuing basis. (c) Exhibits. See (a)(3) above. (d) Financial Statement Schedules. See (a)(2) above. 73 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Exchange Act, the Registrant caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized. June 8, 1999 HYBRID NETWORKS, INC. By: /s/ Carl S. Ledbetter -------------------------- Carl S. Ledbetter Chief Executive Officer Pursuant to the requirements of the Exchange Act, this Report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
NAME TITLE DATE - --------- --------- -------- PRINCIPAL EXECUTIVE OFFICER: /s/ Carl S. Ledbetter Chief Executive Officer June 8, 1999 - --------------------------- Carl S. Ledbetter PRINCIPAL FINANCIAL OFFICER AND PRINCIPAL ACCOUNTING OFFICER: /s/Judson W. Goldsmith President, Chief Operating June 8, 1999 - -------------------------------- Officer, Chief Financial Officer Judson W. Goldsmith and Secretary ADDITIONAL DIRECTORS: /s/ James R. Flach Director June 8, 1999 - ------------------------ James R. Flach /s/ Stephen E. Halprin Director June 8, 1999 - ------------------------------ Stephen E. Halprin /s/ Gary M. Lauder Director June 8, 1999 - ------------------------- Gary M. Lauder /s/ Douglas M. Leone Director June 8, 1999 - ---------------------------- Douglas M. Leone
74 INDEPENDENT AUDITORS REPORT To the Stockholders and Board of Directors Hybird Networks, Inc. San Jose, California Our report on the financial statements of Hybrid Networks, Inc. is included on page 37 of this Form 10-K. In connection with our audits of such financial statements, we have also audited the related financial statement schedule listed in Item 14(a)(2) of this Form 10-K. In our opinion, the financial statement schedule referred to above, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material respects, the information required to be included therein. /s/ HEIN + ASSOCIATES LLP Orange, California April 23, 1999 REPORT OF INDEPENDENT ACCOUNTANTS To the Stockholders and Board of Directors Hybird Networks, Inc. Our audit of the financial statements referred to in our report dated August 28, 1997, appearing on page 38 of this Form 10-K also included an audit of the financial statement schedule listed in Item 14(a)(2) of this Form 10-K. In our opinion, this financial statement schedule presents fairly, in all material respects, the information set forth therein when read in conjunction with the related financial statements. PricewaterhouseCoopers LLP San Jose, California August 28, 1997 75 HYBRID NETWORKS, INC. SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS (IN THOUSANDS) ALLOWANCE FOR DOUBTFUL ACCOUNTS
Additions Weighted Balance at Charged Charged Balance Beginning to Costs and to Other at End For the year ended: of Period Expenses Accounts Deductions of Period --------------- --------------- --------------- --------------- --------------- December 31, 1998 - $ 200 - - $ 200 December 31, 1997 - - - - - December 31, 1996 - - - - -
INVENTORY RESERVES
Additions Weighted Balance at Charged Charged Balance Beginning to Costs and to Other at End For the year ended: of Period Expenses Accounts Deductions of Period --------------- --------------- --------------- --------------- --------------- December 31, 1998 $3,015 $1,691 - $(1,571) $3,135 December 31, 1997 256 2,759 - - 3,015 December 31, 1996 136 126 - (6) 256
76 EX-10.24 2 EXHIBIT 10.24 SEPARATION AGREEMENT AND GENERAL RELEASE This Agreement (this "AGREEMENT") is entered into as of May 30, 1998, between Hybrid Networks, Inc., a Delaware corporation (the "Company"), and Dan E. Steimle ("EMPLOYEE"). RECITALS A. Whereas, the Company has employed Employee as its Vice President, Finance and Administration, Chief Financial Officer and Secretary; B. Whereas Employee wishes to end his employment relationship with the Company as of May 31, 1998 (the "TERMINATION DATE"), and he and the Company wish to provide for termination of that relationship by mutual agreement in a way which will preserve the goodwill that exist between them. Now, therefore, in consideration of the premises and mutual promises herein contained, the parties agree as follows: 1. TERMS OF SEPARATION A. Employee's employment ends as of the Termination Date. The Company will deliver on the Termination Date to Employee a check based on the gross amount set forth in part I of EXHIBIT A hereto for accrued salary, reimbursable expenses, accrued but unused vacation pay and any other similar payments due and owing to Employee up to the Termination Date, adjusted for applicable withholding and deductions. B. Upon completion of the Revocation Period described in Section 13, the Company will deliver to Employee a check based on the gross amount set forth in part 2 of EXHIBIT A, representing severance pay. C. On August 31, 1998, the Company will deliver to Employee a check based on the gross amount set forth in part 3 of EXHIBIT A. representing a bonus payment to Employee for his extraordinary efforts in assisting the Company with its major transactions in the last four months of 1997 and in 1998, including, without limitation, its September 1997 bridge financing, its initial public offering and the proposed business combination with Pacific Monolithics, Inc. D. The Company offers to extend the health insurance coverage it currently provides Employee pursuant to the Consolidated Omnibus Budget Reconciliation Act of 1985 ("COBRA") at Employee's expense. Employee will have 60 days from the Termination Date to notify the Company in writing of his election to continue coverage pursuant to COBRA. E. The Company will continue to provide Employee, during the period commencing with the Termination Date and ending December 31, 1998, the following: (i) use of a lap top computer (Employee will return the lap top computer on January 1, 1999); (ii) availability of access to the Company's server for e-mail receipt and transmittal; and (iii) availability of a telephone extension in the Company's telephone system so that Employee will be able to access voice mail. By signing below, Employee warrants that he has returned to the Company any and all property and data of the Company of any type whatsoever that was in his possession, custody, or control, except for the lap top computer referred to above. F. For six months commencing June 1, 1998 and ending November 30, 1998 (the "PERIOD OF CONSULTANCY"), Employee will serve as an on-call consultant to the Company, performing such duties as the Chief Executive Officer of the Company may from time to time direct; provided that, unless both parties mutually agree otherwise, Employee will not be required to provide more than 40 hours of such consulting services in any month during the Period of Consultancy. In consideration for (i) the agreement of Employee to make himself available to provide consulting services as set forth herein and (ii) the rendering by Employee of up to 20 hours of such services, to the extent requested by the Company, in any month during the Period of Consultancy, the Company will pay to Employee, on the first of each month during the Period of Consultancy, a check based on a gross amount equal to 50% of Employee's current base monthly salary, as set forth in part 4 of EXHIBIT A. In addition, the Company will pay Employee $1,000 per day for each day in which Employee actually provides consulting services to the Company at the Company's request as provided herein in excess of 20 hours of such consulting services in any month during the Period of Consultancy. Employee will not be an employee of the Company for any purpose during the Period of Consultancy. As provided in the existing terms of Employee's options to purchase shares of the Company's Common Stock (constituting options to purchase 141,111 shares in the aggregate) and under the existing terms of the applicable stock option plans, such options will continue to vest during the Period of Consultancy. Upon the termination of the Period of Consultancy, Employee's status as a consultant to the Company will be Terminated (as defined in the applicable stock option plans), and, accordingly, the vesting of the stock options will then terminate and the options will, to the extent then vested, be exercisable for a period of 90 days commencing with the date of such termination. G. Employee agrees the payments he receives herewith pursuant to Sections 1.A, 1.B and 1.C of this Agreement represent the total amount of compensation, benefits and bonuses owed to him by the Company and that the Company does not owe him any other amounts. Employee agrees that all other payments and consideration he receives under this Agreement are in exchange for the covenants and agreements he makes herein. Employee further agrees and understands that any liability for state or federal income or other taxes that may be assessed as a result of the transactions provided for herein is Employee's sole responsibility, and he will not look to the Company for payment or reimbursement of any taxes. H. The parties acknowledge that Employee is bound by the Proprietary Information and Inventions Agreement, which he signed when he commenced employment with the Company, a copy of which is attached hereto as EXHIBIT B (the "PII AGREEMENT"), and that Employee has had access to and has become acquainted with various non-public, confidential or trade secret information of the Company, including, but not limited to information referred to in the PII Agreement as "Proprietary Information" and records of the Company that are regularly used in the operation of the Company's business, that affect the success, profitability and good will of the Company and that are not known or available to persons outside the Company, and other nonpublic, confidential or trade secret information of the Company (collectively, the "PROPRIETARY INFORMATION"). With respect to such Proprietary Information Employee agrees: 2 (i) That all Proprietary Information and documents, memoranda, reports, files, correspondence and records that relate to the Company's business that Employee had contact with remain the Company's sole property; (ii) That Employee will continue to abide by the terms and conditions of the attached PII Agreement to the extent that such terms and conditions provide for continuing obligations after termination of his employment; (iii) That he will not directly or indirectly disclose any of this Proprietary Information, or use it in any way, either during the term of this Agreement or at any time thereafter, except as authorized in writing by the Company; (iv) That he has delivered and returned to the Company all written or graphic records that he knows, suspects or should know contain Proprietary Information. 2. MUTUAL RELEASE Employee and his representatives, heirs, successors and assigns do hereby completely release and forever discharge the Company, its affiliates, present and former shareholders, officers, directors, agents, employees, attorneys, successors and assigns from all claims, rights, demands, actions, obligations, liabilities and causes of action he may have had or now have, known or unknown, to pursue any remedies available to him whether based on tort, contract (express or implied) or any federal, state or local law, statute or regulation, including, but not limited to, matters that could have been raised in a civil action, any employment laws, including but not limited to, claims of unlawful discharge, breach of contract, breach of the covenant of good faith and fair dealing, fraud, violation of public policy, defamation, physical injury, emotional distress, claims under Title VII of the 1964 Civil Rights Act, as amended, the California Fair Employment and Housing Act, the Age Discrimination in Employment Act, the Older Worker Benefit Protection Act and any other laws and/or regulations relating to employment or employment discrimination. Notwithstanding the foregoing, Employee does not release any claims based on obligations created by or reaffirmed in the PII Agreement or this Agreement, whether or not such claims have already arisen or arise after the date hereof. The Company and its successors and assigns do hereby completely release and forever discharge Employee and his representatives, heirs, attorneys, successors and assigns from all claims, rights, demands, actions, obligations, liabilities and causes of action the Company may have had or now have, known or unknown, to pursue any remedies available to the Company whether based on tort, contract (express or implied) or any federal, state or local law, statute or regulation. including, but not limited to, matters that could have been raised in a civil action, any employment laws, including but not limited to, claims of breach of contract, breach of the covenant of good faith and fair dealing, fraud, violation of public policy, defamation, physical injury, emotional distress, claims under Title VII of the 1964 Civil Rights Act, as amended, the California Fair Employment and Housing Act, the Age Discrimination in Employment Act, the Older Worker Benefit Protection Act and any other laws and/or regulations relating to employment. Notwithstanding the foregoing, the Company and its successors and assigns do not release any claims based on obligations created by or reaffirmed in the PII Agreement or this Agreement, including, without limitation, the obligations referred to in Section 1.H above, whether or not such claims have already arisen or arise after the date hereof. 3 3. SECTION 1542 WAIVER Based on information currently available to the Company and Employee, as applicable, (i) the Company is not aware that Employee has committed any wrongdoing or has participated in the preparation and filing with any government agency of any report or final prospectus or registration statement that is incorrect or incomplete or in the preparation and issuance of any public announcement or any filing with any government agency which at the time thereof Employee knew or should have known to be incorrect or incomplete, and (ii) Employee is not aware that the Company has committed any wrongdoing or has prepared and filed with any government agency any report or final prospectus or registration statement that is incorrect or incomplete or in the preparation and issuance of any public announcement or any filing with any government agency which at the time thereof the Company knew or should have known to be incorrect or incomplete. Notwithstanding the foregoing, each party understands that, except for any claims referred to in the last sentence of the first paragraph of Section 2 or in the last sentence of the second paragraph of Section 2 (the "EXCEPTED CLAIMS"), such party releases not only claims presently known to such party, but also all unknown or unanticipated claims, rights, demands, actions, obligations, liabilities and causes of action of every kind and character that would otherwise come within the scope of the release and as described in the preceding sections. Each party understands that such party may hereafter discover facts different from what such party now believes to be true, which if known, could have materially affected this Agreement, but such party nevertheless waives any claims or rights based on different or additional facts, other than any Excepted Claims. Except for the Excepted Claims, each party knowingly and voluntarily waives any and all rights or benefits that such party may now have, or in the future may have, under the terms of section 1542 of the California Civil Code, which provides as follows: A GENERAL RELEASE DOES NOT EXTEND TO CLAIMS WHICH THE CREDITOR DOES NOT KNOW OR SUSPECT TO EXIST IN HIS FAVOR AT THE TIME OF EXECUTING THE RELEASE, WHICH IF KNOWN BY HIM MUST HAVE MATERIALLY AFFECTED HIS SETTLEMENT WITH THE DEBTOR. 4. CONFIDENTIALITY Employee and the Company understand and agree that this Agreement and each of its terms, and the negotiations surrounding it, are confidential and will not be disclosed by Employee or the Company, to any entity or person, for any reason, at any time, without the prior written consent of the other party, except as required by law or to legal advisors for the parties who will be informed of and will agree to be bound by this confidentiality obligation. 5. PRESS RELEASE Notwithstanding the provisions of Section 6, Employee acknowledges that Hybrid will promptly issue a press release regarding Employee's termination of his employment with the Company, and agrees that the Company may do so. The Company agrees to make a copy of the press release available to Employee in advance of issuance and to make reasonable efforts in good faith to reach agreement with Employee regarding the wording of the press release. 4 6. NON-ADMISSION The parties understand and agree that this Agreement is not and will not be deemed or construed at any time or for any purpose as an admission of liability by the Company or by Employee. The liability for any and all claims is expressly denied by the Company and by Employee. 7. INTEGRATION The parties understand and agree that the preceding sections recite the sole consideration for this Agreement; that no representation or promise has been made by Employee, the Company or any other party concerning the subject matter of this Agreement, except as expressly set forth in this Agreement or the PII Agreement; and that all agreements and understandings between the parties concerning the subject matter of this Agreement are embodied and expressed in this Agreement and the PII Agreement. This Agreement and the PII Agreement will supersede all prior agreements and understandings between Employee and the Company, whether written or oral, express or implied, with respect to the engagement, employment, termination and compensation of Employee. 8. AMENDMENTS; WAIVER This Agreement may not be modified, amended, or terminated except by an instrument in writing, signed by each of the parties. No failure to exercise and no delay in exercising any right, remedy or power under this Agreement will operate as a waiver thereof, and no single or partial exercise of any right, remedy or power under this Agreement will preclude any other or further exercise thereof, or the exercise of any other right, remedy or power provided herein or by law or in equity. 9. ASSIGNMENT; SUCCESSORS AND ASSIGNS This Agreement will be binding upon and will inure to the benefit of the parties and their respective heirs, successors, attorneys and permitted assigns. This Agreement will not benefit any other person or entity except as specifically enumerated in this Agreement. 10. SEVERABILITY If any provision of this Agreement, or its application to any person, place or circumstances is held by an arbitrator or a court of competent jurisdiction to be invalid, unenforceable or void, such provision will be enforced to the greatest extent permitted by law, and the remainder of this Agreement and provision as applied to other persons, places and circumstances will remain in full force and effect. 11. GOVERNING LAW This Agreement will be governed by and construed in accordance with the law of the State of California. 5 12. CONSIDERATION PERIOD Employee acknowledges he has read and understands this Agreement and that his signature below is completely voluntary. Employee also acknowledges that the Company as offered him the opportunity to take up to 21 days to consider this Agreement but that he has elected to execute and deliver this Agreement before such 21-day period has elapsed and that he waives his rights to consider this Agreement for such 21-day period. Employee further acknowledges that he has been told by the Company that he has the right to consult with an attorney about this Agreement, that he was encouraged by the Company to consult with an attorney of his own choosing concerning the waivers contained in this Agreement, that he has done so and that the waivers he has made are knowing, conscious and with full appreciation that he may never pursue any of the rights he has waived. 13. REVOCATION PERIOD Employee understands that for seven days after signing this Agreement he has the right to revoke it and that this Agreement will not become effective or enforceable until after those seven days (the "REVOCATION PERIOD") have passed. IN WITNESS WHEREOF, the parties have executed and delivered as of the first date set forth above. Employee: The Company: HYBRID NETWORKS, INC. /s/ Dan E. Steimle - --------------------------------- Dan E. Steimle By: /s/ Carl S. Ledbetter --------------------------------- Carl S. Ledbetter Chief Executive Officer 6 EXHIBIT A Gross amount paid to Employee for accrued salary, reimbursable expenses and accrued but unused vacation pay through May 31, 1998: $17,469.74 2. Gross severance pay to Employee: $27,500 (an amount equal to two months' base salary, to be paid on May 31, 1998). 3. Gross bonus pay to Employee: $75,000 (to be paid on August 31,1998). 4. Gross fixed payments during Period of Consultancy: $6,875 per month commencing June 1, 1998 and ending November 1, 1998 (an amount equal to 50% of base monthly salary); a total of $41,250 over the six months' consulting period (ending November 30, 1998). EX-10.26 3 EXHIBIT 10.26 November 12, 1998 Mr. Judson Goldsmith 1010 Corporation Way Suite 200 Palo Alto, CA 94303 (650) 938-1701 Dear Judson: I am delighted to offer you the exempt position of Vice President, Finance, and Chief Financial Officer of Hybrid Networks, Inc. at a base monthly salary of $14,583.33 ($175,000.00 annualized). This position reports directly to the CEO and is subject to the direction of the Audit Committee of the Board of Directors of the Company. In addition to your base salary you will be eligible for an Executive Bonus Plan based on meeting the objectives outlined in the attached Exhibit A. This plan provides for an amount equal to 40% of your yearly base salary if the target objectives are met and has provisions for higher amounts for greater levels of achievement. A recommendation will be made to the Board of Directors of Hybrid Networks, Inc. that you be granted an Incentive Stock Option to purchase 275,000 shares of common stock in Hybrid under the terms of the Company's 1996 Equity Incentive Plan. The purchase price of these shares will be either the price of the stock on the NASDAQ at the close of business on your first day of work at the Company or, if the stock is not trading on that day, the price set by the Board of Directors for common stock in the Company at the next Board of Directors meeting immediately following your first day of work at the Company; the last options under this plan were priced at $2 3/16 per share in September, 1998. As a full-time employee of Hybrid, you will be eligible to participate in all Company-sponsored benefits. These include medical, dental and life insurance, LTD insurance, Personal Time Off, Company recognized Holidays, our 401(k) Plan and our Section 125 Cafeteria Plan. Employment with the Company is not for a specific term and can be terminated by you or by the Company at any time for any reason, with or without cause. Any contrary representations that may have been made or that may be made to you are superseded by this offer. This is the entire agreement regarding the terms of your employment with the Company and all future modifications have to be agreed upon in writing by both parties. Your employment pursuant to this offer is contingent upon: - - completion of the Employment Application - - executing our standard Proprietary Information and Inventions Agreement - - providing the Company with legally required proof of your identity and authorization to work in the United States. - - successful completion of a background and security check satisfactory to the Company Carl Ledbetter to Judson Goldsmith 11/12/98 Page 2 Please return to me a signed copy of this letter if you accept the above-described offer. THIS OFFER, IF NOT ACCEPTED, WILL EXPIRE ON 20 NOVEMBER, 1998. If you have any questions, please call me at (408) 342-4255. 1 am looking forward to having you join our team as we build toward success. Sincerely, /s/ Carl Ledbetter CARL LEDBETTER CHAIRMAN AND CHIEF EXECUTIVE OFFICER /s/ Judson Goldsmith 11/13/98 11/16/98 - -------------------- ---------------- ---------------------- JUDSON GOLDSMITH Acceptance Date Proposed Starting Date Carl Ledbetter to Judson Goldsmith 1 1 /1 2/98 Page 3 EXHIBIT A Executive Bonus Plan For Judson Goldsmith OBJECTIVES, ACTIONS, MEASUREMENTS, AND BONUS CONSIDERATION: Bonus percentages indicated are percentages of the Target Bonus Amount, which is 40% of Base Salary ($175,000 at the start, so that the Target Bonus Amount is set at $70,000) All activities and bonuses in this section are for the period commencing with the first day of work at the Company as a full-time employee and ending December 31, 1999, unless other dates are specifically indicated. After December 31, 1999, all bonus provisions not already paid out under this plan are cancelled. 1. Publication of 10K for 1997:15% if completed by 31 December, 1998 [i.e., 15% of 40% of $175,000.00, or $10,500.00, if completed]; 10% if completed by 31 January, 1999; 5% if completed after 31 January [$10,500 or $7,000 if completed]. Completing this item will require the securing of consent, at the time of the publication of the 10K for 1997, from PricewaterhouseCoopers to rely upon the audits completed by Coopers & Lybrand of the 10Ks already published by the Company for 1995 and 1996, or, alternatively, the completion of new audits and the publication of revised 10Ks for 1995 and 1996, or 1996 and 1998.) 2. Publication of the 10Qs for Q1, Q2 and Q3 1998: 15% if completed by 31 December, 1998; or 10% if completed by 31 January, 1999; or 5% if completed after 31 January, 1999 [$10,500, $7,000, or $3,500]. 3. Publication of the 10K for 1998 by February 28, 1999: 5% [$3,500 if completed]. 4. The holding of an Annual Stockholders' Meeting for the Company: 10% if completed by 1 April, 1999; or 5% if completed by 15 May, 1999 [$7,000 or $3500 if completed]. 5. Resumption of trading on the NASDAQ: 10% if on or before December 31, 1998, or, alternately, 5% if trading resumed thereafter [$7,000 or $3,500 if completed]. 6. Resolution and dismissal of the class action lawsuits: 15% if on or before March 31, 1999; 25% if on or before December 31, 1998 [$10,500 or $17,500, if completed]. 7. Financing of the Company by the sale of equity in the Company in the indicated amounts through one of the following means a) An equity investment of at least $12 million from a strategic partner at a price per share of at least $3: 30% (of the Bonus Target of 40% of Carl Ledbetter to Judson Goldsmith 11/12/98 Page 4 Base Salary) [$21,000] on or before 30 June, 1999, For an equity investment of at least $8M, but less than $12M, at a price of at least $2 3/16 per share on or before 30 June, 1999, the bonus payment will be 15% of the Bonus Target, or $10,500. In addition to the payments above, the Company will also pay 1% of Base Salary for each $1M of equity raised above $12M at a price per share of $4 or more, 2% per $1M above $12M for a price of $5 or more, 3% per $1M above $12M for a price of $6 or more, etc., up to a maximum of 10% of Base Salary per $1M of equity raised above $12M for a price of $13/share or more, on or before June 30, 1999. [For example, if $18M is invested at $6/share in March, 1999, the bonus amount under this provision would be $52,500 -- 30% of the Target Bonus of 40% of Base Salary, which is 12% of Base Salary, for securing the investment, plus an additional 3% of Base Salary (because the price is $6/share) for each of the additional $6M raised above $12M, or an additional 18% of Base Salary, for a total of 30% of Base Salary.] b) Any acquisition of the Company: 30% of Target Bonus, plus 0.5% of the amount in cash or liquid securities in excess of $45M but less than $55M immediately distributed to the Hybrid Networks' stockholders, plus 1.0% of any such amount in excess of $55M but less than $65M, plus 1.5% of any amount in excess of $65M. [Example: if the Company were to be acquired for $67M in cash and securities of a stock traded on the NASDAQ, and from that paid $2M in investment fees, $5M to creditors, and held back as part of the deal an escrow or other contingency fund of $3M, the amount immediately distributed to shareholders would be $57M. The bonus payment would be 30% of 40% of $175,000, or $21,000, plus 0.5% of $10M ($50,000] and 1.0% of $2M [$20,000] (since $57M is $12M above the target of $45M), for a total of $91,000.1 c) If an acquisition which qualifies under 8b) above is finalized prior to May 15, 1999, the total payout for the portion of the bonus related to section 8b will not be less than $125,000. d) If an equity investment which qualifies under 8a) above is completed and the bonus under that provision paid, but this event is followed within 1 year by an acquisition which qualifies under 8b) above, the total bonus payment under the provisions of this section 8 will be limited to the greater of the bonuses provided for under sections 8a and 8b. EX-10.27 4 EXHIBIT 10.27 HYBRID Networks, Inc. PRODUCT PURCHASE AGREEMENT THIS AGREEMENT ("Agreement") is made this 30th h of June, 1997 ("effective date") by and between HYBRID NETWORKS, INC., "a California corporation"; ("Hybrid") having its principal place of business at 10161 Bubb Road, Cupertino, CA 95014 and RCN Operating Services, Inc., a New Jersey corporation having its principal place of business at 105 Carnegie Center, Princeton, New Jersey 08540("RCN")". RECITALS Hybrid designs, develops, manufactures and distributes certain equipment relating to high speed modem/routers for use in wireless and cable environments. B. RCN is a provider of communications and telecommunications services" in multiple markets in the United States, and has both mechanical and business expertise to make use of Hybrid products for the purpose of distributing data over "certain frequencies". C. RCN desires to purchase certain equipment from Hybrid, and Hybrid is willing to sell such equipment to RCN, on and subject to the terms set forth below. Now, therefore, in consideration of the mutual agreements and covenants herein contained, the parties, intending to be legally bound, agree as follows: 1. SALE AND PURCHASE A. On and subject to the terms and conditions hereof, RCN intends to purchase from Hybrid, and Hybrid agrees to sell to RCN, a minimum of 25,000 units (the "Units") consisting of either Hybrid's model CCM-201/221 wireless and cable client cable modem/router (multi-user (which modems shall be capable of serving at least 20 users)) or N-201/221 modem (single user), or any combination thereof (the "Purchase Plan"). The Purchase Plan per-Unit price for the CCM-201/221 are identified in Addendum B (less the volume purchase agreement identified in Addendum C for the modems) RCN purchases are contingent on Hybrid's ability to provide products that are technically & price competitive, reliable, and can be delivered to meet RCN needs. B. RCN agrees to purchase from Hybrid by year end 12/31/97, and Hybrid agrees to sell to RCN a minimum of one thousand (1,000) Units and three (3) head-end sites plus an option for two (2) additional sites, at designated prices per Addendum A. Purchase Plan includes all equipment purchased by AT&T that is installed in RCN systems, and all equipment purchased by Cable Michigan or Commonwealth Telephone. C. At the end of 1997, an additional discount or credit will be applied towards RCN's purchases for that year. The discount is as follows: PAGE 1 $0-$500,000 = $15,000 credit $501,000-$750,000 = $30,000 credit $751,000 $1,000,000 = $45,000 credit >$1,000,000 = $50,000 credit D. RCN shall also have the right, but not the obligation to purchase additional equipment, identified on Addendum B, at its sole discretion. The purchase price for additional items (which are not included in the Purchase Plan) is contained in Addendum B (the Units and other items contained on Addenda A and B and the Software (as herein defined) are sometimes collectively referred to herein as the "Products"). Payment shall be made in accordance with Section 4 set forth below. RCN shall be permitted to order either the CCM-201/221 or the N-201/221 with (i) encryption support (model numbers CCM-201/221-S and N-201/221-S) which will increase the per Unit price for each such Unit ordered by $100, and (ii) an internal telephone modem (currently in development), which will increase the per Unit price for each such Unit ordered by approximately $50 per Unit. Hybrid shall notify RCN of the actual amount of the price increase prior to RCN placing any order for Units so configured. E. RCN agrees to take delivery of the Purchase Plan over a thirty-six month period, commencing on the Effective Date, and the parties agree to use their best efforts to develop a mutually agreed-upon forecasted delivery schedule not later than July 15, 1997 which schedule shall be revised on a quarterly basis not later than the 10th business days of each new quarter. F. RCN shall order Products by issuing written purchase orders to Hybrid. Such purchase orders will be subject to written acceptance by Hybrid, and upon acceptance, will constitute a binding agreement between Hybrid and RCN with respect to the Products identified herein on the term and conditions included herein. All purchase orders submitted by RCN to Hybrid shall be in English. The terms and conditions of this Agreement will prevail over any inconsistent wording on purchase order forms. Hybrid shall make best efforts to meet the quantities and shipping dates specified by RCN in each purchase order; however, Hybrid shall notify RCN within two (2) days following receipt of an order by Hybrid when quantities or shipping dates differ from those specified by RCN. Hybrid's standard lead times of released products is 45 days after receipt of order. Expedite requests will be handled on a case-by-case basis, Hybrid will make best effort to met RCN expedite requirements at no additional charge. G. Orders placed by RCN for Products will be accepted by Hybrid provided that: i) order is signed by RCN authorized representative ii) the order is received and accepted by Hybrid during the Term iii) the value of any single order is not less than $500 and iv) the order specifies the Products ordered, purchase price(s), exact "ship-to" and "bill-to" address and requested delivery schedule. 2. TERM OF AGREEMENT This Agreement shall come into force on the date first written above ("Effective Date") and shall remain valid for orders placed and delivered during the period of 36 months beginning on the Effective Date (the "term"). PAGE 2 3. PRICES/TAXES All purchase prices are exclusive of shipping and insurance charges which shall be billed separately. Installation and related charges are only included if stated on the face of the order or quotation. Installation and related charges are subject to change due to RCN failure to complete site readiness as stated, non-standard site conditions, force majeure events or RCN caused delays. RCN agrees to pay all such additional charges as invoiced by Hybrid only upon prior written approval of RCN. All prices are exclusive of all sales, use, excise, and other taxes, duties or charges. Unless evidence of tax exempt status is provided by RCN. RCN shall pay, or upon receipt of invoice from Hybrid, shall reimburse Hybrid for all such taxes or charges levied or imposed on RCN, or required to be collected by Hybrid, resulting from the Purchase Plan or any part thereof. All prices are FOB Hybrid' Factory Cupertino, California, U.S.A. Unless instructed otherwise. Hybrid will arrange for insurance and standard commercial shipping, the costs of which will be invoiced to the RCN. RCN will be entitled to Preferred Customer status. If, during the Term hereof, Hybrid sells CCM-201/221 modem/router or N-201/221 single user modem (or the encrypted version of either model) under similar or less advantageous (from Hybrid's standpoint) terms and conditions to those paid by RCN, then the price paid by RCN for all CCM Modem/routers that are on order to be delivered or any future orders during the term of this agreement hereunder will be adjusted downward to be equal to or below the lowest price at which Hybrid has sold said Products. Preferred Customer status only remains valid as long as RCN procurements remain consistent with Purchase Plan over the Term hereof. If during the term hereof RCN chooses to purchase additional equipment above and beyond the Purchase Plan, this Agreement will be amended accordingly based on mutually agreed to terms and conditions provided. that such terms are no less favorable than the terms set forth herein. Prior to delivery, Hybrid reserves the right to make substitutions, modifications and improvements to the Products, provided that such substitution, modification or improvement shall not adversely affect performance in the application originally agreed to with RCN, including, without limitation, any substitution, modification or improvement that adversely affects a Product's compatibility with the current Series 2000 system. 4. PAYMENT/FINANCING Terms of payment will be Net 30 days from date of shipment from Hybrid's factory. All amounts are payable to Hybrid Networks, Inc. at the address set forth on the invoice. RCN has a period of twenty (20) days after receipt of Product within which to notify Hybrid in writing of any discrepancies in the shipment that may give RCN the right to reject such shipment. If RCN fails to satisfy Hybrid on payment arrangements, Hybrid may refuse to accept an order or may allow RCN to make other arrangements satisfactory to Hybrid prior to shipment. 5. EQUIPMENT WARRANTY PAGE 3 Hybrid warrants that all Hybrid manufactured equipment including any equipment subcontracted by Hybrid that carries the Hybrid logo[ will be free from defects of material and workmanship and [(] conform to manufacturer's published specifications for a period of eighteen (18) months from the date of delivery under normal operating conditions, which specifications are attached hereto as Addendum H and incorporated herein by this reference. Hybrid agrees to notify RCN of any modification of any specifications relating to the Products, and further agrees not to modify any such specifications in a manner that would adversely affect the performance of the Products without prior written consent of RCN. Hybrid will assist RCN in any warranty matters with equipment not manufactured for or by Hybrid Technologies but provided to RCN by Hybrid. Should a product fail within this warranty period, Hybrid will repair or replace, at its discretion, the defective product when it is returned to Hybrid, shipping prepaid. Replacement products may be refurbished or contain refurbished materials. Proof of date of delivery of the returned product is required. Hybrid' sole obligation shall be to repair, replace, or refund the purchase price, at its option. Replacement Equipment may be new, refurbished or remanufactured: provided, however, that any Replacement Equipment provided by Hybrid to replace failed equipment upon initial installation thereof shall be new. Returned replaced Equipment shall become Hybrid' property. Replacement Equipment shall be warranted for the unexpired portion of the returned Equipment's warranty. The warranty provided under this section, shall not apply to any item of the equipment which has been altered or modified including any change, addition, or improvement. Hybrids' sole warranty liability to RCN with respect to equipment manufactured by a third party that does not reside in Hybrid's current price list (in Addendum B). and incorporated into Hybrid equipment shall be to pass through to RCN such original equipment manufacturer's available product warranty. The warranty provided herein does not cover damage, defects, malfunctions or service failures caused by: a) RCN's failure to follow Hybrid' environmental, installation, operation or maintenance specifications or instructions: b) Modifications, alterations or repairs made other than by Hybrid: c) RCN's mishandling, abuse, misuse, negligence, or improper storage, servicing or operation of the Equipment (including without limitation use with incompatible equipment). Addendum I includes a written list of compatible equipment to the Hybrid PoP equipment, which list will be updated by Hybrid from time to time. : or d) Power failures, surges, fire, flood, accident, actions of third parties or other like events outside Hybrid' control. Repairs necessitated during the warranty period by any of the foregoing causes may be made by Hybrid, and the RCN shall pay Hybrid' standard charges for time and materials, together with all shipping and handling charges arising from such repairs. THIS WARRANTY CONSTITUTES HYBRIDS' SOLE AND EXCLUSIVE LIABILITY HEREUNDER. AND RCN'S SOLE AND EXCLUSIVE REMEDY FOR DEFECTIVE OR NONCONFORMING ITEMS AND IS IN LIEU OF ALL OTHER WARRANTIES, EXPRESS, IMPLIED OR STATUTORY (INCLUDING THE WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE). 6. SOFTWARE PAGE 4 (a) LICENSE. In connection with the purchase of the Units, Hybrid with its requisite power and authority, grants to RCN a non-exclusive, non-transferable, license to use the software and related documentation ("Software") based on the following conditions: I. for up to 500 subscribers per PoP purchased by CUSTOMER pursuant to Section 1(F) is included in the original system purchase price II. for total number of subscribers ranging from 501-3,000, RCN will pay $10 per subscriber or a one time fee of $25,000 III. Once RCN has reached the 3,000 subscriber level per PoP, no additional software fees will charged. Please note that the Software may include software and documentation that are owned by third parties and distributed by Hybrid under license from the owner. (b) COPIES. RCN shall not make any copies of the Software, except for a single archival copy solely for internal purposes. (c) CONFIDENTIALITY. RCN shall maintain the confidentiality of the Software and shall not sublicense, sell, rent, disclose, make available, disassemble, or otherwise communicate the Software to any other person, or use the Software except as expressly authorized in writing by Hybrid. (d) TITLE. The Software and all copies thereof will at all times remain the sole and exclusive property of Hybrid or its licensor, as applicable, and RCN shall obtain no title to the Software. (e) COPYRIGHT. RCN shall reproduce all copyright notices and any other proprietary legends on any copy of the Software made by RCN. (f) ALTERATION. RCN shall not modify, disassemble, or decompile the Software. (g) WARRANTY. Hybrid does not warrant that the operation of the Software will be error free. Hybrid will use reasonable efforts to correct any defects reported to Hybrid in writing within 90 days of the date of shipment, exclusive of defects caused by physical defects in Software disks due to mishandling, operator error or interfacing other systems not approved by Hybrid. (h) Maintenance and enhancement releases occurring during the Term of this Agreement will automatically be sent to RCN at no additional charge. "Hybrid warrants that is has full power and authority to lawfully grant the rights granted by this Agreement, without the consent of any other person, entity or governmental authority, and that, TO THE BEST OF HYBRID'S KNOWLEDGE the use by Customer of the Software (including the copying thereof) and the Products shall not in any way constitute an infringement or other violation of any copyright, trade secret, trademark, patent, proprietary information, nondisclosure, intellectual property or other rights of any party. Hybrid shall indemnify, defend, and hold harmless RCN, its affiliates and subsidiaries and all officers, directors, employees, and agents of such corporations from and against any and all claims, actions, losses, liabilities, damages, costs, and expenses, including attorney fees, arising out of or relating to any breach of the representations and warranties of this subsection, PROVIDED THAT HYBRID SHALL BE GIVEN (i) PAGE 5 EXPRESS, IMPLIED OR STATUTORY (INCLUDING THE WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE). 7. TRAINING RCN will receive two (2) "free" slots for initial training for each PoP purchased with annual updates as required. Accumulation of free training slots only remains valid so long as this Agreement remains in effect. 8. RIGHTS OF THE PARTIES HYBRID RIGHTS-RCN AGREES TO: a) Issue a national scale press release announcing its purchase of Hybrid equipment. RCN agrees to issue a national press release announcing the commercial data delivery service in each city using Hybrid as soon as practicable after launch of such service. In addition, RCN agrees to issue periodic press release promoting the development of its commercially available data service using Hybrid equipment. During the installation period, both Hybrid and RCN will have the right of review and approval, which will not be unreasonably withheld, of any press release that the other party proposes to issue describing the service and equipment. B) Permit Hybrid to visit each cities facility in the RCN system where Hybrid equipment (listed in ADDENDUM A) is located and showcase the technology and business model for other prospective customers, investors or partnering prospects selected by Hybrid. RCN will be given reasonable advance notice of these visits and they will occur only during normal business hours. Hybrid agrees to indemnify and hold RCN harmless for any claim, loss or liability incurred or made or asserted against RCN (including reasonable fees and disbursements of counsel defending itself against such claims, losses of liabilities) in connection with the rights granted to Hybrid pursuant to this Section: provided, however, there shall be no obligation of Hybrid to so indemnify RCN hereunder if the claim, loss or liability arises solely out of the gross negligence or willful misconduct of RCN. c) Hybrid and RCN will meet quarterly to review status of Purchase Plan and to forecast upcoming shipments. CCM commitments are for unit purchases only and that RCN has the right to manage unit orders among the CCM models contracted. If Hybrid introduces new CCM models during the terms of this Agreement, RCN has the right to apply the new models against volume commitments based on mutually agreed to discounts. d) RCN will receive two (2) Single User CCMs free of charge for every new Hybrid PoP that is purchased. e) Hybrid will develop and support software tools that will allow for network monitoring and simplified installation ("Golden Install"). These tools will be phased into Hybrid's system beginning with the next software release, Hybridware release 4.2. RCN RIGHTS - HYBRID AGREES TO: a) Upgrade all FSK modems (P/N CCM-221 and N-221) to QPSK immediately upon general release. PAGE 6 b) RCN will receive preferential treatment in regards to advance releases of software for the purpose of jointly testing and evaluating said software. Hybrid will make best efforts to keep RCN informed of future releases. In return, RCN will report system errors and problems on a timely basis to Hybrid. c) A joint marketing effort - for every one-hundred (100) Hybrid modems purchased by RCN, Hybrid will Donate one (1) modem (model to be agreed to by both parties)to a designated educational institution. d) RCN has the right to "co-label" Hybrid modems and will be responsible for all expenses associated. 9. SYSTEM/SOFTWARE SUPPORT RCN will receive free of charge "System support" as outlined in ADDENDUM D, for all head end location sites during the first six (6) months following the delivery of the units in these markets. After this period, an "Annual System Support Contract" may be purchased by RCN at the rate set forth in Addendum D. Hybrid will support the Series 2000 product line with Technical Support and spare parts for the Term hereof. Hybrid will follow the "Trouble ticket Process & Clearing" as outlined in ADDENDUM E. If these procedures are changed, Hybrid will notify RCN in writing prior to the effective date of such change. Hybrid will follow the "Escalation Procedures" as outlined in ADDENDUM F. If these procedures are changed, Hybrid will notify RCN in writing prior to the effective date of such change. 10. TECHNICAL SPECIFICATIONS System functionality is limited to the published "Hybrid Series 2000 - System Description". A copy of said manual has been forwarded to RCN. Hybrid shall complete the installation services in accordance with Hybrids' normal installation practices. Hybrid shall perform its standard acceptance testing as outlined on ADDENDUM G, on the installed Equipment and RCN agrees to monitor said testing. Upon completion of installation, as described above, Hybrid shall notify RCN that the Equipment has been installed and operates in accordance with applicable test and performance specifications. The date of such notification shall be the installation cutover date. Hybrid may at its sole discretion use subcontractors to provide installation services. 11. EXCUSABLE DELAY Notwithstanding anything contained in this Agreement to the contrary, neither party shall be liable to the other for failure to perform any obligation under this Agreement (nor shall any charge or payments be made in respect thereof) if prevented from doing so by reason of acts of God, strikes, labor unrest, embargoes, civil commotion, rationing or other governmental orders or requirements, acts of civil or military authorities, or other contingencies if and to the extent such cause is beyond the reasonable control of such party PAGE 7 and all requirements as to notice, another performance required hereunder within a specified period, shall be automatically extended to accommodate the period of any such cause which shall interfere with such performance. 12. CHANGE, CANCELLATION, AND TERMINATION In the event that either party breaches any provision of this Agreement and fails to cure such breach within thirty (30) days after written notice from the other party, the breaching party shall be in default and the non-breaching party shall have the right, but not the obligation, to terminate this Agreement by providing written notice to the breaching party at least thirty (30) days prior to the date of termination. Any subsequent cure of the breach that resulted in the termination notice will not affect the validity of the termination notice, unless such notice is withdrawn by the non-breaching party. 13. ASSIGNMENT Neither party may assign this Agreement in whole or in part without the prior written consent signed by an officer of the other party, which consent shall not be unreasonably withheld; provided, however, that RCN shall be permitted to assign this Agreement, in whole or in part, with notice, but without the necessity of consent, to any of its affiliates (defined in Rule 12b-2 of the Security Exchange Act of 1934, as amended). 14. GOVERNING LAW, VENUE, AND JURISDICTION This Agreement will be governed by and construed in accordance with the laws of the "State of New Jersey", "State of New York", "State of Michigan", "Commonwealth of Pennsylvania", or "Commonwealth of Massachusetts". Reasonable attorney fees shall be reimbursed, with respect to the foregoing, to the party who prevails on the merits. 15. ENFORCEABILITY If any provision of this Agreement shall be held to be invalid, illegal or unenforceable, the validity, legality or enforceability of the remaining provisions shall in no way be affected or impaired. 16. NOTICES Any notice required to be given by either party to the other party shall be in writing and shall be deemed given if personally delivered, if sent by facsimile (with receipt acknowledged) to the facsimile number the other party set forth below or if mailed postage prepaid, to: Hybrid Networks, Inc. RCN Telecom Services, Inc. 10161 Bubb Road 105 Carnegie Center Cupertino, CA 95014 Princeton, New Jersey 08540 Attention: Jeff Gates Attention: Mark Haverkate Fax no. 408/725-2439 Fax no. 609-734-7521 or such other address as the party to which the notice is sent shall have provided to the other party by written notice in accordance with this Section. PAGE 8 17. LIMITATION OF LIABILITY NOTWITHSTANDING ANY OTHER PROVISIONS OF THIS CONTRACT, UNDER NO CIRCUMSTANCES SHALL either party BE LIABLE TO the other party OR ANY THIRD PARTY FOR SPECIAL, INCIDENTAL, INDIRECT OR CONSEQUENTIAL DAMAGES, AS A RESULT OF A BREACH OF ANY PROVISION OF THIS CONTRACT. Each party (the "Indemnifying Party") HEREBY INDEMNIFIES the other party (the "Indemnified Party") AGAINST ALL LOSS OR LIABILITY FROM CLAIMS ARISING OUT OF OR RELATING TO THE INSTALLATION, OPERATION, OR USE OF THE EQUIPMENT, WHETHER ON ACCOUNT OF NEGLIGENCE OR OTHERWISE; PROVIDED, HOWEVER, the Indemnifying Party shall have no obligation to indemnify the Indemnified Party for any loss of liability arising out of Indemnified Party's GROSS NEGLIGENCE OR WILLFUL MISCONDUCT. 18. ENTIRE AGREEMENT This Agreement supersedes all previous communications, transactions, and understandings, whether oral, or written, and constitutes the sole and entire agreement between the parties pertaining to the subject matter hereof. No modification or deletion of, or addition to these terms shall be binding on either party unless made in writing and signed by a duly authorized representative of both parties. 19. "CONFIDENTIAL INFORMATION Hybrid hereby acknowledges that during the course of performing the services under this Agreement, it may come into possession of confidential information which may not be disclosed to any third party. Further, Hybrid agrees not to disclose said information to any person other than on a need-to-know basis. Confidential information shall include, but is not limited to, any information concerning RCN's business and affairs, inventory, improvements, process, techniques, contracts with third party and other trade secrets obtained during the term of this Agreement. INFORMATION WILL NOT BE SUBJECT TO THIS PROVISION IF IT IS OR BECOMES A MATTER OF PUBLIC KNOWLEDGE WITHOUT THE FAULT OF HYBRID, IF IT WAS A MATTER OF WRITTEN RECORD IN HYBRID'S FILES PRIOR TO DISCLOSURE BY RCN, OR IF IT WAS RECEIVED BY HYBRID FROM A THIRD PERSON UNDER CIRCUMSTANCES PERMITTING ITS DISCLOSURE BY HYBRID The terms of this subsection shall survive the termination of this Agreement FOR A PERIOD OF THREE YEARS." In Witness Whereof, duly authorized representatives of the Parties, hereto have executed this Agreement as of the day and year first above written. Hybrid Networks, Inc. RCN: By: /s/ [ILLEGIBLE] By: /s/ [ILLEGIBLE] ------------------------ ------------------------ Title: Chm & CEO Title: EVP --------------------- -------------------- Date: 5 Aug 1997 Date: July 31, 1997 ---------------------- --------------------- PAGE 9 ADDENDUM A FIRST FIVE SITES - 1997 SHIPMENTS ALLENTOWN SITE SERIES 2000 - CABLE DOWN (64QAM), TELEPHONE AND ROUTER RETURN
=================================================================================================================================== PRODUCT CONFIGURATION PRICE QUANTITY ------------------------- CODE COMPONENT MIN MAX (US$) =================================================================================================================================== HYBRID PoP EQUIPMENT, SOFTWARE LICENSES AND SPARE PARTS - ----------------------------------------------------------------------------------------------------------------------------------- CMG-2000 CyberManager 2000 with HybridWare + SW for 500 Subcribers 1 1 25,000 1 XXX - ----------------------------------------------------------------------------------------------------------------------------------- SNL-0500 Subscriber 500 Network License (see Note 1) As Required 5,000 XXX - ----------------------------------------------------------------------------------------------------------------------------------- SNL-2500 Subscriber 2500 Network License (see Note 1) As Required 25,000 XXX - ----------------------------------------------------------------------------------------------------------------------------------- CMD-2000 CM Downstream Router with HybridWare + SW 1 As Required 18,170 1 XXX - ----------------------------------------------------------------------------------------------------------------------------------- SEC-010 Secure Encryption Card (DES) 895 1 XXX - ----------------------------------------------------------------------------------------------------------------------------------- SQC-200-3 SIF (QAM) Card, 3-channel (each 10 Mbps) 1 2 per CMD 4,150 2 XXX - ----------------------------------------------------------------------------------------------------------------------------------- QMC-200-3 64 QAM Modulator Card w/Filter & Combiner, 3 Channel 1 2 per CMD 4,820 2 XXX - ----------------------------------------------------------------------------------------------------------------------------------- HFL-2220 IF Filter (standalone, special purpose) NOTE 2 2 per CMD POA XXX - ----------------------------------------------------------------------------------------------------------------------------------- CMU-2000-8T CM Upstream Router with HybridWare + SW 1 As Required 18,285 XXX - ----------------------------------------------------------------------------------------------------------------------------------- TDC-001-8 Phone Demodulator Card, 8 lines per card 1 8 per CMU 3,095 XXX - ----------------------------------------------------------------------------------------------------------------------------------- COMMERCIAL PoP EQUIPMENT ALSO AVAILABLE FROM HYBRID (TYPICAL PRICES, NO DISCOUNTS, PRICES MAY CHANGE WITHOUT NOTICE) - ----------------------------------------------------------------------------------------------------------------------------------- OFS-200 Fast Ethernet Switch (Cisco Catalyst 2900) 1 17,500 $ XXX - ----------------------------------------------------------------------------------------------------------------------------------- OCM-160 C6M Modulator/Upconverter (USA Spec) 1 NOTE 3 2,140 XXX - ----------------------------------------------------------------------------------------------------------------------------------- OCM-165 C6MP Modulator/Upconverter (USA Spec) 1 NOTE 3,4 2,950 XXX - ----------------------------------------------------------------------------------------------------------------------------------- OCM-260 C6U Modulator/Upconverter (USA and International) 1 NOTE 3 2,950 XXX - ----------------------------------------------------------------------------------------------------------------------------------- APONET BANDWIDTH MANAGER (MODEL 10) 5,000 1 XXX - ----------------------------------------------------------------------------------------------------------------------------------- OCM-400 IP Gateway Router (Cisco 7206) 13,000 1 $ XXX - ----------------------------------------------------------------------------------------------------------------------------------- OCM-401 TI DSU (Generic Internet Connection) 1,250 1 XXX - ----------------------------------------------------------------------------------------------------------------------------------- ORK-719 7-foot, 19-inch rack 1 940 XXX - ----------------------------------------------------------------------------------------------------------------------------------- CKT-201 Baseline One-Way Cable/Telephone System Cabling Kit 1 (or equiv) 100 XXX - ----------------------------------------------------------------------------------------------------------------------------------- DKT-030 Monitor and Keyboard (both rackmount for CMD and CMU) 1 As Required 925 1 XXX - ----------------------------------------------------------------------------------------------------------------------------------- OPS-030 Power Strip As Required 130 XXX - ----------------------------------------------------------------------------------------------------------------------------------- PAGE 10 SPARE PARTS - ----------------------------------------------------------------------------------------------------------------------------------- LAC-010 10/100 BaseT LAN Interface Card 690 XXX - ----------------------------------------------------------------------------------------------------------------------------------- HYBRID CLIENT CABLE MODEMS - ----------------------------------------------------------------------------------------------------------------------------------- CCM-201 Client Cable Modem (multi-user) As Required 540 100 XXX - ----------------------------------------------------------------------------------------------------------------------------------- CCM-201-S Client Cable Modem (multi-user), encryption support (DES) As Required 640 XXX - ----------------------------------------------------------------------------------------------------------------------------------- N-201 Client Cable Modem (single-user) As Required 295 100 $ XXX - ----------------------------------------------------------------------------------------------------------------------------------- N-201-S Client Cable Modem (single-user), encryption support (DES) As Required 395 XXX - ----------------------------------------------------------------------------------------------------------------------------------- COMMERCIAL CABLE MODEM ACCESSORIES (TYPICAL PRICES, NO DISCOUNTS, PRICES MAY CHANGE WITHOUT NOTICE, RECOMMEND LOCAL PURCHASE) - ----------------------------------------------------------------------------------------------------------------------------------- OTM-001 V.34 28.6 Phone Modem (typically US Robotics) As Required 125 200 $ XXX - ----------------------------------------------------------------------------------------------------------------------------------- CBL-001 RS-232 Modem Cable (see Note 5) As Required 8 200 XXX - ----------------------------------------------------------------------------------------------------------------------------------- OEH-005 Ethernet Hub (5-port support for five computers) As Required 80 0 XXX - ----------------------------------------------------------------------------------------------------------------------------------- HYBRID TECHNICAL SUPPORT AND TRAINING (SEE NOTE 6) - ----------------------------------------------------------------------------------------------------------------------------------- TRN-201-4C One-Way Cable (64QAM) Training Program 1 REQUIRED N/C 2 XXX - ----------------------------------------------------------------------------------------------------------------------------------- TRN-201-1C One-Way Cable (64QAM) Training Program/Per Student As Required 1,500 XXX - ----------------------------------------------------------------------------------------------------------------------------------- SRV-100 System Integration per Day As Required 1,500 XXX - ----------------------------------------------------------------------------------------------------------------------------------- TOTAL: $20X ===================================================================================================================================
Notes: 1 Price as listed when purchased with the CMG-2000 2 Standalone filter may be required in remote fiber links using a channel translator 3 One c6m is required per downstream carrier frequency; one C6U is required per 2 downstream carrier frequencies 4 Special order from General Instruments 5 RS-232 modem cables are bulk shipped, used to connect cable modem and telephone modem. 6 Training program prices are for Cupertino Training; additional costs apply to on-site training. PAGE 11 BOSTON SITE SERIES 2000 - CABLE DOWN (64QAM), TELEPHONE AND ROUTER RETURN
=================================================================================================================================== PRODUCT CONFIGURATION PRICE QUANTITY ------------------------- CODE COMPONENT MIN MAX (US$) =================================================================================================================================== HYBRID PoP EQUIPMENT, SOFTWARE LICENSES AND SPARE PARTS - ----------------------------------------------------------------------------------------------------------------------------------- CMG-2000 CyberManager 2000 with HybridWare + SW for 500 Subscribers 1 1 25,000 1 XXX - ----------------------------------------------------------------------------------------------------------------------------------- SNL-0500 Subscriber 500 Network License (see Note 1) As Required 5,000 XXX - ----------------------------------------------------------------------------------------------------------------------------------- SNL-2500 Subscriber 2500 Network License (see Note 1) As Required 25,000 XXX - ----------------------------------------------------------------------------------------------------------------------------------- CMD-2000 CM Downstream Router with HybridWare + SW 1 As Required 18,170 1 XXX - ----------------------------------------------------------------------------------------------------------------------------------- SEC-010 Secure Encryption Card (DES) 895 1 XXX - ----------------------------------------------------------------------------------------------------------------------------------- SQC-200-3 SIF (QAM) Card, 3-channel (each 10 Mbps) 1 2 per CMD 4,150 2 XXX - ----------------------------------------------------------------------------------------------------------------------------------- QMC-200-3 64 QAM Modulator Card w/Filter & Combiner, 3 Channel 1 2 per CMD 4,820 2 XXX - ----------------------------------------------------------------------------------------------------------------------------------- HFL-2220 IF Filter (standalone, special purpose) NOTE 2 2 per CMD POA XXX - ----------------------------------------------------------------------------------------------------------------------------------- CMU-2000-8T CM Upstream Router with HybridWare + SW 1 As Required 18,285 XXX - ----------------------------------------------------------------------------------------------------------------------------------- TDC-001-8 Phone Demodulator Card, 8 lines per card 1 8 per CMU 3,095 XXX - ----------------------------------------------------------------------------------------------------------------------------------- COMMERCIAL PoP EQUIPMENT ALSO AVAILABLE FROM HYBRID (TYPICAL PRICES, NO DISCOUNTS, PRICES MAY CHANGE WITHOUT NOTICE) - ----------------------------------------------------------------------------------------------------------------------------------- OFS-200 Fast Ethernet Switch (Cisco Catalyst 2900) 1 17,500 1 $ XXX - ----------------------------------------------------------------------------------------------------------------------------------- OCM-160 C6M Modulator/Upconverter (USA Spec) 1 NOTE 3 2,140 XXX - ----------------------------------------------------------------------------------------------------------------------------------- OCM-165 C6MP Modulator/Upconverter (USA Spec) 1 NOTE 3,4 2,950 XXX - ----------------------------------------------------------------------------------------------------------------------------------- OCM-260 C6U Modulator/Upconverter (USA and International) 1 NOTE 3 2,950 XXX - ----------------------------------------------------------------------------------------------------------------------------------- Aponet Bandwidth Manager (Model 10) 5,000 1 XXX - ----------------------------------------------------------------------------------------------------------------------------------- OCM-400 IP Gateway Router (CISCO 7206) 13,000 1 $ XXX - ----------------------------------------------------------------------------------------------------------------------------------- OCM-401 TI DSU (generic internet connection) 1,250 1 XXX - ----------------------------------------------------------------------------------------------------------------------------------- ORK-719 7-foot, 19-inch rack 1 940 XXX - ----------------------------------------------------------------------------------------------------------------------------------- CKT-201 Baseline One-Way Cable/Telephone System Cabling Kit 1 (or equiv) 100 XXX - ----------------------------------------------------------------------------------------------------------------------------------- DKT-030 Monitor and Keyboard (both rackmount for CMD and CMU) 1 As Required 925 1 XXX - ----------------------------------------------------------------------------------------------------------------------------------- OPS-030 Power Strip As Required 130 XXX - ----------------------------------------------------------------------------------------------------------------------------------- SPARE PARTS - ----------------------------------------------------------------------------------------------------------------------------------- LAC-010 10/100 BaseT LAN Interface Card 690 XXX - ----------------------------------------------------------------------------------------------------------------------------------- PAGE 12 HYBRID CLIENT CABLE MODEMS - ----------------------------------------------------------------------------------------------------------------------------------- CCM-201 Client Cable Modem (multi-user) As Required 540 100 XXX - ----------------------------------------------------------------------------------------------------------------------------------- CCM-201-S Client Cable Modem (multi-user), encryption support (DES) As Required 640 XXX - ----------------------------------------------------------------------------------------------------------------------------------- N-201 Client Cable Modem (single-user) As Required 295 100 XXX - ----------------------------------------------------------------------------------------------------------------------------------- N-201-S Client Cable Modem (single-user), encryption support (DES) As Required 395 XXX - ----------------------------------------------------------------------------------------------------------------------------------- COMMERCIAL CABLE MODEM ACCESSORIES (TYPICAL PRICES, NO DISCOUNTS, PRICES MAY CHANGE WITHOUT NOTICE, RECOMMEND LOCAL PURCHASE) - ----------------------------------------------------------------------------------------------------------------------------------- OTM-001 V.34 28.8 Phone Modem (typically US Robotics) As Required 125 200 XXX - ----------------------------------------------------------------------------------------------------------------------------------- CBL-001 RS-232 Modem Cable (see Note 5) As Required 8 200 XXX - ----------------------------------------------------------------------------------------------------------------------------------- OEH-005 Ethernet Hub (5-port support for five computers) As Required 80 0 XXX - ----------------------------------------------------------------------------------------------------------------------------------- HYBRID TECHNICAL SUPPORT AND TRAINING (SEE NOTE 6) - ----------------------------------------------------------------------------------------------------------------------------------- TRN-201-4C One-Way Cable (64QAM) Training Program 1 Required N/C 2 XXX - ----------------------------------------------------------------------------------------------------------------------------------- TRN-201-1C One-Way Cable (64QAM) Training Program/Per Student As Required 1,500 XXX - ----------------------------------------------------------------------------------------------------------------------------------- SRV-100 System Integration per day As Required 1,500 XXX - ----------------------------------------------------------------------------------------------------------------------------------- TOTAL: $2XX ===================================================================================================================================
Notes: 1 Price as listed when purchased with the CMG-2000. 2 Standalone filter may be required in remote fiber links using a channel translator. 3 One C6M is required per downstream carrier frequency; one C6U is required per 2 downstream carrier frequencies. 4 Special order from General Instruments. 5 RS-232 modem cables are bulk shipped, used to connect cable modem and telephone modem. 6 Training program prices are for Cupertino Training; additional costs apply to on-site training. PAGE 13 Series 2000 - Cable (64QAM) Down, Cable (FSK) Return - Manhattan, N.Y. (To be completed pending AT&T participation) PAGE 14 Series 2000 - Cable (64QAM) Down, Cable (FSK) Return - Carmel, N.Y. (To be completed pending AT&T participation) PAGE 15 Series 2000 - Cable (64QAM) Down, Cable (FSK) Return - Princeton, N.J. (To be completed pending AT&T participation) PAGE 16 ADDENDUM B GLOBAL PRICE LIST
PoP EQUIPMENT - ---------------------------------------------------------------------------------------------- CMG-2000 CyberMngr 2000 w\HybridWare + SW for 500 Subs. $25,000 - ---------------------------------------------------------------------------------------------- SNL-0500 Subscriber 500 Network License $5,000 - ---------------------------------------------------------------------------------------------- SNL-2500 Subscriber 2500 Network License $25,000 - ---------------------------------------------------------------------------------------------- CMD-2000 CM Downstream Router with Hybridware + SW $18,170 - ---------------------------------------------------------------------------------------------- SEC-010 Secure Encryption Card (DES) $895 - ---------------------------------------------------------------------------------------------- SQC-200-3 SIF (QAM) Card, 3-channel (each 10 Mbps) $4,150 - ---------------------------------------------------------------------------------------------- SVC-100 4VSB 3-Ch SIF Card $4,150 - ---------------------------------------------------------------------------------------------- HEM-2004 Encoder/Modulator (4-VSB) $3,200 - ---------------------------------------------------------------------------------------------- QMC-200-3 64 QAM Modulator Card w/ Filter & Combiner, 3 channel $4,820 - ---------------------------------------------------------------------------------------------- QMC-200-3C 64 QAM Modulator Card w/ Combiner, 3 channel $4,820 - ---------------------------------------------------------------------------------------------- HEM-2004-B Baseband Transmitter (IF-to BB) $2,600 - ---------------------------------------------------------------------------------------------- HEM-2004-I Baseband Receiver (BB to IF) $3,400 - ---------------------------------------------------------------------------------------------- HEM-2004-B Encoder-Baseband (64 QAM) $2,600 - ---------------------------------------------------------------------------------------------- HEM-2204-I Modulator-IF (64-QAM) $3,400 - ---------------------------------------------------------------------------------------------- HFL-2220 IF Filter (standalone, special purpose) POA - ---------------------------------------------------------------------------------------------- CMU-2000-8T CM Upstream Router with HybridWare + SW $18,285 - ---------------------------------------------------------------------------------------------- CMU-2000-14C CM Upstream Router with HybridWare + SW $18,860 - ---------------------------------------------------------------------------------------------- VDC-010-2 4-VSB Demodulator Card, 2 channels per card $2,595 - ---------------------------------------------------------------------------------------------- VBU-010-x Hybrid Block Upconverter $3,200 - ---------------------------------------------------------------------------------------------- CKT-201 Baseline One-Way System Cabling Kit $100 - ---------------------------------------------------------------------------------------------- TDC-001-8 Phone Modem Card, 8 lines per card $3,095 - ---------------------------------------------------------------------------------------------- CSM-2000 CyberSecure 2000, includes HybridWare + SW $15,000 - ---------------------------------------------------------------------------------------------- SUG-2000 Software Upgrade from Series 2000 ELS to full Series 2000 $500 - ---------------------------------------------------------------------------------------------- COMMERCIAL PoP EQUIP. AVAILABLE FROM HYBRID - ---------------------------------------------------------------------------------------------- OFS-200 Fast Ethernet Switch (Cisco Catalyst 2800) $8,700 - ---------------------------------------------------------------------------------------------- OCM-160 C6M Modulator/Upconverter (USA Spec) $2,140 - ---------------------------------------------------------------------------------------------- OCM-165 C6MP Modulator/Upconverter (USA Spec) $2,950 - ---------------------------------------------------------------------------------------------- OCM-260 C6U Modulator/Upconverter (USA and International) $2,950 - ---------------------------------------------------------------------------------------------- ORK-719 7-foot, 19-inch rack $940 - ---------------------------------------------------------------------------------------------- CKT-201 Baseline One-Way Cable/Telephone System Cabling Kit $100 - ---------------------------------------------------------------------------------------------- CKT-221 Baseline Two-Way Cable (FSK) System Cabling Kit $200 - ---------------------------------------------------------------------------------------------- DKT-030 Monitor and Keyboard (both rackmount for CMD AND CMU) $925 - ---------------------------------------------------------------------------------------------- OCS-016 16-way Splitter $0 - ---------------------------------------------------------------------------------------------- ODF-260 Diplex Filter $0 - ---------------------------------------------------------------------------------------------- PAGE 17 - ---------------------------------------------------------------------------------------------- OPS-030 Power Strip $130 - ---------------------------------------------------------------------------------------------- OLP-330 Termianl Server (Portmaster) 30 Port $3,700 - ---------------------------------------------------------------------------------------------- OEX-020-7 Upstream Demodulator Shelf (supports 7 FSK cards) $2,200 - ---------------------------------------------------------------------------------------------- OEC-021 FSK Upstream Demodulator Card $965 - ---------------------------------------------------------------------------------------------- SPARE PART - ---------------------------------------------------------------------------------------------- LAC-010 10/100 BaseT LAN Interface Card $690 - ---------------------------------------------------------------------------------------------- HSB-210-S Secure Encryption Card (SBUS) $895 - ---------------------------------------------------------------------------------------------- HYBRID CLIENT CABLE MODEMS* - MAYBE SUPERCEDED BY VPA - ---------------------------------------------------------------------------------------------- CCM-101 Client Cable Modem $995 - ---------------------------------------------------------------------------------------------- CCM-101-S Client Cable Modem, encryption support (DES) $1,095 - ---------------------------------------------------------------------------------------------- CCM-161 CCM (4-VSB), ELS (Series 2000 compatible) $995 - ---------------------------------------------------------------------------------------------- CCM-161-S CCM (4-VSB), ELS encryption support (DES) $1,095 - ---------------------------------------------------------------------------------------------- CCM-201 Client Cable Modem (multi-user) $795 - ---------------------------------------------------------------------------------------------- CCM-201-S Client Cable Modem (multi-user), encryption support (DES) $895 - ---------------------------------------------------------------------------------------------- CCM-221 Client Cable Modem $845 - ---------------------------------------------------------------------------------------------- CCM-221-S Client Cable Modem, encryption support (DES) $945 - ---------------------------------------------------------------------------------------------- N-201 Client Cable Modem (single-user) $440 - ---------------------------------------------------------------------------------------------- N-201-S Client Cable Modem (single-user), encryption support (DES) $540 - ---------------------------------------------------------------------------------------------- N-221 Client Cable Modem (single-user) $495 - ---------------------------------------------------------------------------------------------- N-221-S Client Cable Modem (single-user), encryption support (DES) $595 - ---------------------------------------------------------------------------------------------- COMMERICAL CABLE MODEM ACCESSORIES - ---------------------------------------------------------------------------------------------- OTM-001 V.34 28.8 Phone Modem (typically US Robotics) $125 - ---------------------------------------------------------------------------------------------- OEH-005 Ethernet Hub (5-port support for five computers) $80 - ---------------------------------------------------------------------------------------------- CBL-001 RS-232 Modem Cable (see Note 5) $8 - ---------------------------------------------------------------------------------------------- HYBRID TECHNICAL SUPPORT AND TRAINING - ---------------------------------------------------------------------------------------------- TRN-201-4 One-Way Cable (640AM) Training Program $6,000 - ---------------------------------------------------------------------------------------------- TRN-201-1 One-Way Cable (640AM) Training Program/Per Student $1,500 - ---------------------------------------------------------------------------------------------- TRN-221-4 Two-Way Cable (640AM) Training Program $7,500 - ---------------------------------------------------------------------------------------------- TRN-221-1 Two-Way Cable (640AM) Training Program/Per Student $1,875 - ---------------------------------------------------------------------------------------------- TRN-240-4 Secure Router Training Program $3,000 - ---------------------------------------------------------------------------------------------- TRN-240-1 Secure Router Training Program/Per Student $750 - ---------------------------------------------------------------------------------------------- SRV-100 System Integration per day $1,500 - ----------------------------------------------------------------------------------------------
PAGE 18 ADDENDUM C VOLUME DISCOUNT LEVELS ALL PRICE IN U.S. DOLLARS
MULTIPLE PC MODEM PRICES - TELEPHONE RETURN ------------------------------------------- LEVEL CABLE MODEM QTY PRICE - ----- ----------- --- ----- 1 CCM-201 0-1,000 $795 2 CCM-201 1,001-3,000 $745 3 CCM-201 3,001-5,000 $695 4 CCM-201 5,001-10,000 $595 5 CCM-201 10,001-25,000 $570 6 CCM-201 25,001 AND GREATER $540 NOTE: for DES encryption add $100 per modem SINGLE PC MODEM PRICES - TELEPHONE RETURN ----------------------------------------- LEVEL CABLE MODEM QTY PRICE - ----- ----------- --- ----- 1 N-201 0-1,000 $440 2 N-201 1,001-3,000 $395 3 N-201 3,001-5,000 $375 4 N-201 5,001-10,000 $345 5 N-201 10,001-25,000 $320 6 N-201 25,001 AND GREATER $295 NOTE: - for internal phone modem add $50.00 per modem (future release) - for DES encryption add $100 per modem MULTIPLE PC MODEM PRICES - CABLE RETURN ----------------------------------------- LEVEL CABLE MODEM QTY PRICE - ----- ----------- --- ----- 1 CCM-221 0-1,000 $845 2 CCM-221 1,001-3,000 $795 3 CCM-221 3,001-5,000 $745 4 CCM-221 5,001-10,000 $645 5 CCM-221 10,001-25,000 $620 6 CCM-221 25,001 AND GREATER $595 NOTE: for DES encryption add $100 per modem PAGE 19 SINGLE PC MODEM PRICES - CABLE RETURN ------------------------------------- LEVEL CABLE MODEM QTY PRICE - ----- ----------- --- ----- 1 N-221 0-1,000 $495 2 N-221 1,001-3,000 $470 3 N-221 3,001-5,000 $440 4 N-221 5,001-10,000 $420 5 N-221 10,001-25,000 $370 6 N-221 25,001 AND GREATER $345 NOTE: - for internal phone modem add $50.00 per modem (future release) - for DES encryption add $100 per modem
* UPON THE EXECUTION OF THIS AGREEMENT, RCN WILL QUALIFYFOR THE LEVEL 6 PRICING AS LONG AS RCN PROCUREMENTS REMAIN CONSISTENT WITH PURCHASE PLAN OVER TERM HEREOF. PAGE 20 ADDENDUM D SYSTEM & SOFTWARE SUPPORT MEDIA WARRANTY Hybrid Networks warrants that the media on which the Hybrid Networks product is recorded will be free from defects in material and workmanship under normal use and service for a period of 90 days from shipment. Defective media will be replaced through the Hybrid Networks RMA process. INITIAL 180 DAY SYSTEM SUPPORT Initial 180-day support for all head ends "launched", telephone support, maintenance releases, enhancement releases, system monitoring, technical bulletins, and access to the electronic bulletin board. SOFTWARE SUPPORT For each site initial software support period begins from the date of Hybrid Networks shipment of the first application software purchase of a particular product type for each site. The support period also applies to all Hybrid Networks software and firmware products containing application code. For the duration of the contract, Hybrid will provide the following software support: Definitions When used in this booklet: a. "Site or Site Location" - refers to physical customer location usually associated with a single address, including the floors of a single building or adjoining buildings, and which has a single network administrative authority. b. "Software" - refers to those computer program products, including Maintenance Releases, in object code form which the customer has licensed from Hybrid Networks. c. "Maintenance Release" - refers to new version levels of software, periodically distributed for the purpose of correcting problems in previous releases. PAGE 21 d. "Enhancement Release" - is defined as new versions of the product which include significant changes and/or additions to functionality. Software Support coverage will be provided free of charge for the duration of the contract and is renewable on an annual basis at a price of $1,000 per CyberManager-TM- per month. The coverage provides for telephone support through the Hybrid Networks Support Center and for active software products; maintenance releases and enhancement releases occurring during the contract term. All software support customers will receive all relevant Technical Bulletins that are released during their contract term and access to the WWW on-line support. Telephone support will consist of access to the Hybrid Networks Solution Center during the normal Hybrid Networks hours of coverage (6am - 5pm Pacific Time, Monday through Friday, excluding Hybrid Networks observed holidays). The support group will provide responses to software related issues such as installations, configuration and problem solving. Maintenance releases and enhancement releases occurring during the contract period will be automatically sent to contract customers at no additional charge. The release quantities will be shipped in the same manner as the contract was purchased. For example, single unit contracts will receive a "one-for-one" update kit and site contracts will receive one master update kit per site. The classification of a given release as "maintenance" or "enhancement" is solely at Hybrid Networks discretion. Both types of releases will be issued on standard media and will include all relevant technical documentation. New software that comprises a new product model, versus an enhancement of an existing model, will require a separate software support agreement. The distinction between new product models and enhancements of existing models is at Hybrid Networks' discretion. For customers whose initial support or contract term has lapsed without renewal, telephone support and new releases will be available on a chargeable, per incident basis. In general, these charges will amount to substantially more than an annual support contract. Those wishing to initiate or reinstate their contract status must first be running the current released software version prior to the effective date of the contract. This prerequisite may require the purchase of a maintenance or enhancement release. PAGE 22 ADDENDUM E TROUBLE TICKET PROCESS & CLEARING STEP 1: SERVICE REQUEST (IR) PROCESS - Call placed to Hybrid Support Center (800)516-9315 or (408)342-4299 - 7am - 6pm Pacific Time - Call Logged using Customer Severity Level - IR is created or updated normally - Escalating an IR is initiated by entering date and time - Current and pending status will be updated daily STEP 2: RETURN MATERIAL AUTHORIZATION (RMA) PROCESS - Call placed to Hybrid Support Center (800)516-9315 or (408)342-4299 - 7am - 6pm Pacific Time - Customer Provide Information to Hybrid - Name, Company, address, and telephone number - Model and serial number of equipment - Detail statement giving the reason for replacement and/or repair (also sent with returned equipment) - Warranty returns will be repaired with a 10-business day turnaround - Products diagnosed by the Support Center as "our-of-the-box" failures, or which fail within the first 30 days of usage at the customer site, will generally be replaced by the next business day PAGE 23 ADDENDUM F ESCALATION PROCEDURES NET CPS ESCALATION PROCEDURE CHART:
- ---------------------------------------------------------------------------------------------------------------------------- 1 2 3 Escalated Escalated Other Emergency Significant Limited by to Advisories - ---------------------------------------------------------------------------------------------------------------------------- Dir Eng Escalation level: I- Net Ops Director Dir/Net Ops Net Ops Tech TO + 4 hrs TO + 8 hrs TO + 5 days Salesman Support Staff Net Ops Tech. Support -------------------------------------------------------------------------------------------------- TO + 48 hrs TO + 96 hrs TO + 14 days Director Net Ops 2 - Net Ops Director Director VP Operations Team/Operations VP Eng Net Ops Eng. VP Sales Salesman -------------------------------------------------------------------------------------------------- 3 - Engineering TO + 5 days TO + 14 days TO + 30 days Eng Exec VP Staff -------------------------------------------------------------------------------------------------- 4 - Exec Staff - Emergency meeting for decision and contingency planning n/a n/a n/a --------------------------------------------------------------------------------------------------
- - Times indicated are total elapsed clock hours from initial call - - Times apply equally to domestic and international calls - - TO Times for Headquarters Technical Support Engineers include one hour telephone response time - - Action plan supersedes the time frames - - Times are flexible in that escalation can occur faster - - Net Ops owns the "problem" and escalation tracking - - Escalation table incidents are not limited to hardware and software bugs, but can include enhancements for marketing or quality issues for manufacturing - - Escalation for severity 1 & 2 which go past Net Ops level will be raised at the weekly bug status meeting - - Action plan supersedes the time frames PAGE 24 ADDENDUM G ACCEPTANCE TEST PROCEDURES ACCEPTANCE TEST PROCEDURES SCOPE OF ACCEPTANCE TEST This acceptance test is designed to determine the functional status of the equipment which Hybrid Networks has proposed, trained and has assisted with installation. The test will demonstrate that the system meets requirements as specified in the Hybrid Networks' specifications. All findings of the test will be reported to the customer upon completion of testing. CONNECTIVITY TEST: Customer will randomly select one (1) Client Cable Modem (CCM) on the Customer's network. Workstation (PC with Windows 95 End Node) to System's network connectivity will be established and verified by a user's CCM being logged onto the network. PING TEST: Once the user is network attached, the Customer and Hybrid will conduct Ping testing. See Windows 95 DOS Ping command listed below. LOCAL PING TEST: With the Ping command, you can send a ping request to the local CCM to verify that it is receiving information. Enter the IP address of the CCM in the destination-list field. From the Windows 95 DOS prompt enter "ping < CCM IP Address >". REMOTE PING TEST: With the Ping command, you can send a ping request to the Hybrid CyberManager to verify that it is receiving information. Enter the IP address of the CyberManager in the destination-list field. From the Windows 95 DOS prompt enter "ping < CyberManager IP Address >". This step will verify the complete network operation of the Hybrid Networks' System and the CCM. CYBERMANAGER FTP TEST: Once the user is network attached, the Customer and Hybrid will conduct FTP testing. Using Hybrid's CableTest, run the FTP test to the CyberManager. File transfer ability will be proven. WWW TEST: (OPTIONAL) Access the World Wide Web (WWW) using Microsoft Internet Explorer 3.0 (or better), Netscape, Mosaic or equivalent. This test can only be performed if the Customer has provide an Internet Access which has been configured. PAGE 25 TEST REPORT A complete test report detailing how the above tests were performed, the exact configuration of the network, and the results of the tests will be generated. This test report will be presented to Customer at test completion. NOTES 1. Failure of Customer to accept or reject the Network within a period of thirty (30) days of notification of certification as provided for herein shall be deemed System Acceptance. 2. If Customer uses any portion of the Hybrid System for production purposes, the System shall be deemed accepted by Customer. 3. Windows 95 DOS Ping Command Syntax. --------------------------------------------------------------------------- WINDOWS 95 DOS PING COMMAND: C:\WINDOWS>ping Usage: ping [-t] [-a] [-n count] [-l size] [-f] [-i TTL] [-v TOS] [-r count] [-s count] [[-j host-list] | [-k host-list]] [-w timeout] destination-list Options: -t Ping the specified host until interrupted. -a Resolve addresses to hostnames. -n count Number of echo requests to send. -l size Send buffer size. -f Set Don't Fragment flag in packet. -i TTL Time To Live. -v TOS Type Of Service. -r count Record route for count hops. -s count Timestamp for count hops. -j host-list Loose source route along host-list. -k host-list Strict source route along host-list. -w timeout Timeout in milliseconds to wait for each reply. --------------------------------------------------------------------------- PAGE 26 CERTIFICATION OF ACCEPTANCE Customer Name: ____________________ Contract Number: __________________ Contract Date: ____________________ Site Location: ____________________ Scope of Work: ______________________________________________________ ______________________________________________________ ______________________________________________________
- -------------------------------------------------------------------------------- TEST COMPLETED - -------------------------------------------------------------------------------- CONNECTIVITY TEST: / / - -------------------------------------------------------------------------------- PING TEST: / / - -------------------------------------------------------------------------------- LOCAL PING TEST: / / - -------------------------------------------------------------------------------- REMOTE PING TEST: / / - -------------------------------------------------------------------------------- CYBERMANAGER FTP TEST: / / - -------------------------------------------------------------------------------- WWW TEST: (Optional) / / - -------------------------------------------------------------------------------- (Only if Internet Access is configured) - --------------------------------------------------------------------------------
I hereby certify that the work represented by the contract described above has been completed by Hybrid Networks and was given final inspection and acceptance on _________________. ____________________________ ____________________ Sign - Customer Date ____________________________ Print ____________________________ ____________________ Sign - Hybrid Networks Date ____________________________ Print PAGE 27 APPENDUM H SYSTEM DESCRIPTION See "Hybrid Series 2000 System Description" document number 018-00003-01 PAGE 28 EX-23.1 5 EXHIBIT 23.1 Exhibit 23.1 CONSENT OF INDEPENDENT AUDITORS We consent to the incorporation by reference in the Registration Statement (333-40027) on Form S-8 of Hybrid Networks, Inc. of our reports dated April 23, 1999 except for the last two paragraphs of Note 16 which are as of May 5, 1999, relating to the balance sheets, and the related statements of operations, stockholders' equity and cash flows and financial statement schedule for the years then ended, which reports appears in the December 31, 1998 annual report on Form 10-K of Hybrid Networks, Inc. /s/ HEIN + ASSOCIATES LLP HEIN + ASSOCIATES LLP Certified Public Accountants Orange, California June 9, 1999 77 EX-23.2 6 EXHIBIT 23.2 Exhibit 23.2 CONSENT OF INDEPENDENT ACCOUNTANTS We consent to the incorporation by reference in this registration statement of Hybrid Networks Incorporated on Form S-8 (File No. 333-40027) of our report dated August 28, 1997 on our audit of the financial statements and financial statement schedule of Hybrid Networks, as of December 31, 1996 and for the year then ended, which reports are included in this Annual Report on Form 10-K. PricewaterhouseCoopers LLP San Jose, California June 9, 1999 78 EX-27.1 7 EXHIBIT 27.1
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE 12/31/98 BALANCE SHEET AND THE STATEMENT OF OPERATIONS FOR THE TWELVE MONTHS THEN ENDED AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 12-MOS DEC-31-1998 JAN-01-1998 DEC-31-1998 3451 0 1633 200 5224 11487 5699 2261 15420 12299 0 0 0 10 2692 15420 12418 12418 14046 14046 22879 0 897 (24625) 0 0 0 0 0 (24625) (2.37) (2.37)
EX-27.2 8 EXHIBIT 27.2
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE 12/31/97 BALANCE SHEET AND THE STATEMENT OF OPERATIONS FOR THE TWELVE MONTHS THEN ENDED AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 12-MOS DEC-31-1997 JAN-01-1997 DEC-31-1997 26158 985 1128 0 6270 34903 3054 1246 39065 11108 0 0 0 10 27293 39065 4120 4120 8899 8899 15473 0 1666 (21602) 0 0 0 0 0 (21602) (6.10) (6.10)
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