UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
ý QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended June 30, 2006
or
o 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 000-30189
VYYO INC.
(Exact name of registrant as specified in its charter)
Delaware |
| 94-3241270 |
(State or other jurisdiction of |
| (I.R.S. Employer |
incorporation or organization) |
| Identification Number) |
|
|
|
6625 The Corners Parkway, Suite 210 |
|
|
Norcross, Georgia |
| 30092 |
(Address of Principal Executive Offices) |
| (Zip Code) |
Registrant’s telephone number, including area code (678) 282-8000
4015 Miranda Avenue, First Floor
Palo Alto, California 94304
(Former Address)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act (Check one):
Large accelerated filer o Accelerated filer o Non-accelerated filer ý
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No ý
As of August 7, 2006, there were 17,736,869 shares of Common Stock outstanding.
INDEX
VYYO INC.
i
Item 1. Condensed Consolidated Financial Statements
Vyyo Inc.
Consolidated Balance Sheets
(In thousands, except share data)
|
| June 30, |
| December 31, |
| ||
|
| (Unaudited) |
|
|
| ||
ASSETS |
|
|
|
|
| ||
Current Assets: |
|
|
|
|
| ||
Cash and cash equivalents |
| $ | 15,149 |
| $ | 2,548 |
|
Short-term investments |
| 12,473 |
| 7,403 |
| ||
Accounts receivable, net |
| 2,703 |
| 868 |
| ||
Inventory (note 2) |
| 2,392 |
| 2,491 |
| ||
Other |
| 1,007 |
| 935 |
| ||
Total Current Assets |
| 33,724 |
| 14,245 |
| ||
Long-Term Assets: |
|
|
|
|
| ||
Restricted cash (note 4) |
| 5,000 |
| 5,000 |
| ||
Property and equipment, net |
| 1,233 |
| 1,585 |
| ||
Employee rights upon retirement funded (note 7) |
| 1,046 |
| 965 |
| ||
Debt issuance costs, net (note 8) |
| 1,145 |
| — |
| ||
TOTAL ASSETS |
| $ | 42,148 |
| $ | 21,795 |
|
|
|
|
|
|
| ||
LIABILITIES AND STOCKHOLDERS’ EQUITY |
|
|
|
|
| ||
Current Liabilities: |
|
|
|
|
| ||
Accounts payable |
| $ | 2,413 |
| $ | 1,832 |
|
Accrued liabilities (note 6) |
| 11,434 |
| 6,391 |
| ||
Total Current Liabilities |
| 13,847 |
| 8,223 |
| ||
|
|
|
|
|
| ||
Long-Term Liabilities: |
|
|
|
|
| ||
Promissory note (note 4) |
| 4,488 |
| 3,967 |
| ||
Senior secured note (note 8) |
| 4,930 |
| — |
| ||
Convertible note (note 8) |
| 10,105 |
| — |
| ||
Liability for employee rights upon retirement (note 7) |
| 1,860 |
| 1,460 |
| ||
Total Liabilities |
| 35,230 |
| 13,650 |
| ||
Stockholders’ Equity: |
|
|
|
|
| ||
Preferred stock, $0.001 par value; 5,000,000 shares authorized, none issued |
| — |
| — |
| ||
Common stock, $0.0001 par value and paid in capital; 50,000,000 shares authorized, 17,706,524 and 15,721,334 shares issued and outstanding at June 30, 2006 and December 31, 2005, respectively |
| 257,319 |
| 243,314 |
| ||
Notes receivable from stockholders |
| (19 | ) | (19 | ) | ||
Accumulated other comprehensive loss |
| (9 | ) | — |
| ||
Accumulated deficit |
| (250,373 | ) | (235,150 | ) | ||
Total Stockholders’ Equity |
| 6,918 |
| 8,145 |
| ||
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY |
| $ | 42,148 |
| $ | 21,795 |
|
The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.
Vyyo Inc.
Condensed Consolidated Statements of Operations
(In thousands, except per share data)
(Unaudited)
|
| Three Months Ended |
| Six Months Ended |
| ||||||||
|
| 2006 |
| 2005 |
| 2006 |
| 2005 |
| ||||
REVENUES |
|
|
|
|
|
|
|
|
| ||||
Revenues (note 11) |
| $ | 136 |
| $ | 1,152 |
| $ | 705 |
| $ | 1,856 |
|
Revenues from related party (notes 3 and 11) |
| 2,625 |
| — |
| 4,425 |
| — |
| ||||
TOTAL REVENUES |
| 2,761 |
| 1,152 |
| 5,130 |
| 1,856 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
COST OF REVENUES |
|
|
|
|
|
|
|
|
| ||||
Cost of products sold |
| 52 |
| 1,347 |
| 370 |
| 2,041 |
| ||||
Cost of products sold, related party |
| 1,881 |
| — |
| 3,373 |
| — |
| ||||
Amortization of technology (note 5) |
| — |
| 92 |
| — |
| 184 |
| ||||
Total Cost of Revenues |
| 1,933 |
| 1,439 |
| 3,743 |
| 2,225 |
| ||||
GROSS PROFIT (LOSS) |
| 828 |
| (287 | ) | 1,387 |
| (369 | ) | ||||
OPERATING EXPENSES (INCOME) |
|
|
|
|
|
|
|
|
| ||||
Research and development (including stock-based compensation expense of $222; $439; $27 and $54, respectively) |
| 2,950 |
| 2,858 |
| 5,411 |
| 5,590 |
| ||||
Sales and marketing (including stock-based compensation expense of $305; $774; $27 and $54, respectively) |
| 2,571 |
| 3,104 |
| 5,214 |
| 5,791 |
| ||||
General and administrative (including stock-based compensation expense of $536; $1,817; $0 and $0, respectively) |
| 2,235 |
| 1,872 |
| 5,401 |
| 3,348 |
| ||||
Amortization of intangible assets (note 5) |
| — |
| 417 |
| — |
| 834 |
| ||||
Restructuring adjustments |
| — |
| (93 | ) | — |
| (408 | ) | ||||
Total Operating Expenses |
| 7,756 |
| 8,158 |
| 16,026 |
| 15,155 |
| ||||
OPERATING LOSS |
| (6,928 | ) | (8,445 | ) | (14,639 | ) | (15,524 | ) | ||||
INTEREST INCOME (EXPENSES) , net |
| (345 | ) | 120 |
| (614 | ) | 196 |
| ||||
LOSS FROM CONTINUING OPERATIONS |
| (7,273 | ) | (8,325 | ) | (15,253 | ) | (15,328 | ) | ||||
DISCONTINUED OPERATIONS |
| 30 |
| 100 |
| 30 |
| 365 |
| ||||
LOSS FOR THE PERIOD |
| $ | (7,243 | ) | $ | (8,225 | ) | $ | (15,223 | ) | $ | (14,963 | ) |
LOSS PER SHARE |
|
|
|
|
|
|
|
|
| ||||
Basic and diluted: |
|
|
|
|
|
|
|
|
| ||||
Continuing operations |
| (0.41 | ) | (0.54 | ) | (0.91 | ) | (1.00 | ) | ||||
Discontinued operations |
| — |
| 0.01 |
| — |
| 0.02 |
| ||||
|
| (0.41 | ) | (0.53 | ) | (0.91 | ) | (0.98 | ) | ||||
WEIGHTED AVERAGE NUMBER OF SHARES |
|
|
|
|
|
|
|
|
| ||||
Basic and diluted |
| 17,611 |
| 15,381 |
| 16,740 |
| 15,288 |
|
The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.
2
Vyyo Inc.
Condensed Consolidated Statements of Cash Flows
(In thousands)
(Unaudited)
|
| Six Months Ended |
| ||||
|
| 2006 |
| 2005 |
| ||
CASH FLOWS FROM OPERATING ACTIVITIES |
|
|
|
|
| ||
Loss for the period |
| $ | (15,223 | ) | $ | (14,963 | ) |
Adjustments to reconcile loss to net cash used in operating activities: |
|
|
|
|
| ||
Income and expenses not involving cash flows: |
|
|
|
|
| ||
Depreciation and amortization |
| 441 |
| 1,516 |
| ||
Accretion and amortization of financing instruments, net |
| 662 |
| — |
| ||
Amortization and charge related to stock-based compensation, net |
| 3,066 |
| (300 | ) | ||
Capital gain on sale of fixed assets |
| — |
| (2 | ) | ||
Changes in assets and liabilities: |
|
|
|
|
| ||
Accounts receivable |
| (1,835 | ) | (284 | ) | ||
Other current assets |
| (72 | ) | (353 | ) | ||
Inventory |
| 99 |
| 400 |
| ||
Accounts payable |
| 581 |
| 15 |
| ||
Accrued liabilities |
| 5,043 |
| (732 | ) | ||
Liability for employee rights upon retirement |
| 400 |
| 99 |
| ||
Net cash used in operating activities |
| (6,838 | ) | (14,604 | ) | ||
|
|
|
|
|
| ||
CASH FLOWS FROM INVESTING ACTIVITIES |
|
|
|
|
| ||
Purchase of property and equipment |
| (89 | ) | (1,004 | ) | ||
Proceeds from sale of property and equipment |
| — |
| 2 |
| ||
Purchase of short-term investments |
| (15,580 | ) | (9,230 | ) | ||
Proceeds from sales and maturities of short-term investments |
| 10,501 |
| 22,886 |
| ||
Contributions of severance pay funds |
| (81 | ) | (2 | ) | ||
Net cash provided by (used in) investing activities |
| (5,249 | ) | 12,652 |
| ||
|
|
|
|
|
| ||
CASH FLOWS FROM FINANCING ACTIVITIES |
|
|
|
|
| ||
Proceeds from exercise of stock options |
| 1,285 |
| 312 |
| ||
Proceeds from issuance of common stock, senior secured note, convertible note and warrants, net of issuance cost |
| 23,403 |
| — |
| ||
Proceeds from notes receivable from stockholders |
| — |
| 187 |
| ||
|
|
|
|
|
| ||
Net cash provided by financing activities |
| 24,688 |
| 499 |
| ||
|
|
|
|
|
| ||
Increase (decrease) in cash and cash equivalents |
| 12,601 |
| (1,453 | ) | ||
Cash and cash equivalents at beginning of period |
| 2,548 |
| 5,512 |
| ||
|
|
|
|
|
| ||
Cash and cash equivalents at end of period |
| $ | 15,149 |
| $ | 4,059 |
|
The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.
3
Vyyo Inc.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
1. General Basis of Presentation
The accompanying unaudited condensed consolidated financial statements of Vyyo Inc. have been prepared in accordance with generally accepted accounting principles in the United States (“GAAP”) for interim financial information and with the instructions to the Quarterly Report on Form 10-Q and Article 10 of Regulation S-X under the Securities Exchange Act of 1934. Accordingly, they do not include all of the information and notes required by GAAP for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals, reclassifications and adjustments) considered necessary for a fair presentation have been included. Operating results for the interim period are not necessarily indicative of the results that may be expected for the full year. You should read these unaudited condensed consolidated financial statements in conjunction with the audited consolidated financial statements in the Annual Report on Form 10-K for the year ended December 31, 2005, filed by Vyyo Inc. with the Securities and Exchange Commission (the “SEC”).
Liquidity, Capital Resources and Going Concern Considerations
The consolidated financial statements of Vyyo Inc. and its wholly-owned subsidiaries (collectively, the “Company”) are presented on a going concern basis, which contemplates the realization of assets and satisfaction of liabilities in the normal course of business. The Company has experienced a significant loss from operations. For the six-month period ended June 30, 2006, the Company incurred a net loss of $15,223,000 and had an accumulated deficit of $250,373,000. The Company’s ability to continue as a going concern will depend upon its ability to raise additional capital or attain profitable operations. In addition, the Company is seeking to expand its revenue base by adding new customers. Failure to secure additional capital or to expand its revenue base would likely result in the Company depleting its available funds and not being able to pay its obligations when they become due. The accompanying unaudited condensed consolidated financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the possible inability of the Company to continue as a going concern.
Organization and Principles of Consolidation
The unaudited condensed consolidated financial statements include the accounts of Vyyo Inc. and its wholly-owned subsidiaries. All material inter-company balances and transactions have been eliminated in consolidation.
The Company provides cable and wireless broadband access solutions through two business segments: the “Cable Solutions” segment and the “Wireless Solutions” segment. The Company’s products are designed to address four markets: Utility, Cable, Wireless Internet Service Providers (“WISP”) and Telecommunication providers. Although the Company is engaged to various degrees in these distinct markets, some of the Company’s core technologies overlap with its respective solutions.
The Cable Solutions segment includes products that are used to deliver telephony and data T1/E1 links to enterprise and cellular providers over cable’s wireless or hybrid-fiber coax (“HFC”) networks. Additionally, the Company’s “Spectrum Overlay” technology is designed to expand cable operators’ typical HFC network capacity in the “last mile” by up to two times in the downstream and up to four times in the upstream. The Cable Solutions segment includes the results of operations of Xtend Networks Ltd., an Israeli company, and its wholly-owned, U.S.-based subsidiary, Xtend Networks Inc. (collectively, “Xtend”). The Company purchased all of the outstanding capital stock of Xtend on June 30, 2004 and consolidated its operations with the Company’s operations beginning July 1, 2004.
The Company’s Wireless Solutions segment includes utility products which enable utilities and other network service providers to operate private wireless networks for communications, monitoring and Supervisory Control And Data Acquisition (“SCADA”) of their geographically disbursed, remote assets. Additionally, it includes the Company’s WISP and telecommunications products which address the needs of rural service providers to serve customers with wireless, high-speed data beyond the reach of traditional terrestrial networks.
The Company is focused on promoting products in the Wireless Solutions segment into the network provider, utility, petrochemical, municipality and enterprise markets. The Company’s Cable Solutions segment is focused on both promoting T1 solutions for business services over cable networks and promoting cable bandwidth expansion solutions that are designed to expand cable operators’ typical HFC network capacity.
4
Summary of Significant Accounting Principles
Use of Estimates in the Preparation of Financial Statements
The preparation of financial statements in conformity with GAAP requires management to make estimates, judgments 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.
On an on-going basis, management evaluates its estimates, judgments and assumptions. Management bases its estimates, judgments and assumptions on historical experience and on various other factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results could differ from these estimates, judgments and assumptions.
Foreign Currency Transactions
The U.S. dollar is the functional currency for the Company and all of the Company’s sales are made in U.S. dollars. In addition, a substantial portion of the Company’s foreign subsidiaries’ costs are incurred in U.S. dollars. Since the U.S. dollar is the primary currency in the economic environment in which the foreign subsidiaries operate, monetary accounts maintained in currencies other than the U.S. dollar (principally cash and liabilities) are remeasured into U.S. dollars using the representative foreign exchange rate at the balance sheet date. Operational accounts and nonmonetary balance sheet accounts are measured and recorded at the rate in effect at the date of the transaction. The effects of foreign currency remeasurement are reported in current operations in the Statements of Operations under “Interest Income (Expenses), net” and have not been material to date.
Investments in Marketable Securities
The Company has designated its investments in debt securities as available-for-sale. Available-for-sale securities are carried at fair value, which is determined based upon the quoted market prices of the securities, with unrealized gains and losses reported in “Accumulated other comprehensive loss,” in the Balance Sheets, a component of stockholders’ equity, until realized. Realized gains and losses and declines in value judged to be other-than-temporary on available-for-sale securities are included in the Statements of Operations as part of “Interest Income (Expenses), net.” The Company views its available-for-sale portfolio as available for use in its current operations. Accordingly, the Company has classified all investments as short-term in the Balance Sheets under “Short-term investments,” even though the stated maturity date may be one year or more from the current balance sheet date. Interest, amortization of premiums, accretion of discounts and dividends on securities classified as available-for-sale are also included in the Statements of Operations as part of “Interest Income (Expenses), net.”
The Company recognizes an impairment charge when the decline in the fair values of these investments below their cost basis is deemed to be other-than-temporary. The Company considers various factors in determining whether to recognize an impairment charge, including the length of time and the extent to which the fair value has been below the cost basis, the current financial condition of the investee and the Company’s intent and ability to hold the investment for a period of time sufficient to allow for any anticipated recovery in market value. The Company recognized an other-than-temporary impairment in its available-for-sale securities of $0 and $(42,000) for the three and six months ended June 30, 2006, respectively, and $23,000 and $135,000 for the three and six months ended June 30, 2005, respectively, and realized losses of $0 and $31,000 for the three and six months ended June 30, 2006, respectively, and $0 and $0 for the three and six months ended June 30, 2005, respectively.
Cash Equivalents
Cash equivalents are short-term, highly-liquid investments and deposits that have original maturities of three months or less at the time of investment and that are readily convertible to cash.
Inventory
Inventory is stated at the lower of cost or market, where cost includes material and labor. The Company regularly monitors inventory quantities on hand and records a provision for excess and obsolete inventory based primarily on the Company’s estimated forecast of future product demand and production requirements. Although the Company makes every effort to ensure the accuracy of its forecasts of future product demand, any significant unanticipated changes in demand or technological developments would significantly impact the value of the inventory and the reported operating results. If actual market conditions are different than the Company’s assumptions, additional provisions may be required. The Company’s estimates of future product demand may prove to be inaccurate, in which case the Company may have understated or overstated the provision required for excess and obsolete inventory. In the future, if the inventory is determined to be
5
overvalued, the Company would be required to recognize such costs in its cost of sales at the time of such determination. If the Company’s inventory is determined to be undervalued, the Company may have overstated its cost of sales in previous periods and would be required to recognize additional operating income only when the undervalued inventory was sold. During the three and six months ended June 30, 2006, the Company did not write down any inventory. During the three months ended June 30, 2005, the Company recorded a write-down of inventory of $350,000. The Company took this write-down to account for excess inventory resulting from the Company’s increased focus on providing products to utility and cable customers.
Fair Value of Financial Instruments
The fair value of the financial instruments included in the Company’s working capital approximates carrying value. The Promissory Note, Senior Secured Note and Convertible Note are presented in the Balance Sheets as “Long-Term Liabilities,” at their estimated fair value.
Debt Issuance Costs
Costs incurred in the issuance of the Convertible Note and Senior Secured Note are deferred and amortized as a component of interest expense over the period from issuance through the first redemption date.
Property and Equipment
Property and equipment are stated at cost less accumulated depreciation and amortization. Depreciation and amortization are provided using the straight-line method over the estimated useful lives of the assets.
Leasehold improvements are amortized over the shorter of the lease term or the estimated useful life of the related asset.
Intangible Assets
During 2005, the Company recorded an impairment charge of $11,388,000 for the full remaining carrying value of its intangible assets. The Company’s intangible assets in 2005 related to the acquisition of Xtend and consisted of technology, non-competition agreements, an exclusive sales agreement and workforce. These definite-life intangible assets were amortized using the straight-line method over their estimated useful lives, ranging between one and six years. See also note 5.
Impairment of Long-Lived Assets
Statement of Financial Accounting Standards (“SFAS”) No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (“SFAS No. 144”), requires that long-lived assets, including definite life intangible assets to be held and used or disposed of by an entity, be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable. Under SFAS No. 144, if the sum of the expected future cash flows (undiscounted and without interest charges) of the long-lived assets is less than the carrying amount, the Company would recognize an impairment loss and would write down the assets to their estimated fair values. See also note 5.
Revenue Recognition
Revenues from product sales are recognized when an arrangement exists, delivery has occurred and title has passed to the customer, the Company’s price to the customer is fixed or determinable and collectability is reasonably assured. When sales transactions include more then one deliverable (unit of accounting) sold, the Company follows the guidance of Emerging Issues Task Force (“EITF”) Issue 00-21, “Revenue Arrangements with Multiple Deliverables,” and Staff Accounting Bulletin (“SAB”) 104, “Revenue Recognition.” Under the provisions in these statements, the Company separates the different units of accounting in sales with multiple deliverables based on the objective and reliable evidence of fair value of the different elements. Revenue for each unit of accounting is then recognized when products are delivered or when services are rendered or ratably over the contractual period, depending on the nature of the deliverable.
Revenues related to the exclusivity provisions contained in the Equipment Purchase Agreement described in note 3 are recognized over the 10-year term of the Equipment Purchase Agreement.
The Company’s products are generally off-the-shelf products, sold “as is,” without further adjustment or installation. Sales contracts with distributors stipulate fixed prices and current payment terms and are not subject to the distributors’ resale or any other contingencies. Accordingly, when all criteria above are met, sales of finished products to distributors are recognized as revenue upon delivery and after title and risk pass to the distributors.
The Company does not grant any rights of return or cancellation to any of its customers.
6
In contracts where there is a customer acceptance provision or there is uncertainty about customer acceptance, the Company defers the associated revenue until it has evidence of customer acceptance. The Company performs ongoing credit evaluations of its customers’ financial condition and in some cases requires various forms of security.
Product Warranty
The Company provides for product warranty costs when it recognizes revenue from sales of its products. The provision is calculated as a percentage of sales, based on historical experience.
Research and Development Costs
Research and development costs are expensed as incurred and consist primarily of personnel, facilities, equipment and supplies for research and development activities. Grants received from the Office of the Chief Scientist at the Ministry of Industry and Trade in Israel and other research foundations are deducted from research and development expenses as the related costs are incurred.
Loss Per Share of Common Stock
Basic and diluted loss per share are calculated and presented in accordance with SFAS No. 128, “Earnings per share.” For the three and six months ended June 30, 2006 and 2005, the following have been excluded from the calculation of diluted loss per share because all such securities are anti-dilutive for the presented periods: 6,514,000 and 5,844,000 outstanding stock options, 75,000 and 75,000 shares of restricted stock and 79,559 and 0 warrants to purchase shares of common stock, respectively.
Employee Stock-Based Compensation
Until December 31, 2005, the Company accounted for employee stock-based compensation in accordance with Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations. Charges for stock-based compensation represent the amortization of deferred compensation charges, which are based on aggregate differences between the respective exercise price of stock options, shares of restricted stock and purchase price of the underlying common stock on one hand versus the fair market value of the common stock on the other hand. Deferred stock-based compensation is amortized over the vesting period of the underlying stock options and the shares of restricted stock.
Under “fixed plan” accounting, compensation cost is fixed, measured at grant date and is not subsequently adjusted. Under “variable plan” accounting, the measurement date occurs after the grant date and compensation cost is estimated and recorded each period from the grant date to the measurement date, based on the difference between the option price and the fair market value of the underlying common stock at the end of each period.
As of January 1, 2006, the Company adopted SFAS No. 123 (Revised 2004), “Share-Based Payment” (“SFAS No. 123(R)”), using the modified prospective method. This new standard requires measurement of stock-based compensation cost for all stock-based awards at the fair value on the grant date and recognition of stock-based compensation over the service period for awards that the Company expects will vest. The fair value of stock options is determined based on the number of shares granted and the price of the Company’s common stock, and calculated based on the Black-Scholes and the binomial valuation models, which is consistent with the Company’s valuation techniques previously utilized for options in footnote disclosures required under SFAS No. 123, “Accounting for Stock Based Compensation,” as amended by SFAS No. 148, “Accounting for Stock-Based Compensation — Transition and Disclosure.” The Company recognizes such value as expense over the service period, net of estimated forfeitures, using the accelerated method under SFAS No. 123(R). Due to its adoption of SFAS No. 123(R), the Company no longer has employee stock-based compensation awards subject to variable accounting treatment. The cumulative effect of the Company’s adoption of SFAS No. 123(R), as of January 1, 2006, was not material.
The fair value of each stock option granted during the three and six months ended June 30, 2006 and 2005 was estimated at the date of grant using the Black-Scholes and the binomial valuation models, using the following assumptions:
7
|
| Three Months Ended |
| Six Months Ended |
| ||||
|
| 2006 |
| 2005 |
| 2006 |
| 2005 |
|
Black-Scholes model assumptions: |
|
|
|
|
|
|
|
|
|
Risk-free interest rates ranges |
| 4.66%-4.74 | % | 3.45 | % | 4.66%-4.74 | % | 3.45 | % |
Weighted-average expected life range |
| 2.5-5.0 |
| 2.50 |
| 2.5-5.0 |
| 2.50 |
|
Volatility ranges |
| 0.62-0.76 |
| 0.74 |
| 0.62-0.76 |
| 0.58 |
|
Dividend yields |
| — |
| — |
| — |
| — |
|
|
|
|
|
|
|
|
|
|
|
Binomial valuation model assumptions: |
|
|
|
|
|
|
|
|
|
Risk-free interest rates ranges |
| 4.87%-5.33 | % | — |
| 4.66%-5.33 | % | — |
|
Weighted-average expected life range |
| 2.29%-3.36 | % | — |
| 2.29%-5.00 | % | — |
|
Volatility ranges |
| 0.42%-0.87 | % | — |
| 0.42%-0.87 | % | — |
|
Dividend yields |
| — |
| — |
| — |
| — |
|
The Company’s pro forma information for the three and the six months ended June 30, 2005 is as follow:
|
| Three Months Ended |
| Six Months Ended |
| ||
|
| 2005 |
| ||||
|
| (In thousands, except per share data) |
| ||||
Loss from continuing operations as reported |
| $ | (8,325 | ) | $ | (15,328 | ) |
Deduct: stock-based employee compensation income included in reported loss |
| (39 | ) | (300 | ) | ||
Add: stock-based employee compensation expense determined under fair value method for all awards |
| (1,635 | ) | (2,999 | ) | ||
Pro forma loss from continuing operations |
| $ | (9,999 | ) | $ | (18,627 | ) |
Income from discontinued operations as reported |
| $ | 100 |
| $ | 365 |
|
Add: stock-based employee compensation expenses determined under fair value method for all awards |
| — |
| — |
| ||
Pro forma income from discontinued operations |
| 100 |
| 365 |
| ||
Pro forma loss |
| $ | (9,899 | ) | $ | (18,262 | ) |
|
|
|
|
|
| ||
Basic and diluted loss per share: |
|
|
|
|
| ||
As reported: |
|
|
|
|
| ||
Continuing operations |
| $ | (0.54 | ) | $ | (1.00 | ) |
Discontinued operations |
| 0.01 |
| 0.02 |
| ||
Loss |
| $ | (0.53 | ) | $ | (0.98 | ) |
|
|
|
|
|
| ||
Pro forma: |
|
|
|
|
| ||
Continuing operations |
| $ | (0.65 | ) | $ | (1.22 | ) |
Discontinued operations |
| 0.01 |
| 0.02 |
| ||
Loss |
| $ | (0.64 | ) | $ | (1.20 | ) |
Recent Accounting Pronouncements
In February 2006, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 155, “Accounting for Certain Hybrid Financial Instruments” (“SFAS No. 155”), which amends SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities” (“SFAS No. 133”), and SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities” (“SFAS No. 140”). SFAS No. 155 simplifies the accounting for certain derivatives embedded in other financial instruments by allowing them to be accounted for as a whole if the holder elects to account for the whole instrument on a fair value basis. SFAS No. 155 also clarifies and amends certain other provisions of SFAS No. 133 and SFAS No. 140. SFAS No. 155 is effective for all financial instruments acquired, issued or subject to a remeasurement event occurring in fiscal years beginning after September 15, 2006. The Company does not expect adoption of SFAS No. 155 to have a material impact on its consolidated financial position, results of operations or cash flows.
8
In June 2006, FASB issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109” (“FIN No. 48”). FIN No. 48 prescribes a recognition threshold and measurement attribute for financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return, and also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. FIN No. 48 is effective for fiscal years beginning after December 15, 2006. The Company is currently assessing FIN No. 48 to determine the impact that adoption of FIN No. 48 will have on its results of operations and financial condition.
Reclassifications
Certain amounts in the 2005 financial statements have been reclassified to conform to the 2006 presentation.
2. Inventory
Inventory is comprised of the following:
| June 30, 2006 |
| December 31, 2005 |
| |||
|
| (In thousands) |
| ||||
Raw materials |
| $ | 926 |
| $ | 488 |
|
Work in process |
| 125 |
| 415 |
| ||
Finished goods |
| 1,341 |
| 1,588 |
| ||
|
|
|
|
|
| ||
|
| $ | 2,392 |
| $ | 2,491 |
|
3. Agreement with Arcadian Networks, Inc.
On March 31, 2006, the Company entered into an Equipment Purchase Agreement (the “Purchase Agreement”) with Arcadian Networks, Inc. (“ANI”). Davidi Gilo, the Company’s Chief Executive Officer and Chairman of the Board of Directors, is also the Chairman of the Board of Directors of ANI and the sole member of the limited liability company that is the general partner of a major stockholder of ANI.
Pursuant to the Purchase Agreement, the Company sells certain of its products and services to ANI over a 10-year term. The Company distributes these products to ANI on an exclusive basis in the United States, Canada and the Gulf of Mexico (the “Relevant Territory”) to identified markets if: (a) ANI makes two payments of $4,000,000 during the first two years of the Purchase Agreement; (b) ANI meets specified annual minimum product purchase amounts; and (c) ANI’s outstanding balances are below specified amounts.
Exclusivity after the second year will depend on ANI’s meeting the minimum purchase amounts. In addition, to maintain its exclusivity rights in the Purchase Agreement, ANI must purchase at least 25% of its minimum product purchase amounts within the first six months of any given year, and at least 32% within the first six months of any given year if ANI purchases from third parties more than 15% of products with similar functionality to the products covered by the Purchase Agreement.
The Purchase Agreement fixes the product prices for the first two years, after which time prices are subject to adjustment according to the amount of product purchased by ANI compared to specified forecasted purchase amounts.
The Purchase Agreement does not prohibit the Company from selling any of its products or services to areas outside of the Relevant Territory. In addition, the Company may sell its products within the Relevant Territory to end users or resellers other than those engaged in the following markets: (a) electricity generation, transmission or distribution (both downstream and upstream); (b) oil or gas exploration, manufacture, transportation or distribution; (c) water utility; (d) chemical manufacture; (e) mining; (f) environmental monitoring or protection; (g) transportation facilities (including railroads); (h) border control; and (i) public safety. Specifically, the Company may sell its products in the Relevant Territory to cable television customers.
The Company received the first exclusivity payment of $4,000,000 on April 3, 2006 and an initial purchase order for $10,000,000 on March 31, 2006, which satisfies ANI’s requirements for exclusivity in the first year of the Purchase Agreement.
For the three and six months ended June 30, 2006, the Company recognized revenue of $2,625,000 and $4,425,000, respectively, under the Purchase Agreement. Those revenues include sales of products and income related to the exclusivity payment. The Company will recognize the exclusivity payments from ANI over the 10-year term of the Purchase Agreement.
9
4. Promissory Note Issued in Connection with Acquisition of Xtend
On June 30, 2004, the Company acquired all of the outstanding shares of Xtend. In connection with the acquisition, the Company issued 1,398,777 shares of its common stock valued at $8,492,000, and made cash payments of approximately $2,970,000 for non-competition agreements with certain Xtend employees. In addition, the Company provided a promissory note in the principal amount of $6,500,000 originally payable on March 31, 2007 (the “Promissory Note”). On December 16, 2005, the Company amended key provisions of the Promissory Note as follows:
· the maturity date was extended by one year from March 31, 2007 to March 31, 2008;
· the provision that would have allowed the holder to accelerate the Promissory Note if the sum of the Company’s cash, cash equivalents, short-term investments and accounts receivables, net of short- and long-term debt, was less than $20,000,000 on December 31, 2005 or June 30, 2006 was waived;
· The Promissory Note will be cancelled if:
(a) the Company’s revenue (including that of all subsidiaries, except for newly-acquired businesses) equals or exceeds $60,000,000 and gross margin equals or exceeds 35%, for either of the fiscal years ending December 31, 2006 or December 31, 2007;
(b) beginning on the first day that the Company’s common stock closes at or above $18.00 per share and at any time thereafter, the holder sells all of its Remaining Shares at an average sales price at or above $18.00 per share. “Remaining Shares” means those shares of the Company’s common stock received by the holder in the Xtend acquisition;
(c) all of the Remaining Shares are included in a successfully concluded secondary offering (on Form S-3 or otherwise) at an offering price at or above $18.00 per share in which the holder either (i) sells all of the Remaining Shares or (ii) is provided an opportunity to sell all of such shares into such secondary offering and elects not to sell, provided that the successfully concluded offering included no fewer than the number of Remaining Shares; or
(d) the holder receives a bona fide offer for the purchase of all of the Remaining Shares at an average sales price at or above $18.00 per share. A “bona fide” offer means a fully funded and unconditional offer for purchase by a buyer who has provable and sufficient financial resources to purchase all of the Remaining Shares for cash within a commercially reasonable period of time from the date of offer, not to exceed 30 days.
As security for the amended Promissory Note, the Company delivered to the holder a $5,000,000 letter of credit whereby the Company deposited this $5,000,000 with a bank, and agreed to restrictions on the deposit. This deposit is reflected in the Balance Sheets as “Restricted cash.” The letter of credit will be cancelled if any time after June 30, 2006, for 45 consecutive trading days, all of the following conditions exist: (a) the weighted average trading price of the Company’s common stock is equal to or higher than $18.00 per share; (b) the average daily trading volume of the Company’s common stock is higher than 150,000 shares per day; and (c) the holder is lawfully able to sell publicly in one transaction or in a series of transactions, during such 45 consecutive trading days, all of its shares of the Company’s common stock without registration under the Securities Act of 1933, as amended. If the Company’s consolidated revenues in the year ended December 31, 2006 equal or exceed $60,000,000 and the Company’s consolidated gross margin equals or exceeds 35% during the same period, the Promissory Note will be canceled.
The Company determined that, as of the time it amended the Promissory Note and immediately prior to its amendment, the contingency had been resolved and, therefore, the Company recorded $6,500,000 as additional consideration paid in the Xtend acquisition. This resulted in an increase in the value of the intangible assets acquired. Following an impairment test performed on the intangible assets, the assets were immediately impaired as discussed in note 5. In addition, the Company estimated the fair value of the amended Promissory Note at approximately $3,967,000 and recorded this amount in its Balance Sheets as a long-term liability under “Promissory note.” The Company recorded a $2,533,000 difference between the value of the amended Promissory Note and the original Promissory Note as “Gain Resulting from Amendment to Promissory Note” in its Statements of Operations for the year ended December 31, 2005. Increases in the value of the amended Promissory Note will be recorded as interest expenses up to $2,533,000 during the remaining term of the Promissory Note unless it is cancelled as described above. For the three and six months ended June 30, 2006, the Company recorded an increase of $204,000 and $521,000, respectively, in interest expenses related to the amended Promissory Note.
10
5. Intangible Assets, Net
The current focus of the Company’s Cable Solutions segment is on the residential market for cable television multi-system operators (“MSOs”), rather then the commercial market for MSOs, the Company’s prior focus at the time of the Xtend acquisition. This change in focus has required the Company to invest additional efforts in the development of suitable technology and products. Given this change in focus, and in conjunction with the Company’s ongoing review of the carrying value of its intangible assets, the Company’s management determined in December 2005 that, in accordance with SFAS No. 144, an impairment test of intangible assets was required.
The fair value of the intangible assets was estimated by management with the assistance of an independent third party appraiser, based upon future expected discounted cash-flows as of December 31, 2005. Based on this appraisal, by using a weighted discounted cash flow model for the estimation of a fair value of group of assets, as set forth in SFAS No. 144, together with other facts and circumstances, the Company’s management decided to record an impairment charge of $11,388,000 relating to the full remaining carrying value of the intangible assets as of December 31, 2005.
Amortization of intangible assets acquired for the three and six months ended June 30, 2005 was $509,000 and $1,018,000, respectively, consisting of the amortization of existing technology (classified in the Statements of Operations as “Cost of Revenues”), of $92,000 and $184,000, respectively; non-competition agreements of $220,000 and $440,000, respectively; an exclusive sales agreement of $135,000 and $270,000, respectively; and workforce of $62,000 and $124,000, respectively.
In 2005, intangible assets were amortized using the straight-line method over their estimated useful lives as follows: existing technology over six years; non-competition agreements over approximately three years; an exclusive sales agreement over four and a half years; and workforce over one year.
6. Accrued Liabilities
Accrued liabilities consist of the following:
| June 30, 2006 |
| December 31, 2005 |
| |||
|
| (In thousands) |
| ||||
Withholding tax |
| $ | 3,013 |
| $ | 2,582 |
|
Compensation and benefits |
| 1,824 |
| 1,812 |
| ||
Royalties |
| 930 |
| 930 |
| ||
Warranty* |
| 96 |
| 104 |
| ||
Legal and professional fees |
| 81 |
| 28 |
| ||
Payment received from insurer |
| 206 |
| — |
| ||
Deferred income |
| 3,943 |
| — |
| ||
Other |
| 1,341 |
| 935 |
| ||
|
| $ | 11,434 |
| $ | 6,391 |
|
* The changes in the warranty balances consist of the following:
| Six Months Ended |
| Year Ended |
| |||
|
| (In thousands) |
| ||||
Balance at beginning of period |
| $ | 104 |
| $ | 426 |
|
Product warranty issued for new sales |
| 95 |
| 133 |
| ||
Changes in accrual of warranty periods ending |
| (103 | ) | (455 | ) | ||
Balance at end of period |
| $ | 96 |
| $ | 104 |
|
11
7. Severance Liabilities
The amounts paid related to severance and severance expenses were:
|
| Three Months |
| Six Months |
| ||||||||
|
| 2006 |
| 2005 |
| 2006 |
| 2005 |
| ||||
|
| (In thousands) |
| (In thousands) |
| ||||||||
Amounts paid related to severance |
| $ | 500 |
| $ | 181 |
| $ | 674 |
| $ | 325 |
|
|
|
|
|
|
|
|
|
|
| ||||
Severance expenses* |
| $ | 564 |
| $ | 329 |
| $ | 962 |
| $ | 503 |
|
* With respect to its Israeli employees, the Company expects to contribute $260,000 to a defined contribution plan and $229,000 to insurance and pension plans for the year ended December 31, 2006 (includes amounts contributed in the six months ended June 30, 2006).
8. Financing
On March 18, 2006, the Company entered into a Securities Purchase Agreement (the “Financing Agreement”) for the private placement of $25,000,000 of common stock, a Convertible Note, a Senior Secured Note and Warrants to purchase common stock to Goldman, Sachs & Co. (the “Financing”). In the Financing, the Company issued (a) 1,353,365 shares of common stock, (b) a $10,000,000 10% Convertible Note, (c) a $7,500,000 9.5% Senior Secured Note, and (d) Warrants to purchase 298,617 shares of common stock. The transaction resulted in estimated net proceeds to the Company of approximately $23,400,000. The transactions contemplated by the Financing Agreement closed on March 23, 2006.
The Convertible Note matures on March 22, 2011 and accrues interest at a rate of 10% per annum, payable in cash quarterly in arrears, and is convertible at the holder’s option into shares of common stock at a conversion price of $10.00 per share, subject to adjustment. In the event of a Fundamental Transaction (as defined in the Convertible Note), the holder may, at its option, require the Company to redeem all or any portion of the Convertible Note at a price equal to 101% of the principal amount, plus all accrued and unpaid interest, if any, and subject to specified conditions, may be entitled to a “make-whole” premium calculated in accordance with the terms of the Convertible Note. Any default in the payment of interest or principal will result in an increase in the interest rate by an additional 2% until the default is cured. In addition, holders of more than one-third of the aggregate principal balance then outstanding may declare all outstanding amounts immediately due and payable upon the occurrence of any event of default. The Convertible Note is unsecured and subordinate to the Company’s senior indebtedness.
The Senior Secured Note matures on March 22, 2011 and accrues interest at a rate of 9.5% per annum. The entire principal amount plus all accrued interest is payable at maturity, unless earlier redeemed or repurchased. The Company has the option to prepay the Senior Secured Note in whole or in part, beginning March 22, 2007, subject to payment of an applicable premium. In the event of a Fundamental Transaction (as defined in the Senior Secured Note), the holder may require that the Company redeem the entire Senior Secured Note at a price equal to 101% of the principal amount, plus all accrued and unpaid interest. Any default in the payment of interest or principal will result in an increase in the interest rate by an additional 2% until the default is cured. In addition, holders of more than one-third of the aggregate principal balance then outstanding may declare all outstanding amounts immediately due and payable upon the occurrence of any event of default. In connection with the Senior Secured Note, the Company also issued a Warrant exercisable for 298,617 shares of common stock at an exercise price of $0.10 per share, to expire on March 22, 2011. Goldman, Sachs & Co. exercised this Warrant on March 24, 2006. The Senior Secured Note is a senior secured obligation of the Company and is secured by the Company’s assets and the intellectual property of certain of its subsidiaries, as set forth in the Guaranty and Security Agreement.
The Company allocated the proceeds received in the Financing to the different instruments based on the relative fair value of each instrument as follows:
|
| Face value |
| Relative fair value |
| ||
1,353,365 shares of common stock |
| $ | 7,500,000 |
| $ | 8,260,000 |
|
10% Convertible Note due March 22, 2011 |
| 10,000,000 |
| 10,111,000 |
| ||
9.5% Senior Secured Note due March 22, 2011 |
| 7,500,000 |
| 4,830,000 |
| ||
Warrants to purchase 298,617 shares of common stock for $0.10 per share |
| — |
| 1,799,000 |
| ||
Total gross proceeds received in Financing |
| $ | 25,000,000 |
| $ | 25,000,000 |
|
12
The Senior Secured Note and the Convertible Note net of the issuance costs will be accreted by up to $2,559,000 to their face values of $7,500,000 and $10,000,000, respectively, through their five-year term until maturity. The accretion will be recorded as interest expense.
The estimated issuance costs of the Financing were approximately $1,993,000 including (a) a $1,210,000 payment and issuance of warrants to purchase 79,559 shares of the Company’s common stock, at exercise prices ranging from $0.10 to $10.00 (at an estimated fair value of $366,000), to the Company’s financial advisor and (b) accrual of approximately $417,000 for legal and other professional fees and costs. Of these estimated issuance costs, $806,000 and $385,000 were allocated to the Convertible Note and the Senior Secured Note, respectively. These costs will be amortized based on the effective interest amortization method through the five-year term until maturity of the notes and recorded as interest expense, based on the effective interest method of amortization.
The issuance costs described above were allocated to the different instruments based on their relative fair values.
9. Stock-Based Compensation
Stock Option Plans
The Company has the following stock option plans: the 1999 Employee and Consultant Equity Incentive Plan and the Third Amended and Restated 2000 Employee and Consultant Equity Incentive Plan (the “2000 Plan”). The Company’s 1996 Equity Incentive Plan expired by its terms as of February 3, 2006. The Company currently makes grants only from the 2000 Plan, which permits the grant of incentive stock options (“ISOs”) to employees, nonstatutory stock options to employees, directors and consultants and stock options which comply with Israeli law if granted to persons who are subject to Israel income tax. The 2000 Plan also provides for the awards of restricted stock and stock bonuses.
ISOs must have an exercise price equal to the fair value of the common stock on the grant date as determined by the Board of Directors. The period within which the option may be exercised is determined at the time of grant, but may not be longer than 10 years. The number of shares reserved under the 2000 Plan is subject to automatic annual increases on the first day of each fiscal year, equal to the lesser of 1,000,000 shares or 10% of the number of outstanding shares on the last day of the immediately preceding year.
On November 1, 2004, the Company entered into an at-will employment agreement with Xtend’s former chief executive officer under which he was granted an option to purchase 300,000 shares of the Company’s common stock. In January 2005, he also was granted an option to purchase 400,000 shares of the Company’s common stock. No compensation expense was recorded for these options as the fair value of the stock was not greater than the exercise price. Effective October 31, 2005, the employment of this officer was terminated, and 25% of his outstanding options (175,000) were immediately vested. All remaining outstanding options were forfeited.
In August 2005, the Company granted certain employees options to purchase 145,000 shares of the Company’s common stock at an exercise price of $0.10 per share. The market price on the date of grant was $6.75, which resulted in deferred stock compensation of $964,000 which was amortized during the year ended December 31, 2005 by $222,000. Fifty percent of these options will vest on December 10, 2006 with the remaining vesting on December 10, 2007.
In March 2005, the Company granted its Chairman of the Board and Chief Executive Officer and certain executives 630,000 options to purchase shares of common stock for $7.50 to $10.50 per share. The options vest and become exercisable if the closing price of the Company’s common stock is at or above specified prices for 10 trading days out of any 30 consecutive trading days, so long as the optionee remains an employee of or consultant to the Company on the 10th day of the period. The options expire five years after the grant date, or, if earlier, 90 days after the optionee is no longer an employee of or consultant to the Company. As of March 31, 2006, 75,000 of these stock options were forfeited as a result of the termination of an optionee’s employment. In the three and the six months ended June 30, 2006, the Company recorded expenses of $235,000 and $352,000, respectively, related to these stock options.
The cumulative effect of the Company’s adoption of SFAS 123(R), as of January 1, 2006, was not material.
13
Restricted Stock
Recipients of shares of restricted stock are entitled to cash dividends, to the extent paid, and to vote their shares throughout the restricted period. The shares are valued at the market price on the grant date, and compensation is amortized ratably over the vesting period. The Company must recognize compensation expenses for shares of restricted stock subject to designated performance criteria if the performance criteria are being attained or it is probable that they will be attained.
In July 2004, the Company granted a former Xtend employee 146,000 shares of restricted stock, of which 71,000 shares have vested and 75,000 shares will vest subject to designated performance criteria. For the three and six months ended June 30, 2006, the Company did not record compensation expenses since the Company does not expect that performance conditions related to the remaining restricted stock will be achieved.
Grant of Stock Options to Davidi Gilo
On February 10, 2006, the Company’s Compensation Committee approved the grant to Mr. Gilo of options to purchase 900,000 shares of the Company’s common stock. These options vest as follows:
(a) 300,000 shares vested upon the closing of the Financing.
(b) 300,000 shares vest at such time as the per share price of the Company’s common stock closes at or above $10.44 for a period of any 22 (consecutive or non-consecutive) trading days, so long as Mr. Gilo remains an employee of or consultant to the Company on the 22nd day of such period.
(c) 300,000 shares vest at such time as the per share price of the Company’s common stock closes at or above $15.66 for a period of any 22 (consecutive or non-consecutive) trading days, so long as Mr. Gilo remains an employee of or consultant to the Company on the 22nd day of such period.
The Company recorded stock-based compensation expenses of $0 and $750,000 for the three and the six months ended June 30, 2006, respectively, related to the 300,000 options granted to Mr. Gilo that vested upon the closing of the Financing. The Company also recorded stock-based compensation expenses of $56,000 and $86,000 for the three and six months ended June 30, 2006 in connection with the 600,000 stock options granted to Mr. Gilo which vest based on the closing price of the Company’s common stock. These stock-based compensation expenses were calculated based on the binomial valuation method.
A summary of stock option plans, shares of restricted stock and related information, under all of the Company’s equity incentive plans for the year ended December 31, 2005 and the six months ended June 30, 2006 are as follows (in thousands, except per share data):
|
| Options/Shares |
| Number |
| Weighted average |
| Weighted Average |
|
Balance at January 1, 2006 |
| 839 |
| 5,585 |
| 5.35 |
| — |
|
Authorized |
| 1,000 |
| — |
| — |
| — |
|
Granted* |
| (1,631 | ) | 1,631 |
| 5.72 |
| 3.03 |
|
Exercised |
| — |
| (335 | ) | 3.83 |
| — |
|
Expired plans |
| (39 | ) | — |
| — |
| — |
|
Cancelled |
| 357 |
| (367 | ) | 7.01 |
| — |
|
Balance at June 30, 2006 |
| 526 |
| 6,514 |
| 5.42 |
| — |
|
* Includes 75,625 options granted to non-employee directors in the six months ended June 30, 2006.
14
The following table summarizes information concerning outstanding and exercisable options under stock option plans as of June 30, 2006:
|
| Options outstanding |
| Options exercisable |
| ||||||||
Range of exercise Prices |
| Number |
| Weighted average |
| Weighted average |
| Number |
| Weighted average |
| ||
|
| (In thousands) |
| (In years) |
|
|
| (In thousands) |
|
|
| ||
Plans: |
|
|
|
|
|
|
|
|
|
|
| ||
0.10 |
| 140 |
| 4.11 |
| $ | 0.10 |
| 0 |
| 0.00 |
| |
0.99 |
| 2 |
| 1.61 |
| 0.99 |
| 2 |
| $ | 0.99 |
| |
2.27 - 3.40 |
| 887 |
| 1.47 |
| 3.17 |
| 809 |
| 3.16 |
| ||
3.57 - 5.22 |
| 2,645 |
| 5.21 |
| 4.65 |
| 1,291 |
| 4.40 |
| ||
5.60 - 8.39 |
| 2,658 |
| 4.17 |
| 6.95 |
| 897 |
| 6.77 |
| ||
8.43 - 10.50 |
| 182 |
| 3.43 |
| 9.46 |
| 46 |
| 9.04 |
| ||
|
| 6,514 |
| 4.20 |
| $ | 5.42 |
| 3,045 |
| $ | 4.83 |
|
As of June 30, 2006, the Company had issued approximately 6,514,000 options to purchase shares of common stock and had 525,686 shares of common stock available for issuance under it stock options plans.
10. Comprehensive Loss
The components of comprehensive loss are as follows:
|
| Three Months Ended |
| Six Months Ended |
| ||||||||
|
| 2006 |
| 2005 |
| 2006 |
| 2005 |
| ||||
|
| (In thousands) |
| (In thousands) |
| ||||||||
Loss |
| $ | (7,243 | ) | $ | (8,225 | ) | $ | (15,223 | ) | $ | (14,963 | ) |
Unrealized loss (gain) on available-for-sale securities |
| (9 | ) | 95 |
| (9 | ) | 71 |
| ||||
Comprehensive loss |
| $ | (7,252 | ) | $ | (8,130 | ) | $ | (15,232 | ) | $ | (14,892 | ) |
11. Segment Reporting
Following the acquisition of Xtend, the Company’s business is divided into two segments: “Wireless Solutions” and “Cable Solutions.”
|
| Three Months Ended |
| Six Months Ended |
| ||||||||
|
| 2006 |
| 2005 |
| 2006 |
| 2005 |
| ||||
|
| (In thousands) |
| (In thousands) |
| ||||||||
Consolidated revenues from: |
|
|
|
|
|
|
|
|
| ||||
Wireless Solutions, related party |
| $ | 2,625 |
| — |
| $ | 4,425 |
| — |
| ||
Wireless Solutions |
| 25 |
| $ | 1,152 |
| 166 |
| $ | 1,856 |
| ||
Cable Solutions |
| 111 |
| — |
| 539 |
| — |
| ||||
Consolidated revenues |
| $ | 2,761 |
| $ | 1,152 |
| $ | 5,130 |
| 1,856 |
| |
|
|
|
|
|
|
|
|
|
| ||||
Operating loss from continuing operations: |
|
|
|
|
|
|
|
|
| ||||
Wireless Solutions |
| (3,318 | ) | (4,461 | ) | (8,339 | ) | (7,999 | ) | ||||
Cable Solutions |
| (3,610 | ) | (3,984 | ) | (6,300 | ) | (7,525 | ) | ||||
Total consolidated operating loss from continuing operations |
| (6,928 | ) | (8,445 | ) | (14,639 | ) | (15,524 | ) | ||||
Interest income (expenses), net |
| (345 | ) | 120 |
| (614 | ) | 196 |
| ||||
Loss from continuing operations |
| $ | (7,273 | ) | $ | (8,325 | ) | $ | (15,253 | ) | $ | (15,328 | ) |
15
The following provides information on the Company’s assets:
| June 30, 2006 |
| December 31, 2005 |
| |||
|
| (In thousands) |
| ||||
|
|
|
|
|
| ||
Wireless Solutions |
| $ | 39,688 |
| $ | 19,935 |
|
Cable Solutions |
| 2,460 |
| 1,860 |
| ||
|
| $ | 42,148 |
| $ | 21,795 |
|
| Three Months Ended |
| Six Months Ended |
| |||||||||
|
| 2006 |
| 2005 |
| 2006 |
| 2005 |
| ||||
|
| (In thousands) |
| (In thousands) |
| ||||||||
Expenditures for long-lived assets: |
|
|
|
|
|
|
|
|
| ||||
Wireless Solutions |
| $ | 38 |
| $ | 165 |
| $ | 56 |
| $ | 208 |
|
Cable Solutions |
| 16 |
| 285 |
| 33 |
| 796 |
| ||||
|
| $ | 54 |
| $ | 450 |
| $ | 89 |
| $ | 1,004 |
|
|
|
|
|
|
|
|
|
|
| ||||
Depreciation and amortization expenses: |
|
|
|
|
|
|
|
|
| ||||
Wireless Solutions |
| $ | 98 |
| $ | 159 |
| $ | 212 |
| $ | 323 |
|
Cable Solutions: |
|
|
|
|
|
|
|
|
| ||||
Intangible assets |
| — |
| 509 |
| — |
| 1,018 |
| ||||
Other assets |
| 114 |
| 87 |
| 229 |
| 175 |
| ||||
|
| 114 |
| 596 |
| 229 |
| 1,193 |
| ||||
|
| $ | 212 |
| $ | 755 |
| $ | 441 |
| $ | 1,516 |
|
The following is a summary of operations within geographic areas based on the location of the customers:
|
| Three Months Ended |
| Six Months Ended |
| ||||||||
|
| 2006 |
| 2005 |
| 2006 |
| 2005 |
| ||||
|
| (In thousands) |
| (In thousands) |
| ||||||||
Revenues from sales to affiliated and unaffiliated customers from continuing operations in the Wireless Solutions segment: |
|
|
|
|
|
|
|
|
| ||||
North America, related party |
| $ | 2,625 |
| — |
| $ | 4,425 |
| — |
| ||
North America |
| 18 |
| $ | 905 |
| 148 |
| $ | 1,262 |
| ||
Asia |
| — |
| 237 |
| — |
| 538 |
| ||||
Rest of the world |
| 7 |
| 10 |
| 18 |
| 56 |
| ||||
|
| $ | 2,650 |
| $ | 1,152 |
| $ | 4,591 |
| $ | 1,856 |
|
|
|
|
|
|
|
|
|
|
| ||||
Cable Solutions segment: |
|
|
|
|
|
|
|
|
| ||||
North America |
| $ | 111 |
| $ | — |
| $ | 539 |
| $ | — |
|
| June 30, 2006 |
| December 31, 2005 |
| |||
|
| (In thousands) |
| ||||
Property and equipment, net |
|
|
|
|
| ||
Israel |
| $ | 1,074 |
| $ | 1,378 |
|
United States |
| 159 |
| 207 |
| ||
|
| $ | 1,233 |
| $ | 1,585 |
|
16
Sales to major customers out of total revenues are as follows:
|
| Three Months Ended |
| Six Months Ended |
| ||||
|
| 2006 |
| 2005 |
| 2006 |
| 2005 |
|
Customer A, related party |
| 94 | % | — |
| 86 | % | — |
|
Customer B |
| 4 | % | — |
| 10 | % | — |
|
Customer C |
| 1 | % | 66 | % | 1 | % | 50 | % |
Customer D |
| — |
| 13 | % | — |
| 10 | % |
Customer E |
| — |
| 2 | % | — |
| 10 | % |
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
You should read this Management’s Discussion and Analysis of Financial Condition and Results of Operations in conjunction with the unaudited condensed consolidated financial statements and accompanying notes of Vyyo Inc. (collectively with its subsidiaries, “we,” “us” and “our”) appearing elsewhere in this Quarterly Report on Form 10-Q. The matters addressed in this Management’s Discussion and Analysis of Financial Condition and Results of Operations, with the exception of the historical information presented, contain forward-looking statements involving risks and uncertainties. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of certain factors, including those set forth in Item 1A below and elsewhere in this report.
Overview
We provide cable and wireless broadband access solutions through two business segments: the “Cable Solutions” segment and the “Wireless Solutions” segment. Our products are designed to address four markets: Utility, Cable, Wireless Internet Service Providers (“WISP”) and Telecommunication providers. Although we are engaged to various degrees in these distinct markets, some of our core technologies overlap with our respective solutions.
Our Cable Solutions segment includes products that are used to deliver telephony and data T1/E1 links to enterprise and cellular providers over cable’s wireless or hybrid-fiber coax networks (“HFC”). Additionally, our “Spectrum Overlay” technology is designed to expand cable operators’ typical HFC network capacity in the “last mile” by up to two times in the downstream and up to four times in the upstream. Our Cable Solutions segment includes the results of operations of Xtend Networks Ltd., an Israeli company, and its wholly-owned, U.S.-based subsidiary, Xtend Networks Inc (collectively, “Xtend”). We purchased all of the outstanding capital stock of Xtend on June 30, 2004 and consolidated its operations with our operations beginning July 1, 2004. For a discussion of the Xtend acquisition, please refer to note 6 of our 2005 annual Consolidated Financial Statements.
Our Wireless Solutions segment includes our utility products which enable utilities and other network service providers to operate private wireless networks for communications, monitoring and Supervisory Control And Data Acquisition (“SCADA”) of their geographically disbursed, remote assets. Additionally, it includes our WISP and telecommunications products which address the needs of rural service providers to serve customers with wireless, high-speed data beyond the reach of traditional terrestrial networks.
We are focused on promoting products in our Wireless Solutions segment into the network provider, utility, petrochemical, municipality and enterprise markets. Our Cable Solutions segment is focused on both promoting T1 solutions for business services over cable networks and promoting cable bandwidth expansion solutions that are designed to expand cable operators’ typical HFC network capacity.
On March 23, 2006, we closed the private placement of $25,000,000 of common stock, a Convertible Note, a Senior Secured Note and Warrants to purchase common stock to Goldman, Sachs & Co. (“the Financing”) resulting in net proceeds to us of approximately $23,400,000. See note 8 above for additional discussion of the Financing.
We have incurred substantial losses since commencing operations, and as of June 30, 2006, we had an accumulated deficit of $250,373,000. We have not achieved profitability. As we continue to build our customer and revenue base we expect to continue to incur net losses. We will need to generate significantly higher revenues to support research and development, sales and marketing and general and administrative expenses, and to achieve and maintain profitability. We are likely to require additional funding and there is no guarantee that such funding will be available to us. See “Liquidity, Capital Resources and Going Concern Considerations.”
17
Critical Accounting Principles
The discussion and analysis of our financial condition and results of operations is based upon our unaudited condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates, judgments and assumptions that affect the reported assets and liabilities, revenues and expenses and related disclosure of contingent assets and liabilities at the date of the financial statements. Actual results may differ from these estimates, judgments and assumptions.
Our significant accounting principles are described in the notes to our 2005 annual consolidated financial statements in the Annual Report on Form 10-K for the year ended December 31, 2005. We determined the critical principles by considering accounting principles that involve the most complex or subjective decisions or assessments. We believe our most critical accounting principles include the following:
Revenue Recognition
Revenues from product sales are recognized when an arrangement exists, delivery has occurred and title has passed to the customer, our price to the customer is fixed or determinable and collectability is reasonably assured. When sales transactions include more then one deliverable (unit of accounting) sold, we follow the guidance of Emerging Issues Task Force (“EITF”) Issue 00-21, “Revenue Arrangements with Multiple Deliverables,” and Staff Accounting Bulletin (“SAB”) SAB 104, “Revenue Recognition.” Under the provisions in these statements, we separate the different units of accounting in sales with multiple deliverables based on the objective and reliable evidence of fair value of the different elements. Revenue for each unit of accounting is then recognized when products are delivered or when services are rendered or ratably over the contractual period, depending on the nature of the deliverable.
Revenues related to the exclusivity provisions contained in the Equipment Purchase Agreement described in note 3 are recognized over the 10-year term of the Equipment Purchase Agreement.
Our products are generally off-the-shelf products, sold “as is,” without further adjustment or installation. Sales contracts with distributors stipulate fixed prices and current payment terms and are not subject to the distributors’ resale or any other contingencies. Accordingly, when all criteria above are met, sales of finished products to distributors are recognized as revenue upon delivery and after title and risk pass to the distributors.
We do not grant any rights of return or cancellation to any of our customers.
In contracts where there is a customer acceptance provision or there is uncertainty about customer acceptance, the associated revenue is deferred until we have evidence of customer acceptance. We perform ongoing credit evaluations of our customers’ financial condition and in some cases we require various forms of security.
Inventory
We regularly monitor inventory quantities on hand and record a provision for excess and obsolete inventory based primarily on our estimated forecast of future product demand and production requirements. Although we make every effort to ensure the accuracy of our forecasts of future product demand, any significant unanticipated changes in demand or technological developments would significantly impact the value of our inventory and reported operating results. If actual market conditions are different from our assumptions, additional provisions may be required. Our estimate of future product demand may prove to be inaccurate, in which case we may have understated or overstated the provision required for excess and obsolete inventory. If we later determine that our inventory is overvalued, we would be required to recognize such costs in our costs of sales at the time of such determination. If we later determine that our inventory is undervalued, we may have overstated our costs of sales in previous periods and would be required to recognize additional operating income only when the undervalued inventory was sold.
Employee Stock-Based Compensation
Prior to January 1, 2006, we accounted for stock-based compensation under the intrinsic value method, which followed the recognition and measurement principles of Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations. Charges for stock-based compensation represented the amortization of deferred compensation charges, which was based on aggregate differences between the respective exercise price of stock options, shares of restricted stock and purchase price of the underlying common stock on one hand versus the fair market value of the common stock on the other hand. Deferred stock-based compensation is amortized over the vesting period of the underlying stock options and the shares of restricted stock.
18
Under “fixed plan” accounting, compensation cost is fixed, measured at grant date and is not subsequently adjusted. Under “variable plan” accounting, the measurement date occurs after the grant date and compensation cost is estimated and recorded each period from the grant date to the measurement date, based on the difference between the option price and the fair market value of the underlying common stock at the end of each period.
As of January 1, 2006, we adopted Statement of Financial Accounting Standards (“SFAS”) No. 123 (Revised 2004), “Share-Based Payment” (“SFAS No. 123(R)”), using the modified prospective method. This new standard requires measurement of stock-based compensation cost for all stock-based awards at the fair value on the grant date and recognition of stock-based compensation over the service period for awards that we expect will vest. The fair value of stock options is determined based on the number of shares granted and the price of our common stock, and calculated based on the Black-Scholes and the binomial valuation models, which is consistent with our valuation techniques previously utilized for options in footnote disclosures required under SFAS No. 123, “Accounting for Stock Based Compensation,” as amended by SFAS No. 148, “Accounting for Stock-Based Compensation — Transition and Disclosure.” We recognize such value as expense over the service period, net of estimated forfeitures, using the accelerated method under SFAS No. 123(R). Due to our adoption of SFAS No. 123(R), we no longer have employee stock-based compensation awards subject to variable accounting treatment. The cumulative effect of our adoption of SFAS 123(R), as of January 1, 2006, was not material.
Expense (income) related to stock-based compensation is included in the following line items in the Statements of Operations:
|
| Three Months Ended |
| Six Months Ended |
| ||||||||
|
| 2006 |
| 2005 |
| 2006 |
| 2005 |
| ||||
|
| (In thousands) |
| (In thousands) |
| ||||||||
Cost of revenues |
| $ | 22 |
| $ | — |
| $ | 36 |
| $ | — |
|
Research and development |
| $ | 222 |
| $ | 27 |
| $ | 439 |
| $ | 54 |
|
Sales and marketing |
| $ | 305 |
| $ | 27 |
| $ | 774 |
| $ | 54 |
|
General and administrative |
| $ | 536 |
| $ | — |
| $ | 1,817 |
| $ | — |
|
Restructuring adjustments |
| $ | — |
| $ | (93) |
| $ | — |
| $ | (408 | ) |
Recent Accounting Pronouncements
In February 2006, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 155, “Accounting for Certain Hybrid Financial Instruments” (“SFAS No. 155”), which amends SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities” (“SFAS No. 133”), and SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities” (“SFAS No. 140”). SFAS No. 155 simplifies the accounting for certain derivatives embedded in other financial instruments by allowing them to be accounted for as a whole if the holder elects to account for the whole instrument on a fair value basis. SFAS No. 155 also clarifies and amends certain other provisions of SFAS No. 133 and SFAS No. 140. SFAS No. 155 is effective for all financial instruments acquired, issued or subject to a remeasurement event occurring in fiscal years beginning after September 15, 2006. We do not expect the adoption of SFAS No. 155 to have a material impact on our consolidated financial position, results of operations or cash flows.
In June 2006, FASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes an interpretation of FASB Statement No. 109” (“FIN No. 48”). FIN No. 48 prescribes a recognition threshold and measurement attribute for financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return, and also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. FIN No. 48 is effective for fiscal years beginning after December 15, 2006. We are currently assessing FIN No. 48 to determine the impact that adoption of FIN No. 48 will have on our results of operations and financial condition.
Results of Operations
Revenues
Revenues increased to $2,761,000 in the three months ended June 30, 2006 from $1,152,000 in the three months ended June 30, 2005, and to $5,130,000 in the six months ended June 30, 2006 from $1,856,000 in the six months ended June 30, 2005. This increase in revenues for the three and six months ended June 30, 2006 was primarily due to the $2,625,000 and $4,425,000, respectively, in revenue from our Wireless Solutions segment for products sold to Arcadian Networks, Inc. (“ANI”) and $111,000 and $539,000 respectively, in revenue from our Cable Solutions segment for products sold to a top five cable television multi-system operator (“MSO”). ANI is a related party as discussed above in note 3. Revenues for the
19
three and six months ended June 30, 2006 and 2005 did not include inventory previously written down to $0.
Our revenue is concentrated among relatively few customers, as set forth in the following table. Though our principal revenue-generating customers are likely to vary on a quarterly basis, we anticipate that our revenues will remain concentrated among a few customers for the foreseeable future.
|
| Three Months Ended |
| Six Months Ended |
| ||||
|
| 2006 |
| 2005 |
| 2006 |
| 2005 |
|
Customer A, related party |
| 94 | % | — |
| 86 | % | — |
|
Customer B |
| 4 | % | — |
| 10 | % | — |
|
Customer C |
| 1 | % | 66 | % | 1 | % | 50 | % |
Customer D |
| — |
| 13 | % | — |
| 10 | % |
Customer E |
| — |
| 2 | % | — |
| 10 | % |
Cost of Revenues
Cost of revenues consists of component and material costs, direct labor costs, warranty costs and overhead related to manufacturing our products.
Cost of revenues increased to $1,933,000 during the three months ended June 30, 2006 from $1,439,000 during the three months ended June 30, 2005, and was $3,743,000 and $2,225,000 in the six months ended June 30, 2006 and 2005, respectively. The increase in cost of revenues was primarily attributable to increases in shipments of our products. For the three months ended June 30, 2005, we recorded a write-down of inventory of $350,000. Our gross margins during the three and six months ended June 30, 2006 and 2005 increased primarily due to the increase in shipments of our products together with flat fixed costs. We anticipate that our gross margins will continue to fluctuate based on our product and customer mix, revenue level and inventory valuations.
Research and Development
Our research and development expenses were $2,950,000 and $2,858,000 during the three months ended June 30, 2006 and 2005, respectively, and $5,411,000 and $5,590,000 for the six months ended June 30, 2006 and 2005, respectively. Approximately $1,591,000 and $1,551,000 of these expenses were from our Cable Solutions segment for the three months ended June 30, 2006 and 2005, respectively, and $2,741,000 and $3,152,000 of these expenses were from our Cable Solutions segment for the six months ended June 30, 2006 and 2005, respectively. Approximately $1,359,000 and $1,307,000 of these expenses were from our Wireless Solutions segment for the three months ended June 30, 2006 and 2005, respectively, and $2,670,000 and $2,438,000 of these expenses were from our Wireless Solutions segment for the six months ended June 30, 2006 and 2005, respectively. These expenses consisted primarily of personnel, facilities, equipment and supplies and were charged to operations as incurred. All of our research and development activities were conducted in our facility in Israel.
The increase in our research and development expenses in our Cable Solutions segment during the three months ended June 30, 2006 compared to the three months ended June 30, 2005 resulted from non-cash expenses related to stock option grants to our research and development employees and consultants of $121,000 compared to $27,000 during the three months ended June 30, 2006 and 2005, respectively, partly offset by a decrease in salaries and compensation from $805,000 during the three months ended June 30, 2005 to $756,000 during the three months ended June 30, 2006. The decrease in our research and development expenses in our Cable Solutions segment during the six months ended June 30, 2006 compared to the six months ended June 30, 2005 mainly resulted from a decrease in our salaries and compensation from $1,607,000 to $1,369,000 and from a decrease in material procurement from $655,000 to $457,000 during the six months ended June 30, 2006 and 2005, respectively. This decrease was partly offset by an increase in non-cash expenses related to stock option grants from $54,000 to $236,000 during the six months ended June 30, 2005 and 2006, respectively.
The increase in our research and development expenses in our Wireless Solutions segment during the six months ended June 30, 2006 compared to the six months ended June 30, 2005 mainly resulted from non-cash expenses related to stock option grants of $203,000 compared to $0 during the six months ended June 30, 2006 and 2005, respectively.
We anticipate that we will need to increase our research and development workforce in future periods to meet our customer demands.
Sales and Marketing
Sales and marketing expenses decreased to $2,571,000 and $5,214,000 during the three and six months ended June
20
30, 2006, respectively, compared to $3,104,000 and $5,791,000 during the three and six months ended June 30, 2005, respectively. Sales and marketing expenses consist of salaries and related costs for sales and marketing employees, consulting fees and expenses for travel, trade shows, market research, branding and promotional activities. The decrease in our sales and marketing expenses during the three and six months ended June 30, 2006 reflects our decreased workforce resulting from our restructuring program in August 2005.
Sales and marketing expenses for our Wireless Solutions segment were approximately $768,000 and $1,867,000 in the three and the six months ended June 30, 2006, respectively. For the three and the six months ended June 30, 2005, the sales and marketing expenses for our Wireless Solutions segment were $1,377,000 and $2,759,000, respectively. The decrease in the expenses for our Wireless Solutions segment in the three and six months ended June 30, 2006 resulted from the closings of our China office and our international sales department. During the three months period ended June 30, 2006 we relocated our wireless sales and marketing department from Palo Alto, California to Norcross, Georgia, and decreased our workforce. Given this reduction, we anticipate that our sales and marketing expenses of our Wireless Solutions segment will decrease in future periods.
Sales and marketing expenses for our Cable Solutions segment were approximately $1,803,000 and $3,347,000 during the three and six months ended June 30, 2006, respectively, compared to $1,727,000 and $3,032,000 for the three and six months ended June 30, 2005, respectively. The increase during the three months ended June 30, 2006 resulted mainly from increased charges for stock-based compensation of approximately $394,000 compared to approximately $27,000 during the three months ended June 30, 2005 and an increase in our professional fees of approximately $181,000 compared to approximately $112,000 during the three months ended June 30, 2005. The increase in sales and marketing expenses during the six months ended June 30, 2006 compared to the six months ended June 30, 2005, resulted primarily from increased charges for stock-based compensation of approximately $723,000 compared to approximately $54,000 during the six months ended June 30, 2005 and an increase in our professional fees of approximately $286,000 compared to approximately $171,000 during the six months ended June 30, 2005. This increase was partly offset by the decrease in salaries and recruitment expenses of approximately $237,000, and one time expenses of $200,000 in the six months ended June 30, 2005 related to market research.
We anticipate that our sales and marketing workforce will increase in future periods as we increase our efforts to penetrate the cable market and meet our customer demands.
General and Administrative
General and administrative expenses increased to $2,235,000 during the three months ended June 30, 2006 compared to $1,872,000 during the three months ended June 30, 2005, and to $5,401,000 during the six months ended June 30, 2006 compared to $3,348,000 during the six months ended June 30, 2005. Of these expenses, approximately $287,000 and $572,000 were from our Cable Solutions segment, and $1,948,000 and $4,829,000 were from our Wireless Solutions segment during the three and six months ended June 30, 2006, respectively. This compares to $219,000 and $345,000 from our Cable Solutions segment and $1,653,000 and $3,003,000 from our Wireless Solutions segment during the three and six months ended June 30, 2005, respectively. General and administrative expenses consisted primarily of personnel and related costs for general corporate functions, including finance, accounting, implementation of the Sarbanes-Oxley Act of 2002, strategic and business development and legal.
The increase in general and administrative expenses during the three months ended June 30, 2006 compared to the three months ended June 30, 2005 was primarily due to (a) an increase in our non-cash stock-based compensation charges from $0 during the three months ended June 30, 2005 to $536,000 during the three months ended June 30, 2006, (b) an increase of $87,000 in fees paid to consultants and (c) an increase in our withholding tax expenses of approximately $148,000. These increases were partly offset by a decrease in travel expenses of approximately $504,000. The increase in general and administrative expenses during the six months ended June 30, 2006 compared to the six months ended June 30, 2005 resulted from (a) an increase in our non-cash stock-based compensation charges from $0 during the six months ended June 30, 2005 to $1,817,000 during the six months ended June 30, 2006, (b) an increase in salaries and severance compensation of $252,000 primarily related to the relocation of our Wireless Solutions segment from Palo Alto, California to Norcross, Georgia and a one-time severance provision of $300,000 in connection with the new employment agreement of our Chief Executive Officer and Chairman of our Board of Directors, (c) an increase of $135,000 in fees paid to consultants, and (d) an increase in our withholding tax expenses of approximately $192,000.These increases were partly offset by a decrease in travel expenses of approximately $674,000.
We expect general and administrative expenses to be higher in the future as we continue to implement internal controls over financial reporting as required by the Sarbanes-Oxley Act and to execute our strategic plans and business development efforts. We will complete the consolidation of our United States locations in the third quarter of 2006. We expect that the initial increases in general and administrative expenses due to relocation expenses and personnel changes will be offset by reduced facility charges.
21
Amortization of Intangible Assets
Amortization of intangible assets acquired was $0 and $509,000 during the three months ended June 30, 2006 and 2005, respectively, and $0 and $1,018,000 during the six months ended June 30, 2006 and 2005, respectively. We estimated the fair value of our intangible assets with the assistance of an independent third party appraiser, based upon future expected discounted cash-flows as of December 31, 2005. Based on this appraisal, by using a weighted discounted cash flow model for the estimation of a fair value of group of assets as set forth in SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” together with other facts and circumstances, we recorded an impairment charge of $11,388,000 related to the full remaining carrying value of the intangible assets as of December 31, 2005. Therefore, we did not amortize intangible assets during the three and six months ended June 30, 2006.
The amortization of intangible assets acquired for the three and six months ended June 30, 2005 consisted of the amortization of existing technology of $92,000 and $184,000, respectively (recorded in our Statements of Operations as “Cost of Revenues”); non-competition agreements of $220,000 and $440,000, respectively; an exclusive sales agreement of $135,000 and $270,000, respectively; and workforce of $62,000 and $124,000, respectively. For additional information, see notes 6 and 7 of our 2005 annual consolidated financial statements included in our Annual Report on Form 10-K.
Restructuring Charges
In 2001, we implemented a restructuring program to reduce operating expenses due to the dramatic and continuing slowdown in the telecommunications sector and the general economy. In connection with this program, we recorded restructuring income of $93,000 and $408,000 during the three and six months ended June 30, 2005, respectively, from a positive adjustment with respect to a variable compensation plan related to our former chief executive officer.
As of December 31, 2005, there were no severance expenses or termination of contractual obligations payments attributable to the restructuring. Therefore, no restructuring charges were recorded during the three and six months ended June 30, 2006.
Interest Income (Expense), Net
Interest income (expense), net includes interest and investment income, foreign currency remeasurement gains and losses. Net interest expense was $345,000 and $614,000 for the three and six months ended June 30, 2006, respectively, compared to net interest income of $120,000 and $196,000 for the three and six months ended June 30, 2005, respectively. Net interest expense increased due to increased interest on our amended Promissory Note, 10% Convertible Note and 9.5% Senior Secured Note. These increases were partially offset by interest income derived mainly from our cash and short-term investment balances, and recognition of an other-than-temporary impairment in our available-for-sale securities of ($0) and ($42,000) and realized losses of $0 and $31,000 for the three and six months ended June 30, 2006. During the three months ended June 30, 2005, we recorded an other-than-temporary investment impartment of $23,000 given that we did not hold the debt securities for a reasonable time beyond maturity.
We will incur increased interest expenses for the remainder of 2006 and beyond due to long-term debt related to our Financing with Goldman, Sachs & Co. in which $10,000,000 of the proceeds bear an annual interest rate of 10.0% and $7,500,000 of the proceeds bear an annual interest rate of 9.5%, plus the amortization of deferred expenses incurred as part of the Financing. We will expense accretion of $3,610,000 over the terms of the long-term debts. Interest expenses also will increase given the accretion to the value of the $6,500,000 amended Promissory Note delivered as part of the acquisition of Xtend. We will record accretion of $2,012,000 throughout the term of the amended Promissory Note, unless the note is cancelled.
Income Taxes
As of December 31, 2005, our Israeli subsidiaries had net operating loss carryforwards of approximately $90,000,000. These carryforwards have no expiration date.
Our Israeli subsidiaries have been granted “Approved Enterprise” status for several investment programs. The “Approved Enterprise” status entitles these subsidiaries to receive tax exemption periods, ranging from two to six years, on undistributed earnings commencing in the year in which the subsidiaries attain taxable income. In addition, this “Approved Enterprise” status provides a reduced corporate tax rate of between 10% to 25% (as opposed to the usual Israeli corporate tax rate of 31% for 2006) for the remaining term of the program on the plan’s proportionate share of income.
Since our Israeli subsidiaries have not achieved taxable income, the tax benefits periods have not yet commenced. The subsidiaries’ losses are expected to offset certain future earnings of the subsidiaries during the tax-exempt period; therefore, the utilization of the net operating losses will generate no tax benefits. Accordingly, deferred tax assets from such losses have not been included in our 2005 annual consolidated financial statements or our June 30, 2006 unaudited condensed
22
consolidated financial statements. The entitlement to the above benefits is conditioned upon the subsidiaries fulfilling the conditions stipulated by the law, regulations published thereunder and the instruments of approval for the specific investments in approved enterprises.
Discontinued Operations
On August 12, 2003, our Board of Directors determined to cease the software business operated by Shira Computers Ltd. (“Shira”), the Company’s wholly owned subsidiary, and terminate all of Shira’s employees due to the continuing decline in Shira’s sales, Shira’s recurring losses and its inability to penetrate the market. On March 31, 2005, we sold all of our shares of Shira to third parties. Under the sale agreement, the purchasers must pay us 22.5% to 42.5% of the proceeds that they receive upon a later sale of Shira or its assets. The purchasers have assumed all of Shira’s liabilities totaling $270,000. The gain from this sale was $290,000 and was recorded in discontinued operations.
Liquidity, Capital Resources and Going Concern Considerations
Our financial statements are presented on a going concern basis, which contemplates the realization of assets and satisfaction of liabilities in the normal course of business. We have experienced a significant loss from operations. For the six months ended June 30, 2006, we incurred a net loss of $15,223,000 and had an accumulated deficit of $250,373,000. Our ability to continue as a going concern will depend upon our ability to raise additional capital or attain profitable operations. In addition, we are seeking to expand our revenue base by adding new customers. Failure to secure additional capital or to expand our revenue base would likely result in depleting our available funds and not being able to pay our obligations when they become due. The accompanying unaudited condensed consolidated financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from our possible inability to continue as a going concern.
As of June 30, 2006, we had $27,622,000 of cash, cash equivalents and short-term investments. During the six months ended June 30, 2006, net cash used in operations was $6,838,000, comprised mainly of our loss of $15,223,000 partially offset by (a) non-cash charges related to depreciation and amortization of $441,000 and stock-based compensation of $3,066,000, (b) a $400,000 increase in liability for employee rights upon retirement, (c) $662,000 of accretion and amortization of financing instruments, net and (d) changes in other working capital accounts of $3,816,000. During the six months ended June 30, 2005, net cash used in operations was $14,604,000, comprised mainly of (a) our loss of $14,963,000, (b) changes in other working capital accounts of $857,000, and (c) non-cash charges of income related to stock-based compensation of $300,000 partially offset by non-cash charges of depreciation and amortization of $1,516,000.
During the six months ended June 30, 2006, net cash used in investing activities was $5,249,000 comprised mainly of the purchase of $5,079,000 of short-term investments, net of sales and maturities of our short-term investments. During the six months ended June 30, 2005, net cash provided by investing activities was $12,652,000, comprised of $13,656,000 net of sales and purchases of our short-term investments partially offset by $1,004,000 in purchases of property and equipment.
Financing activities in the six months ended June 30, 2006 were approximately $24,688,000 related to (a) the Financing, which included the issuance of our common stock, 9.5% Senior Secured Note, 10% Convertible Note and Warrants to purchase our common stock, net of issuance costs and (b) proceeds from stock option exercises. See note 8 above for additional information about the Financing. Financing activities in the six months ended June 30, 2005 were approximately $499,000 consisting of proceeds from stock option exercises and notes receivables from stockholders.
Our capital requirements depend on numerous factors, including market acceptance of our products, the resources we devote to developing, marketing, selling and supporting our products and other factors. During the next 12 months, we may need to raise additional capital to execute our business plan and to provide adequate working capital to satisfy our business objectives and requirements. If we raise additional funds through the issuance of equity or convertible debt securities, we may be required to do so at a price per share below then-current trading prices thereby diluting our current stockholders. We may not be able to obtain additional funds on acceptable terms, or at all. This potential inability to raise funds on acceptable terms could seriously harm our business. If we cannot raise needed funds on acceptable terms, we may not be able to execute our business plan or to continue as a going concern.
We have purchase obligations to our suppliers that support our operations in the normal cause of our business. The obligations require us to purchase minimum quantities of the suppliers’ products at a specified price. As of December 31, 2005 and June 30, 2006, we had approximately $1,538,000 and $2,224,000, respectively, of purchase obligations. These obligations are expected to become payable at various times through 2006.
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Forward-Looking Statements
You should read Management’s Discussion and Analysis of Financial Condition and Results of Operations in conjunction with the consolidated financial statements and accompanying notes appearing elsewhere in our Quarterly Report on Form 10-Q. The matters addressed in Management’s Discussion and Analysis of Financial Condition and Results of Operations, with the exception of the historical information presented, contain forward-looking statements involving risks and uncertainties, as well as assumptions that, if they do not fully materialize or prove incorrect, could cause our business and results of operations to differ materially from those expressed or implied by such forward-looking statements. Such forward-looking statements include:
· our belief that our most critical accounting principles include principles relate to revenue recognition, inventory and employee stock-based compensation;
· our belief that SFAS No. 155 will not have a material impact on our consolidated financial position, results of operations or cash flows;
· our expectation that a few customers will account for a large percentage of our revenues;
· our expectation that our gross margins will continue to fluctuate based on our product and customer mix, revenue level and inventory valuations;
· our expectation that we will need to increase our research and development workforce in future periods to meet our customer demands;
· our expectation that expenses of our Wireless Solutions Segment will decrease in future periods;
· our expectation that our sales and marketing workforce will increase in future periods as we increase our efforts to penetrate the cable market and meet our customer demand;
· our expectation that general and administrative expenses will be higher in the future as we continue to implement internal controls over financial reporting as required by the Sarbanes-Oxley Act and to execute our strategic plans and business development efforts;
· our expectation that the initial increases in general and administrative expenses due to relocation expenses and personnel changes incurred in the consolidation of our United States locations will be offset by reduced facility charges;
· our expectation that we will incur increased interest expenses for the remainder of 2006 and beyond;
· our expectation that the losses of our Israeli subsidiaries will offset certain future earnings of the subsidiaries during their tax-exempt period and that, therefore, we will receive no tax benefits from the utilization of the net operating losses;
· our belief that we may need additional capital to execute our business plan and to provide adequate working capital to satisfy our business objectives;
· our belief that we may not be able to obtain additional funds on acceptable terms, or at all;
· our belief that if we cannot raise additional funds on acceptable terms, we may not be able to execute our business plan or to continue as a going concern; and
· our belief that we may need to sell additional equity or convertible debt securities, which would result in additional dilution to our stockholders.
You can identify these and other forward-looking statements by the use of words such as “may,” “will,” “should,” “could,” “intend,” “expect,” “plan,” “estimate,” “project,” “anticipate,” “believe,” “potential,” “continue,” or the negative of such terms, or other comparable terminology. The risks, uncertainties and assumptions referred to above that could cause our actual results to differ materially from the results expressed or implied by such forward-looking statements include those set forth under Item 1A below and the risks, uncertainties and assumptions discussed from time to time in our other public filings and public announcements. All forward-looking statements included in this document are based on information available to us as of the date hereof, and we assume no obligation to update these forward-looking statements.
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Item 3. Quantitative and Qualitative Disclosures about Market Risk
We are exposed to financial market risks including changes in interest rates and foreign currency exchange rates. Substantially all of our revenue and capital spending is transacted in U.S. dollars, although a substantial portion of the cost of our operations, relating mainly to our personnel and facilities in Israel, is incurred in New Israeli Shekels, or NIS. We have not engaged in hedging transactions to reduce our exposure to fluctuations that may arise from changes in foreign exchange rates. In the event of an increase in inflation rates in Israel, or if appreciation of the NIS occurs without a corresponding adjustment in our dollar-denominated revenues, our results of operation and business could be materially harmed.
As of June 30, 2006, we had cash, cash equivalents and short-term investments of $27,622,000. Substantially all of these amounts consisted of corporate and government fixed income securities and money market funds that invest in corporate and government fixed income securities that are subject to interest rate risk. We place our investments with high credit quality issuers and by policy limit the amount of the credit exposure to any one issuer.
Our general policy is to limit the risk of principal loss and ensure the safety of invested funds by limiting market and credit risk. Highly liquid investments with maturity of less than three months at the date of purchase are considered to be cash equivalents; investments with maturities of three months or greater are classified as available-for-sale and considered to be short-term investments.
While all our cash equivalents and short-term investments are classified as “available-for-sale,” we generally have the ability to hold our fixed income investments until maturity and therefore we would not expect our operating results or cash flows to be affected to any significant degree by the effect of a sudden change in market interest rates on our securities portfolio. We may not be able to obtain similar rates after maturity as a result of fluctuating interest rates. We do not hedge any interest rate exposures.
Quantitative Interest Rate Disclosure as of June 30, 2006
If market interest rates were to increase on June 30, 2006 immediately and uniformly by 10%, the fair value of the portfolio would decline by approximately $1,000, or approximately 0.004% of the total portfolio (approximately 0.002% of total assets). Assuming that the average yield to maturity on our portfolio at June 30, 2006 remains constant throughout the third quarter of 2006 and assuming that our cash, cash equivalents and short-term investments balances at June 30, 2006 remain constant for the duration of the third quarter of 2006, interest income for the third quarter of 2006 would be approximately $269,000. Assuming a decline of 10% in the market interest rates at June 30, 2006, interest income for the third quarter of 2006 would be approximately $264,000, which represents a decrease in interest income of approximately $5,000. The decrease in interest income will result in a decrease of the same amount to net income and cash flows from operating activities for the six months ended June 30, 2006. These amounts are determined by considering the impact of the hypothetical interest rates on our cash equivalents and available-for-sale securities at June 30, 2006 over the remaining contractual lives.
Item 4. Controls and Procedures
Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the period covered by this report. Based on such evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of such period, our disclosure controls and procedures were effective to ensure that information we are required to disclose in reports that we file under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission rules and forms.
There have not been any changes in our internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the fiscal quarter to which this report relates that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
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Our business is subject to substantial risks, including the risks described below.
We have a history of significant losses, expect future losses and may never achieve or sustain profitability.
We have incurred significant losses since our inception, and we expect to continue to incur losses for the foreseeable future. We incurred losses of $15,223,000 for the six months ended June 30, 2006. As of June 30, 2006, our accumulated deficit was $250,373,000. Our revenues and gross margins may not grow or even continue at their current level and may decline even further. If our revenues do not rapidly increase, or if our expenses increase at a greater pace than our revenues, we will never become profitable.
We have written down and may need to further write-down our inventory in the future if our sales levels do not match our expectations, or if selling prices decline more than we anticipate, which could adversely impact our operating results.
We operate in an industry that is characterized by intense competition, supply shortages or oversupply, rapid technological change, declining average selling prices and rapid product obsolescence, all of which make it more challenging to effectively manage our inventory. In addition, we are required to order or build inventory well in advance of the time of our anticipated sales.
Our inventory is stated at the lower of cost or market value. Determining market value of our inventory involves numerous judgments, including, but not limited to, judgments regarding average selling prices and sales volumes for future periods. We primarily utilize estimated selling prices for measuring any potential declines in market value below cost. When market value is determined to be below cost, we make appropriate allowances to reduce the value of inventories to net realized value. We may reduce the value of our inventory when we determine that inventory is slow moving, obsolete, excessive or if the selling price of the product is insufficient to cover product costs and selling expenses.
In this regard, our inventory increased substantially in 2004 and 2005 because sales were substantially less than our anticipated demand and we were required to make advance inventory purchase commitments for anticipated sales. Accordingly, we recorded a write down of inventory and purchase commitments of approximately $2,050,000 for the year ended December 31, 2005.
In the event that our sales do not increase, the sales price of our products decrease or we are otherwise unable to control inventory levels consistent with actual demand, we may be required to write down additional inventory. Any such write-down would adversely affect our operating results in future periods.
We have insufficient capital to execute our business plan.
On March 23, 2006, we closed the Financing of $25,000,000 from Goldman, Sachs & Co., resulting in net proceeds to us of approximately $23,400,000. Notwithstanding this Financing, we will need additional capital to execute our business plan. If we are unsuccessful in securing additional cash, either through additional equity and/or debt financings or increased revenues, we will not be able to successfully execute our business plan.
If we default under either the Convertible Note or the Senior Secured Note delivered to Goldman, Sachs & Co. in the Financing, the principal and accrued interest under each note would become due and payable which would substantially harm our cash position and business prospects.
On March 23, 2006, we closed the Financing for $25,000,000 which included delivery of a 10% Convertible Note in the principal amount of $10,000,000 and a 9.5% Senior Secured Note in the principal amount of $7,500,000. Each of these notes contains events of default that, if triggered, would require us to pay the principal and accrued interest under both notes immediately (after the expiration of applicable cure periods). If an event of default occurs under the notes and the holder declares all outstanding principal and interest immediately due and payable, our cash position and business prospects would be substantially harmed.
If we fail to achieve significant market penetration and customer acceptance of our cable products, our prospects would be substantially harmed.
The market for broadband products in the cable television industry is extremely competitive, subject to drastic technological changes and highly fragmented. Our products in the Cable Solutions segment are new and relatively unknown; accordingly, we have not generated significant revenue in this segment. We have only recently received our first commercial purchase order for the initial deployment of our Spectrum Overlay solution in a major market by a top MSO. Other than this order, to date, we have only begun to install our Spectrum
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Overlay products with customers in field trials. There can be no assurance that our initial installations of our cable products will be successful. As our cable products continue to be in a development stage, we may face challenges such as market resistance to a new product, perceptions regarding customer support and quality control.
We will generate significant sales only if we are able to penetrate the market and create market share in this industry. If we are unable to do so, our business would be harmed and our prospects significantly diminished.
The loss of one or more of our key customers would result in a loss of a significant amount of our revenues and adversely affect our business.
A relatively small number of customers account for a large percentage of our revenues, as set forth in the table below:
|
| Three Months Ended |
| Six Months Ended |
| ||||
|
| 2006 |
| 2005 |
| 2006 |
| 2005 |
|
Customer A, related party |
| 94 | % | — |
| 86 | % | — |
|
Customer B |
| 4 | % | — |
| 10 | % | — |
|
Customer C |
| 1 | % | 66 | % | 1 | % | 50 | % |
Customer D |
| — |
| 13 | % | — |
| 10 | % |
Customer E |
| — |
| 2 | % | — |
| 10 | % |
We expect that we will continue to depend on a limited number of customers for a substantial portion of our revenues in future periods. The loss of a major customer could seriously harm our ability to sustain revenue levels, which would seriously harm our operating results.
In this regard, sales to Customer A in the six months ended June 30, 2006 accounted for the vast majority of our sales during that period. This customer was formed and initially capitalized in the first quarter of 2006 and has a very limited history of operations, profitable or otherwise. We expect sales to this customer to be material to our operations for the foreseeable future. If this customer is not successful in operating its business, or if sales to this customer are lower than our expectations, our business could be harmed.
Our success will depend on MSOs’ willingness and ability to substantially increase the available bandwidth on their networks using our alternative technology solution.
For our cable products to be sold in significant quantities, MSOs must be willing and able to substantially increase the available bandwidth on their networks. MSOs may not be willing or able to develop additional services and revenue streams to justify the deployment of our technology. Meanwhile, major MSOs have indicated that the imminent completion of significant network upgrades, which involve significant labor and construction costs, will lead to lower capital expenditures in the future. If our product portfolio and product development plans do not position us well to capture an increased portion of the expected reduced capital spending of these cable operators, our operating results would be adversely affected.
If the adoption of broadband wireless technology continues to be limited, we will not be able to sustain or expand our business.
Our future success in the telecommunications market depends on high-speed wireless communications products gaining market acceptance as a means to provide voice and data communications services. Because these markets are relatively new and unproven, it is difficult to predict if these markets will ever develop, expand or be sufficiently large to sustain our business. Major service providers in the United States have ceased, delayed or reduced their rollouts and may further delay or reduce rollouts in the future. Our expectations with respect to a recovery, if any, in the telecommunications market, may not prove accurate. In the event that service providers adopt technologies other than the wireless technologies that we offer or if they delay further their deployment of high-speed wireless communication products, we will not be able to sustain or expand our business.
While we are continuing to operate our traditional Wireless Solutions segment and have increased our sales and marketing efforts to address the utilities and oil and gas market and other new markets, we may also consider a variety of alternatives to this business, including the sale, divestiture, license or restructuring of a substantial portion or all of our current wireless network technology or assets. In the event of any such transaction, the value we may realize in the current market could be minimal.
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If telecommunications service providers and systems integrators do not promote and purchase our products, or if the telecommunications equipment market does not improve and grow, our business will seriously be harmed.
Telecommunications service providers continually evaluate alternative technologies, including digital subscriber line, fiber and cable. Should service providers or systems integrators, to which we may sell products in the future, cease to emphasize systems that include our products, choose to emphasize alternative technologies or promote systems of our competitors, our business would be seriously harmed.
Market conditions remain difficult and capital spending plans are often constrained. It is likely that further industry restructuring and consolidation will take place. Companies that have historically not had a large presence in the broadband access equipment market have begun to expand their market share through mergers and acquisitions. The continued consolidation of our competitors could have a significant negative impact on us. Further, our competitors may bundle their products or incorporate functionality into existing products in a manner that discourages users from purchasing our products or which may require us to lower our selling prices resulting in lower gross margins.
If the telecommunications market, and in particular the market for broadband access equipment, does not improve and grow, our business would be substantially harmed.
If the communications, Internet and cable television industries do not grow and evolve in a manner favorable to our business strategy, our business may be seriously harmed.
Our future success depends upon the growth of the communications industry, the cable television industry and, in particular, the Internet. These markets continue to evolve rapidly because of advances in technology and changes in customer demand. We cannot predict growth rates or future trends in technology development. It is possible that cable television operators, telecommunications companies or other suppliers of broadband services will decide to adopt alternative architectures or technologies that are incompatible with our current or future products. If we are unable to design, develop, manufacture and sell products that incorporate or are compatible with these new architectures or technologies, our business will suffer. Also, decisions by customers to adopt new technologies or products are often delayed by extensive evaluation and qualifications processes and can result in delays of current products.
In addition, the deregulation, privatization and economic globalization of the worldwide communications market, which resulted in increased competition and escalating demand for new technologies and services, may not continue in a manner favorable to us or our business strategies. In addition, the growth in demand for Internet services and the resulting need for high-speed or enhanced communications products may not continue at its current rate or at all.
Our success depends significantly on Davidi Gilo, our Chairman of the Board and Chief Executive Officer, the loss of whom could seriously harm our business.
Our future success depends in large part on the continued services of our senior management and key personnel. In particular, we are significantly dependent on the services of Davidi Gilo, our Chairman of the Board and Chief Executive Officer. We do not carry key person life insurance on our senior management or key personnel. Any loss of the services of Mr. Gilo or other members of senior management or other key personnel could seriously harm our business.
We may not be able to successfully operate businesses that we may acquire, in a cost-effective and non-disruptive manner and realize anticipated benefits.
We may continue to explore investments in or acquisitions of other companies, products or technologies, including companies or technologies that are not complementary or related to our current wireless broadband access business. We ultimately may be unsuccessful in operating and/or integrating an acquired company’s personnel, operations, products and technologies into our business. These difficulties may disrupt our ongoing business, divert the time and attention of our management and employees and increase our expenses.
Moreover, the anticipated benefits of our acquisition of Xtend or any other acquisition may not be realized or may not be realized in the time period we expect. Future acquisitions could result in dilutive issuances of equity securities, the incurrence of debt, contingent liabilities or amortization expenses related to goodwill and other identifiable intangible assets and the incurrence of large and immediate write-offs, any of which could seriously harm our business. In addition, we expect that we will expend significant resources in searching for and investigating new business opportunities, and may be unsuccessful in acquiring new businesses.
We will need to develop distribution channels and management resources to market and sell our cable products.
Our Spectrum Overlay solutions are at a development stage in the commercialization of our cable products. We currently have limited relationships with potential customers and distributors as well as limited professional sales staff. We will be successful only if we are able to develop distribution channels to market and sell our cable products.
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In order to develop such channels and market and sell our cable products, we will need to continue to build a well-connected team of executives and marketing professionals. Many of these executive and professionals will be based in the United States. It may be difficult for us to hire and retain qualified personnel. Integrating new personnel, particularly U.S. based personnel, may be challenging from a culture and logistics perspective because most of our employees in our Cable Solutions segment are currently based in Israel. Meanwhile, our management has limited experience in the cable industry.
We currently have limited exposure to global business opportunities. We will not be able to take advantage of any meaningful potential global demand for our products unless and until we are able to develop global distribution channels and strategies.
We have not yet produced or deployed our cable products in high volumes.
We have not yet produced our Spectrum Overlay solutions products in high volumes and there may be challenges and unexpected delays, such as quality control issues, in our attempts to increase volume and lower production costs. Our long-term success depends on our ability to produce high quality products at a low cost and, in particular, to reduce the production cost of our cable products designed for residential use.
Because we have not yet deployed our Spectrum Overlay solutions products in high volume, there is significant technology risk associated with any such future deployment. We cannot be sure that any such high volume deployment would be successful.
We will depend on cable and telecommunications industry capital spending for much of our revenue and any decrease or delay in such spending would adversely affect our prospects.
Demand for our products will depend on the size and timing of capital expenditures by telecommunications service providers and MSOs. These capital spending patterns are dependent upon factors including:
· the availability of cash or financing;
· budgetary issues;
· regulation and/or deregulation of the telecommunications industry;
· competitive pressures;
· alternative technologies;
· overall demand for broadband services, particularly relatively new services such as voice over internet protocol (“VoIP”);
· industry standards;
· the pattern of increasing consolidation in the industry; and
· general consumer spending and overall economic conditions.
If MSOs and telecommunications service providers do not make significant capital expenditures, our prospects would be adversely affected.
We will depend on future demand for additional bandwidth by the cable industry and its end customers.
Because our cable products expand available bandwidth over existing infrastructure, demand for these products depends on demand for additional bandwidth by the cable industry and its end customers. The scope and timing of end customer demand for such additional bandwidth is uncertain and hard to predict. The factors influencing this demand include competitive offerings, applications availability, pricing models, costs, regulatory requirements and the success of initial roll-outs. If the future demand for bandwidth is insubstantial, is addressed by alternative technologies or does not develop in the near future, our prospects would be adversely affected.
Our participation or lack of participation in industry standards groups may adversely affect our business.
We are not active in the standards process of the Cable Television Laboratories, Inc., a cable industry consortium that establishes cable technology standards and administers compliance testing. In the future, we may determine to join or not
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join other standards or similar organizations. Our membership in these organizations could dilute our proprietary intellectual property rights in our products while our failure to participate in others could jeopardize acceptance of any of our products that do not meet industry standards.
Product standardization, as may result from wireless industry initiatives or from initiatives of the major cable operators, may adversely affect our prospects.
Product standardization initiatives encouraged by telecommunications companies and cable operators may adversely affect revenues, gross margins and profits. In the past, standardization efforts by major cable operators have negatively impacted equipment vendors by leading to equipment obsolescence, commoditization and reduced margins. If our products are not compliant with future standards, our prospects could be adversely affected.
Since we reduced our workforce in August 2005, our research and development efforts could be harmed.
We implemented a cost reduction program in August 2005 by reducing our workforce. The full implementation of this program resulted in a reduction of our workforce of approximately 16%. This reduction has had the largest effect on our research and development activities. Our ability to further develop and market our products may be limited if we have not accurately predicted the appropriate workforce requirements for our research and development efforts. In this regard, we are currently experiencing some difficulty in hiring skilled research and development personnel in Israel. If this difficulty continues in the foreseeable future, our research and development efforts would be harmed.
Competition may result in lower average selling prices, and we may be unable to reduce our costs at offsetting rates, which may impair our ability to achieve profitability.
There has been significant price erosion in the broadband equipment field. We expect that continued price competition among broadband access equipment and systems suppliers will reduce our gross margins in the future. We anticipate that the average selling prices of broadband access systems will continue to decline as product technologies mature. We may be unable to reduce our manufacturing costs in response to declining average per unit selling prices. Our competitors may be able to achieve greater economies of scale and may be less vulnerable to the effects of price competition than we are. These declines in average selling prices will generally lead to declines in gross margins and total profitability for these systems. If we are unable to reduce our costs to offset declines in average selling prices, we may not be able to achieve or maintain profitability.
Our future growth depends on market acceptance of several emerging broadband services, on the adoption of new broadband technologies and on several other broadband industry trends.
Future demand for our broadband wireless and cable products will depend significantly on the growing market acceptance of several emerging broadband services, including digital video, video-on-demand, high definition television, very high-speed data services and VoIP telephony. The effective delivery of these services will depend in part on a variety of new network architectures, such as fiber-to-the premises networks, video compression standards such as MPEG-4 and Microsoft’s Windows Media 9, the greater use of protocols such as IP and the introduction of new consumer devices, such as advanced set-top boxes and digital video recorders. If adoption of these emerging services and/or technologies is not as widespread or as rapid as we expect, our net sales growth would be materially and adversely affected.
Furthermore, other technological, industry and regulatory trends will affect the growth of our business. These trends include the following:
· convergence, or the desire of certain operators to provide a combination of video, voice and data services to consumers, also known as the “triple play;”
· the use of digital video by businesses and governments;
· the privatization of state owned telecommunication companies in other countries;
· efforts by regulators and governments in the United States and abroad to encourage the adoption of broadband and digital technologies; and
· the extent and nature of regulatory attitudes toward such issues as competition between operators, access by third parties to networks of other operators and new services such as VoIP.
If, for instance, operators do not pursue the triple play as aggressively as we expect, our net sales growth would be materially and adversely affected. Similarly, if our expectations regarding these and other trends are not met, our net sales
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could be materially and adversely affected.
Our quarterly operating results fluctuate, which may cause our share price to decline.
Our quarterly operating results have varied significantly in the past and are likely to vary significantly in the future. These variations result from a number of factors, including:
· the uncertain timing and level of market acceptance for our systems and the uncertain timing and extent of rollouts of broadband access equipment and systems by the major service providers;
· the fact that we often recognize a substantial proportion of our revenues in the last few weeks of each quarter;
· the ability of our existing and potential direct customers to obtain financing for the deployment of broadband access equipment and systems;
· the mix of products sold by us and the mix of sales channels through which they are sold;
· reductions in pricing by us or our competitors;
· global economic conditions;
· the effectiveness of our system integrator customers in marketing and selling their network systems equipment;
· changes in the prices or delays in deliveries of the components we purchase or license; and
· any acquisitions or dispositions we may effect.
A delay in the recognition of revenue, even from one customer, could have a significant negative impact on our results of operations for a given period. Also, because only a small portion of our expenses vary with our revenues, if revenue levels for a quarter fall below our expectations, we would not be able to timely adjust expenses accordingly, which would harm our operating results in that period. We believe that period-to-period comparisons of our results of operations are not meaningful and should not be relied upon as indicators of future performance. If our operating results fall below the expectations of investors in future periods, our share price would likely decline.
Because we operate in international markets, we are exposed to additional risks which could cause our international sales to decline and our foreign operations to suffer.
Our research and development facilities are located in Israel. Our reliance on international sales, operations and suppliers exposes us to foreign political and economic risks, which may impair our ability to generate revenues. These risks include:
· economic, inflation and political instability;
· terrorist acts, international conflicts and acts of war;
· our international customers’ ability to obtain financing to fund their deployments;
· changes in regulatory requirements and licensing frequencies to service providers;
· import or export licensing requirements and tariffs;
· labor shortages or stoppages;
· trade restrictions and tax policies; and
· limited protection of intellectual property rights.
Any of the foregoing difficulties of conducting business internationally could seriously harm our business.
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Conditions in Israel affect our operations and could limit our ability to produce and sell our systems.
Our research and development and final testing and assembly facilities, a majority of our employees and some of our contract manufacturers are located in Israel. Political, economic and military conditions in Israel directly affect our operations. Since the establishment of the State of Israel in 1948, a number of armed conflicts have taken place between Israel and its Arab neighbors and a state of hostility, varying in degree and intensity, has led to security and economic problems for Israel. Hostilities within Israel have dramatically escalated in recent years, which could disrupt our operations. In addition, the recent wars in Iraq and Afghanistan and the current military and political presence of the United States or its allies in Iraq and Afghanistan could cause increasing instability in the Middle East and further disrupt relations between Israel and its Arab neighbors. We could be adversely affected by any major hostilities involving Israel, the interruption or curtailment of trade between Israel and its trading partners, a significant increase in inflation or a significant downturn in the economic or financial condition of Israel. As a result of the hostilities and unrest presently occurring within Israel, Lebanon and the Middle East, the future of the peace efforts between Israel and its Arab neighbors is uncertain. Moreover, several countries still restrict business with Israel and with Israeli companies. We could be adversely affected by restrictive laws or policies directed towards Israel or Israeli businesses.
Our Chief Financial Officer, one of our directors and a majority of our employees are based in Israel, and many of them are currently obligated to perform annual reserve duty and are subject to being called to active duty at any time under emergency circumstances. Recent hostilities in Israel and Lebanon have resulted in the call up of some Israeli reserve units; our personnel could be among those required to serve. We cannot assess the full impact of these requirements on our workforce or business if conditions should change, and we cannot predict the effect on us of any expansion or reduction of these obligations.
Because substantially all of our revenues are generated in U.S. dollars while a portion of our expenses are incurred in New Israeli Shekels, our results of operations could be seriously harmed if the rate of inflation in Israel exceeds the rate of devaluation of the New Israeli Shekel against the U.S. dollar.
Our functional currency is the U.S. dollar. We generate substantially all of our revenues in U.S. dollars, but we incur a substantial portion of our expenses, principally salaries and related personnel expenses related to research and development, in New Israeli Shekels, or NIS. As a result, we are exposed to the risk that the rate of inflation in Israel will exceed the rate of devaluation of the NIS in relation to the dollar or that the timing of this devaluation lags behind inflation in Israel.
Because we generally do not have long-term contracts with our customers, our customers can discontinue purchases of our systems at any time, which could adversely affect future revenues and operating results.
We generally sell our broadband access equipment and systems based on individual purchase orders. Our customers generally are not obligated by long-term agreements to purchase our systems, and the agreements we have entered into, other than our agreement with ANI, do not obligate our customers to purchase a minimum number of systems. Our customers can generally cancel or reschedule orders on short notice and discontinue using our systems at any time. Further, having a successful field system trial does not necessarily mean that the customer will order large volumes of our systems. The reduction, delay or cancellation of orders from one or more of our customers could seriously harm our operating results.
The potential effects of regulatory actions could impact spectrum allocation and frequencies worldwide and cause delays or otherwise negatively impact the growth and development of the broadband market, which would adversely affect our business.
Countries worldwide are considering or are in the process of allocating frequencies for wireless applications, but not all markets have done so. If the United States and/or other countries do not provide sufficient spectrum for wireless applications or reallocate spectrum in the wireless frequency bands for other purposes, our customers may delay or cancel deployments in broadband wireless, which could seriously harm our business. Further, if our customers are unable to obtain licenses or sufficient spectrum in the wireless frequency bands our business could be seriously harmed.
The cable industry is also heavily regulated and changes in the regulatory landscape may adversely affect our business. For example, cable operators are currently required to carry a significant number of analog channels. A reduction or elimination of this requirement may free bandwidth for these operators and reduce the potential market for our products.
Competition may decrease our market share, net revenues and gross margins, which could cause our stock price to decline.
The market for broadband access equipment and systems is intensely competitive, rapidly evolving and subject to rapid technological change. The main competitive factors in our markets include:
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· product performance, features and reliability;
· price;
· stability;
· scope of product line;
· sales and distribution capabilities;
· technical service and support;
· relationships, particularly those with system integrators and operators; and
· industry standards.
Certain of our competitors and potential competitors have substantially greater financial, technical, distribution, marketing and other resources than we have and, therefore, may be able to respond more quickly to new or changing opportunities, technologies and other developments. In addition, many of our competitors have longer operating histories, greater name recognition, broader product lines and established relationships with system integrators and service providers. Our primary competitors are Alvarion Inc.; Aperto Networks, Inc.; NextNet Wireless, Inc.; IP Wireless, Inc.; Navini Networks, Inc.; Wi-LAN Inc.; SR Telecom Inc.; Harris Corporation; Cambridge Wireless Limited; Flarion Technologies Inc. (acquired by Qualcomm Incorporated in January 2006); VCom Inc.; Airspan Networks, Inc.; ZTE Corporation; Scientific Atlanta (purchased by Cisco Systems, Inc. in 2006); Motorola, Inc.; C Cor Incorporated and Narad Networks, Inc. Most of these competitors have existing relationships with one or more of our prospective customers. For our broadband wireless offerings, we face competition from technologies such as digital subscriber line, fiber and cable. In the cable industry, our cable offerings face competition from technologies such as digital set-top boxes, high-end compression technologies and DVRs. Furthermore, the move toward open standards may increase the number of operators who will offer new services, which in turn may increase the number of competitors and drive down the capital expenditures per subscriber deployed. We may not be able to compete successfully against our current and future competitors, and competitive pressures could seriously harm our business.
Hardware defects or firmware errors could increase our costs and impair the market acceptance of our systems, which would adversely affect our future operating results.
Our systems will occasionally contain certain defects or errors. This may result either from defects in components supplied by third parties or from errors or defects in our firmware or hardware that we have failed to detect. We have in the past experienced, and may experience from time to time in the future, defects in new or enhanced products and systems after commencement of commercial shipments, or defects in deployed systems. This may be observed in connection with stability or other performance problems. Our customers integrate our systems into their networks with components from other vendors. Accordingly, when problems occur in a network system, it may be difficult to identify the component that caused the problem. Regardless of the source of these defects or errors, we will need to divert the attention of our engineering personnel from our product development efforts to address the defect or error. We have incurred in the past and may again incur significant warranty and repair costs related to defects or errors, and we also may be subject to liability claims for damages related to these defects or errors. The occurrence of defects or errors, whether caused by our systems or the components of another vendor, may result in significant customer relationship problems and injury to our reputation and may impair the market acceptance of our systems.
We depend on contract manufacturers and third party equipment and technology suppliers, and these manufacturers and suppliers may be unable to fill our orders or develop compatible, required technology on a timely basis, which would result in delays that could seriously harm our results of operations.
We currently have relationships with a limited number of contract manufacturers for the manufacturing of our broadband wireless systems, substantially all of whom are located in Israel and Taiwan. Our cable products are manufactured in Israel by contract manufacturers. These relationships may be terminated by either party with little or no notice. If our manufacturers are unable or unwilling to continue manufacturing our systems in required volumes, we would have to identify qualified alternative manufacturers, which would result in delays that could cause our results of operations to suffer. Our limited experience with these manufacturers does not provide us with a reliable basis on which to project their ability to meet delivery schedules, yield targets or costs. If we are required to find alternative manufacturing sources, we may not be able to satisfy our production requirements at acceptable prices and on a timely basis, if at all. Any significant interruption in supply would affect the allocation of systems to customers, which in turn could seriously harm our business. In addition, we
33
currently have no formal written agreement with a manufacturer for our modem products. Our current inventory of modems will likely be insufficient to fulfill anticipated demand, and we will therefore be required to find a manufacturer in the near future. Our inability to enter into a written agreement with a manufacturer for our modems would harm our business.
In addition to sales to system integrators, we also sell in some instances directly to service providers. Such direct sales require us to resell equipment to service providers manufactured by third party suppliers and to integrate this equipment with the equipment we manufacture. We are particularly dependent on third party radio suppliers in selling our 3.5 Ghz and other products. We currently have no formal relationship with any third party supplier. If we are unable to establish relationships with suppliers, or if these suppliers are unable to provide equipment that meets the specifications of our customers on the delivery schedules required by our customers, and at acceptable prices, our business would be substantially harmed.
Our Spectrum Overlay solutions are implemented over the HFC plant and, as such, they interface and integrate with existing products from multiple other vendors. Future offerings by these vendors may not be sufficiently compatible with our Spectrum Overlay solutions. In addition, we depend on the continuous delivery of components by various manufacturers of electronic connectors, filters, boards and transistors.
We obtain some of the components included in our systems from a single source or a limited group of suppliers, and the loss of any of these suppliers could cause production delays and a substantial loss of revenue.
We currently obtain key components from a limited number of suppliers. Some of these components, such as semiconductor components for our wireless hubs, are obtained from a single source supplier. We generally do not have long-term supply contracts with our suppliers. These factors present us with the following risks:
· delays in delivery or shortages in components could interrupt and delay manufacturing and result in cancellation of orders for our systems;
· suppliers could increase component prices significantly and with immediate effect;
· we may not be able to develop alternative sources for system components, if or as required in the future;
· suppliers could discontinue the manufacture or supply of components used in our systems. In such event, we might need to modify our systems, which may cause delays in shipments, increased manufacturing costs and increased systems prices; and
· we may hold more inventory than is immediately required to compensate for potential component shortages or discontinuation.
The occurrence of any of these or similar events would harm our business.
If we do not effectively manage our costs, our business could be substantially harmed.
We have increased certain expenses to address new business opportunities in both the Wireless Solutions and Cable Solutions segments, and we will need to continue to monitor closely our costs and expenses. If the market and our business do not expand, we may need to further reduce our operations. In addition, our acquisition of Xtend has caused our costs to increase as we seek to develop business.
Delays and shortages in the supply of components from our suppliers and third party vendors could reduce our revenues or increase our cost of revenue.
Delays and shortages in the supply of components are typical in our industry. We have experienced minor delays and shortages on more than one occasion in the past. In addition, any failure of necessary worldwide manufacturing capacity to rise along with a rise in demand could result in our subcontract manufacturers allocating available capacity to larger customers or to customers that have long-term supply contracts in place. Our inability to obtain adequate manufacturing capacity at acceptable prices, or any delay or interruption in supply, could reduce our revenues or increase our cost of revenue and could seriously harm our business.
Third parties may bring infringement claims against us that could harm our ability to sell our products and result in substantial liabilities.
Third parties could assert, and it could be found, that our technologies infringe their proprietary rights. We could incur substantial costs to defend any litigation, and intellectual property litigation could force us to do one or more of the following:
34
· obtain licenses to the infringing technology;
· pay substantial damages under applicable law;
· cease the manufacture, use and sale of infringing products; or
· expend significant resources to develop non-infringing technology.
Any infringement claim or litigation against us could significantly harm our business, operating results and financial condition.
If we fail to adequately protect our intellectual property, we may not be able to compete and our ability to provide unique products may be compromised.
Our success depends in part on our ability to protect our proprietary technologies. We rely on a combination of patent, copyright and trademark laws, trade secrets and confidentiality and other contractual provisions to establish and protect our proprietary rights. Our pending or future patent applications may not be approved and the claims covered by such applications may be reduced. If allowed, our patents may not be of sufficient scope or strength, and others may independently develop similar technologies or products. Litigation, which could result in substantial costs and diversion of our efforts, may also be necessary to enforce any patents issued or licensed to us or to determine the scope and validity of third party proprietary rights. Any such litigation, regardless of the outcome, could be expensive and time consuming, and adverse determinations in any such litigation could seriously harm our business.
Similarly, our pending or future trademark applications may not be approved and may not be sufficient to protect our trademarks in the markets where we either do business or hope to conduct business. The inability to secure any necessary trademark rights could be costly and could seriously harm our business.
We regularly evaluate and seek to explore and develop derivative products relating to the systems of our Wireless Solutions and Cable Solutions segments. We may not be able to secure all desired intellectual property protection relating to such derivative products. Furthermore, because of the rapid pace of change in the broadband industry, much of our business and many of our products rely on technologies that evolve constantly and this continuing uncertainty makes it difficult to forecast future demand for our products.
Because of our long product development process and sales cycle, we may incur substantial expenses without anticipated revenues that could cause our operating results to fluctuate.
A customer’s decision to purchase our products typically involves a significant technical evaluation, formal internal procedures associated with capital expenditure approvals and testing and acceptance of new systems that affect key operations. For these and other reasons, the sales cycle associated with our systems can be lengthy and subject to a number of significant risks, over which we have little or no control. Because of the growing sales cycle and the likelihood that we may rely on a small number of customers for our revenues, our operating results could be seriously harmed if such revenues do not materialize when anticipated, or at all.
Government regulation and industry standards may increase our costs of doing business, limit our potential markets or require changes to our business model and adversely affect our business.
The emergence or evolution of regulations and industry standards for broadband products, through official standards committees or widespread use by operators, could require us to modify our systems, which may be expensive and time-consuming, and to incur substantial compliance costs. Radio frequencies are subject to extensive regulation under the laws of the United States, foreign laws and international treaties. Each country has different regulations and regulatory processes for wireless communications equipment and uses of radio frequencies. Failure by the regulatory authorities to allocate suitable, sufficient radio frequencies to potential customers in a timely manner could result in the delay or loss of potential orders for our systems and seriously harm our business.
We are subject to export control laws and regulations with respect to certain of our products and technology. We are subject to the risk that more stringent export control requirements could be imposed in the future on product classes that include products exported by us, which would result in additional compliance burdens and could impair the enforceability of our contract rights. We may not be able to renew our export licenses as necessary from time to time. In addition, we may be required to apply for additional licenses to cover modifications and enhancements to our products. Any revocation or expiration of any requisite license, the failure to obtain a license for product modifications and enhancements, or more stringent export control requirements could seriously harm our business.
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We are incurring additional costs and devoting more management resources to comply with increasing regulation of corporate governance and disclosure.
The Sarbanes Oxley Act of 2002 that became law in July 2002 and the resulting rules of the Nasdaq Global Market have required and will continue to require changes in our corporate governance, public disclosure and compliance practices. The number of rules and regulations applicable to us has increased and will continue to increase our legal and financial compliance costs. In addition, we have incurred and will continue to incur significant costs as we prepare to comply with Section 404 of the Sarbanes Oxley Act of 2002 regarding internal control over financial reporting. These laws and regulations and perceived increased risk of liability could make it more difficult for us to attract and retain qualified members of our Board of Directors, particularly to serve on our audit committee, and qualified executive officers. We cannot estimate the timing or magnitude of additional costs we may incur as a result.
In addition to the increased costs discussed above, we are spending an increased amount of management time and internal resources to understand and comply with these changing laws, regulations and standards relating to corporate governance and public disclosure. Allocating the necessary resources to comply with evolving corporate governance and public disclosure standards has increased general and administrative expenses and caused a diversion of management time and attention to compliance activities.
Recent regulations related to equity compensation could adversely affect earnings, affect our ability to raise capital and affect our ability to attract and retain key personnel.
Since our inception, we have used stock options as a fundamental component of our employee compensation packages. We believe that our stock option plans are an important tool to link the long-term interests of stockholders and employees, especially executive management, and serve to motivate management to make decisions that will, in the long run, give the best returns to stockholders. FASB has adopted changes to U.S. GAAP that require us to record a charge to earnings for employee stock option grants, as well as other equity based awards. The change has negatively impacted our earnings and, if such impact is material in the future, could affect our ability to raise capital on acceptable terms. In addition, regulations implemented by the Nasdaq Global Market requiring stockholder approval for all stock option plans could make it more difficult for us to grant stock options to employees in the future. To the extent these new regulations make it more difficult or unacceptably expensive to grant stock options to employees, we may incur increased compensation costs, change our equity compensation strategy or find it difficult to attract, retain and motivate employees, each of which could materially and adversely affect our business.
The government programs and benefits we receive require us to satisfy prescribed conditions. These programs and benefits may be terminated or reduced in the future, which would increase our costs and taxes and could seriously harm our business.
Certain of our capital investments have been granted “approved enterprise” status under Israeli law providing us with certain Israeli tax benefits. The benefits available to an approved enterprise are conditioned upon the fulfillment of conditions stipulated in applicable law and in the specific certificate of approval. If we fail to comply with these conditions, in whole or in part, we may be required to pay additional taxes for the period in which we enjoyed the tax benefits and would likely be denied these benefits in the future. From time to time, the government of Israel has considered reducing or eliminating the benefits available under the approved enterprise program. These tax benefits may not be continued in the future at their current levels or at all. The termination or reduction of these benefits would increase our taxes and could seriously harm our business. As of the date hereof, our Israeli subsidiaries, Vyyo Ltd. and Xtend, have accumulated loss carry forwards for Israeli tax purposes and therefore have not enjoyed any tax benefits under current approved enterprise programs.
In the past, we have received grants from the government of Israel for the financing of a portion of our research and development expenditures for previous products in Israel. The regulations under which we received these grants restrict our ability to manufacture products or transfer technology outside of Israel for products developed with this technology. Furthermore, these grants may not be available to us in the future.
As of April 1, 2005, the government of Israel eliminated the ability of companies to submit new applications for approved enterprise status. This change in the government policy may hinder us in the future with respect to any benefits we may have received for new undertakings which would have been entitled to “approved enterprise” status.
A majority of our directors and certain officers have relationships with Davidi Gilo and his affiliated companies that could be deemed to limit their independence.
A majority of our Board of Directors, Lewis Broad, Neill Brownstein, Avraham Fischer, Samuel Kaplan and Alan Zimmerman and certain of our officers, have had professional relationships with Davidi Gilo, our Chief Executive Officer
36
and Chairman of the Board, and his affiliated companies for several years. These members of our Board of Directors previously served on the boards of directors of DSP Communications, Inc. and/or DSP Group, Inc., of which Mr. Gilo was formerly the controlling stockholder and the Chairman of the Board. In addition, Avraham Fischer is a senior partner of the law firm of Fischer, Behar, Chen & Co., which represents us on matters relating to Israeli law, and is an investor and co-Chief Executive Officer of an Israeli investor group in which Mr. Gilo was an investor until October 2005. There are no family relationships between these directors and officers, and no member of our compensation committee serves as a member of the Board of Directors or compensation committee of any entity that has one or more executive officers serving as a member of our Board of Directors or compensation committee. However, the long-term relationships between these directors and officers and Mr. Gilo and his affiliated companies could be considered to limit their independence.
Because our management has the ability to control stockholder votes, the premium over market price that an acquirer might otherwise pay could be reduced and any merger or takeover could be delayed.
As of June 30, 2006, our management collectively owned approximately 31.1% of our outstanding common stock (based on the number of shares owned by these individuals and the number of shares issuable upon exercise of options within 60 days of June 30, 2006).
As a result, these stockholders, acting together, will be able to control the outcome of all matters submitted for stockholder action, including:
· electing members to our Board of Directors;
· approving significant change-in-control transactions;
· determining the amount and timing of dividends paid to themselves and to our public stockholders; and
· controlling our management and operations.
This concentration of ownership may have the effect of impeding a merger, consolidation, takeover or other business consolidation involving us, or discouraging a potential acquirer from making a tender offer for our shares. This concentration of ownership could also negatively affect our stock’s market price or decrease any premium over market price that an acquirer might otherwise pay.
We rely on a continuous power supply to conduct our operations, and any electrical or natural resource crisis could disrupt our operations and increase our expenses.
We rely on a continuous power supply for manufacturing and to conduct our business operations. Interruptions in electrical power supplies occur around the world from time to time. Meanwhile, prices of the resources, such as electrical power and crude oil, upon which we ultimately rely, directly or indirectly, in running our business have been volatile. Power shortages, as have occurred in California and China, could disrupt our manufacturing and business operations and those of many of our suppliers, and could cause us to fail to meet production schedules and commitments to customers and other third parties. Any disruption to our operations or those of our suppliers could result in damage to our current and prospective business relationships and could result in lost revenue and additional expenses, thereby harming our business and operating results.
Because the Nasdaq Global Market is likely to continue to experience extreme price and volume fluctuations, the price of our stock may decline.
The market price of our shares has been and likely will continue to be highly volatile and could be subject to wide fluctuations in response to numerous factors, including the following:
· actual or anticipated variations in our quarterly operating results or those of our competitors;
· announcements by us or our competitors of new products or technological innovations;
· introduction and adoption of new industry standards;
· changes in financial estimates or recommendations by securities analysts;
· �� changes in the market valuations of our competitors;
· announcements by us or our competitors of significant acquisitions or partnerships; and
37
· sales of our common stock.
Many of these factors are beyond our control and may negatively impact the market price of our common stock, regardless of our performance. In addition, the stock market in general, and the market for technology and telecommunications related companies in particular, have been highly volatile. Our common stock may not trade at the same levels compared to shares of other technology companies and shares of technology companies, in general, may not sustain their current market prices. In the past, securities class action litigation has often been brought against a company following periods of volatility in the market price of its securities. We could become the target of similar litigation in the future. Securities litigation could result in substantial costs and divert management’s attention and resources, which could seriously harm our business and operating results.
Provisions of our governing documents and Delaware law could discourage acquisition proposals or delay a change in control.
Our Fourth Amended and Restated Certificate of Incorporation and Amended and Restated Bylaws contain anti-takeover provisions that could make it more difficult for a third party to acquire control of us, even if that change in control would be beneficial to stockholders. Specifically:
· our Board of Directors has the authority to issue common stock and preferred stock and to determine the price, rights and preferences of any new series of preferred stock without stockholder approval;
· our Board of Directors is divided into three classes, each serving three-year terms;
· super majority voting is required to amend key provisions of our Fourth Amended and Restated Certificate of Incorporation and Amended and Restated Bylaws;
· there are limitations on who can call special meetings of stockholders;
· stockholders are not able to take action by written consent; and
· advance notice is required for nominations of directors and for stockholder proposals.
In addition, provisions of Delaware law and our stock option plans may also discourage, delay or prevent a change of control or unsolicited acquisition proposals.
It may be difficult to enforce a judgment in the United States against us and our nonresident Chief Financial Officer and certain directors.
Our Chief Financial Officer and two of our directors are not residents of the United States, and a substantial portion of our assets and the assets of these persons are located outside the United States. Therefore, it may be difficult to enforce a judgment obtained in the United States based upon the civil or criminal liabilities provisions of the United States federal securities laws against us or any of those persons or to effect service of process upon these persons in the United States.
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Item 4. Submission of Matters to a Vote of Security Holders
We held our annual meeting of stockholders on May 8, 2006. At the annual meeting, the following matters were voted upon and approved by the stockholders:
(a) The election of three Class III Directors to serve for a three-year term until the 2009 annual meeting of stockholders. The results were as follows:
Nominee |
| For |
| Withheld |
|
Ronn Benatoff |
| 14,780,531 |
| 16,548 |
|
Samuel L. Kaplan |
| 14,780,431 |
| 16,648 |
|
Alan L. Zimmerman |
| 14,734,357 |
| 62,722 |
|
The following persons also continue to serve as directors: Davidi Gilo, Lewis S. Broad, Neill H. Browstein, Avraham Fischer and John P. Griffin.
(b) Ratification of the appointment of Kesselman & Kesselman CPAs (ISR), a member of PricewaterhouseCoopers International Limited, as the independent registered public accounting firm for the year ending December 31, 2006. The results were as follows:
For: |
| 14,790,572 |
Against: |
| 2,232 |
Abstain: |
| 4,275 |
No Votes: |
| 0 |
Exhibit |
| Exhibit Description |
|
|
|
3.1 |
| Fourth Amended and Restated Certificate of Incorporation. Previously filed as an exhibit to our Quarterly Report on Form 10-Q for the period ended March 31, 2005, and incorporated herein by reference. |
|
|
|
3.2 |
| Amended and Restated Bylaws. Previously filed as an exhibit to our Registration Statement on Form S-1 (File No. 333-96129), and incorporated herein by reference. |
|
|
|
4.1 |
| Reference is made to Exhibits 3.1 and 3.2 above. |
|
|
|
10.1 |
| First Amendment to Lease between Xtend Networks Inc. and I&G Peachtree Corners, L.L.C., dated as of July 17, 2006. |
|
|
|
10.2 |
| Guaranty of Vyyo Inc., dated as of July 17, 2006. |
|
|
|
31.1 |
| Certificate of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
|
|
|
31.2 |
| Certificate of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
|
|
|
32.1 |
| Certificate of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
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Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
| Date: August 14, 2006 |
| |
|
|
| |
|
|
| |
| VYYO INC. |
| |
|
|
| |
|
|
| |
| By: | /s/ Davidi Gilo |
|
|
| Davidi Gilo, Chief Executive Officer |
|
|
| (Duly Authorized Officer) |
|
|
|
| |
|
|
| |
| By: | /s/ Arik Levi |
|
|
| Arik Levi, Chief Financial Officer |
|
|
| (Duly Authorized Officer and Principal Financial Officer) |
|
40
Exhibit |
| Exhibit Description |
|
|
|
3.1 |
| Fourth Amended and Restated Certificate of Incorporation. Previously filed as an exhibit to our Quarterly Report on Form 10-Q for the period ended March 31, 2005, and incorporated herein by reference. |
|
|
|
3.2 |
| Amended and Restated Bylaws. Previously filed as an exhibit to our Registration Statement on Form S-1 (File No. 333-96129), and incorporated herein by reference. |
|
|
|
4.1 |
| Reference is made to Exhibits 3.1 and 3.2 above. |
|
|
|
10.1 |
| First Amendment to Lease between Xtend Networks Inc. and I&G Peachtree Corners, L.L.C., dated as of July 17, 2006. |
|
|
|
10.2 |
| Guaranty of Vyyo Inc., dated as of July 17, 2006. |
|
|
|
31.1 |
| Certificate of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
|
|
|
31.2 |
| Certificate of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
|
|
|
32.1 |
| Certificate of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
41