1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended
June 30, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ...... to ...... .
Commission file number 0-26820
- --------------------------------------------------------------------------------
TERA COMPUTER COMPANY
(Exact name of registrant as specified in its charter)
- --------------------------------------------------------------------------------
WASHINGTON 93-0962605
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
411 FIRST AVENUE SOUTH, SUITE 600
SEATTLE, WA 98104-2860
(206) 701 - 2000
(Address of principal executive offices)
(Registrant's telephone number, including area code)
----------------------------------------
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 X No
----- -----
As of August 12, 1999, 23,797,854 shares of the Company's Common Stock,
par value $0.01 per share, were outstanding.
2
TERA COMPUTER COMPANY
TABLE OF CONTENTS
Page No.
--------
PART I FINANCIAL INFORMATION
Item 1. Financial Statements:
Balance Sheets as of December 31, 1998
and June 30, 1999 3
Statements of Operations for the Three Months
and Six Months Ended June 30, 1998 and 1999 4
Statements of Shareholders' Equity for the Three
Months Ended March 31, 1999, and June 30, 1999 5
Statements of Cash Flows for the Six Months
Ended June 30, 1998 and 1999 6
Notes to Financial Statements 7
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 9
Item 3. Quantitative and Qualitative Disclosures about
Market Risk 25
PART II OTHER INFORMATION
Item 2. Changes in Securities 26
Item 4. Submission of Matters to a Vote of Security Holders 28
Item 6. Exhibits and Reports on Form 8-K 29
2
3
TERA COMPUTER COMPANY
BALANCE SHEETS
December 31, June 30,
1998 1999
(unaudited)
------------- -------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 3,161,867 $ 25,876,499
Accounts receivable 378,933 290,983
Related party receivable 306,819 324,772
Inventory 10,246,029 9,221,984
Advances to suppliers 415,834 466,946
Prepaid expenses and other assets 585,008 443,304
------------- -------------
Total current assets 15,094,490 36,624,488
PROPERTY AND EQUIPMENT, NET 4,501,613 5,523,143
LEASE DEPOSITS 537,101 537,101
PATENTS 155,033 183,704
------------- -------------
TOTAL $ 20,288,237 $ 42,868,436
============= =============
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 5,470,617 $ 4,064,330
Accrued payroll and related expenses 1,544,056 1,731,183
Accrued private placement expenses 1,190,000
Accrued interest 10,536
Deferred revenue 19,178 60,917
Contract adjustment reserve 250,000 250,000
Current portion of obligations under capital leases 542,045 575,841
------------- -------------
Total current liabilities 7,825,896 7,882,807
OBLIGATIONS UNDER CAPITAL LEASES 573,054 409,474
CONVERTIBLE NOTES PAYABLE, NET OF DISCOUNT 430,591
SHAREHOLDERS' EQUITY:
Preferred Stock, par $.01 - Authorized, 5,000,000 shares; issued
and outstanding, 6,000 and 0 shares of Series B Convertible 5,674,406
Common Stock, par $.01 - Authorized, 50,000,000 shares;
issued and outstanding, 14,204,430 and 23,747,891 shares 68,744,437 110,233,108
Preferred stock dividend distributable 75,000
Accumulated deficit (62,604,556) (76,087,544)
------------- -------------
11,889,287 34,145,564
------------- -------------
TOTAL $ 20,288,237 $ 42,868,436
============= =============
See accompanying notes
3
4
TERA COMPUTER COMPANY
STATEMENTS OF OPERATIONS
(unaudited)
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
1998 1999 1998 1999
------------ ------------ ------------ ------------
REVENUE:
Product and other revenue $ 1,244,322 $ 22,094 $ 1,244,322 $ 601,261
Service revenue 282,281 238,283 303,233 319,709
------------ ------------ ------------ ------------
1,526,603 260,377 1,547,555 920,970
------------ ------------ ------------ ------------
OPERATING EXPENSES:
Cost of product and other revenue 1,195,747 21,325 1,195,747 600,758
Cost of service revenue 233,397 121,266 249,270 162,672
Manufacturing costs and inventory adjustments 1,642,632 4,038,377
Research and development 3,561,256 3,710,786 7,874,557 6,791,745
Marketing and sales 374,339 545,150 784,389 1,177,629
General and administrative 504,830 637,668 980,235 1,102,726
------------ ------------ ------------ ------------
5,869,569 6,678,827 11,084,198 13,873,907
------------ ------------ ------------ ------------
RESEARCH FUNDING 48,262 24,571 75,783 72,197
------------ ------------ ------------ ------------
Loss from operations (4,294,704) (6,393,879) (9,460,860) (12,880,740)
OTHER INCOME/(EXPENSE) (4,381) (277,842) 100,318 (602,248)
------------ ------------ ------------ ------------
NET LOSS (4,299,085) (6,671,721) (9,360,542) (13,482,988)
PREFERRED STOCK DIVIDEND (94,287) (45,284) (224,311) (115,341)
------------ ------------ ------------ ------------
LOSS FOR COMMON STOCK $ (4,393,372) $ (6,717,005) $ (9,584,853) $(13,598,329)
============ ============ ============ ============
LOSS PER COMMON SHARE,
BASIC AND DILUTED $ (0.37) $ (0.40) $ (0.83) $ (0.87)
============ ============ ============ ============
WEIGHTED AVERAGE SHARES
OUTSTANDING, BASIC AND DILUTED 11,755,569 16,677,106 11,545,504 15,696,137
============ ============ ============ ============
See accompanying notes
4
5
TERA COMPUTER COMPANY
STATEMENTS OF SHAREHOLDERS' EQUITY
(unaudited)
Series B Convertible
Preferred Stock Common Stock
---------------------- ------------------------ Preferred
Number of Number of Stock Accumulated
Shares Amount Shares Amount Dividend Deficit Total
--------- ----------- ---------- ------------ -------- ------------ -----------
BALANCE, January 1, 1999 6,000 $ 5,674,406 14,204,430 $ 68,744,437 $ 75,000 $(62,604,556) $11,889,287
Exercise of stock options 83,578 29,480 29,480
Issuance of shares under Employee
Stock Purchase Plan 24,109 144,729 144,729
Common stock issued in
private placement, net of
issuance costs of $115,457 1,225,000 4,884,543 4,884,543
Conversion of Series B preferred shares (1,619) (1,689,058) 350,498 1,634,296 (54,762)
Issuance of common stock for
accrued dividends 13,332 75,000 (75,000)
Beneficial conversion feature in
notes & interest expense recognized
on convertible warrants 594,623 594,623
Preferred stock dividend distributable 54,762 54,762
Net loss (6,811,267) (6,811,267)
------ ----------- ---------- ------------ -------- ------------ -----------
BALANCE, March 31, 1999 4,381 3,985,348 15,900,947 76,107,108 54,762 (69,415,823) 10,731,395
Exercise of stock options 6,096 2,135 2,135
Options issued for services 69,000 69,000
Conversion of Series B preferred shares (4,381) (3,985,348) 937,335 3,985,348
Issuance of common stock for
accrued dividends 9,735 54,762 (54,762)
Common stock issued in
private placement, net of
issuance costs of $1,190,000 6,460,193 27,968,234 27,968,234
Common stock issued in
exchange for notes 433,585 2,046,521 2,046,521
Net loss (6,671,721) (6,671,721)
------ ----------- ---------- ------------ -------- ------------ -----------
BALANCE, June 30, 1999 $ 23,747,891 $110,233,108 $ $(76,087,544) $34,145,564
====== =========== ========== ============ ======== ============ ===========
See accompanying notes
5
6
TERA COMPUTER COMPANY
STATEMENTS OF CASH FLOWS
(unaudited)
SIX MONTHS ENDED
June 30,
1998 1999
------------ ------------
OPERATING ACTIVITIES:
Net loss $ (9,360,542) $(13,482,988)
Adjustments to reconcile net loss to
net cash used by operating activities:
Depreciation and amortization 499,740 885,129
Beneficial conversion feature of notes payable 530,923
Cash provided (used) by changes in
operating assets and liabilities:
Accounts receivable (86,544) 87,950
Inventory (1,325,967) (8,062)
Other assets (82,798) 113,033
Accounts payable and other accrued liabilities 517,100 (732,460)
Accrued payroll and related expenses (121,654) 187,127
Deferred revenue 49,178 41,739
Advances to suppliers (19,539) (51,112)
------------ ------------
Net cash used by operating activities (9,931,026) (12,428,721)
INVESTING ACTIVITIES:
Purchases of property and equipment (983,202) (710,432)
------------ ------------
Net cash used by investing activities (983,202) (710,432)
FINANCING ACTIVITIES:
Related party (receivable)/payments 71,720 (17,953)
Issuance of notes payable 1,900,000
Sale of common stock 589,719 34,069,906
Proceeds from exercise of options 31,616
Sale of preferred stock 5,674,406
Capital leases, net 198,997 (129,784)
------------ ------------
Net cash provided by financing activities 6,534,842 35,853,785
NET INCREASE (DECREASE) IN CASH
AND CASH EQUIVALENTS (4,379,386) 22,714,632
CASH AND CASH EQUIVALENTS:
Beginning of period 13,329,115 3,161,867
------------ ------------
End of period $ 8,949,729 $ 25,876,499
============ ============
SUPPLEMENTAL DISCLOSURE OF
NON CASH INVESTING AND FINANCING
ACTIVITIES:
Inventory reclassed to fixed assets $ 1,032,107
Fixed asset additions through common stock $ 164,120
Notes payable converted to common stock $ 2,000,000
Accounts payable converted to notes $ 594,291
Stock dividends $ 154,189 $ 54,762
SUPPLEMENTAL DISCLOSURE OF
CASH FLOW INFORMATION:
Cash paid for interest $ 73,480 $ 86,887
See accompanying notes
6
7
TERA COMPUTER COMPANY
NOTES TO FINANCIAL STATEMENTS
(unaudited)
BASIS OF PRESENTATION
In the opinion of management, the accompanying balance sheets and
related interim statements of operations, shareholders' equity and cash flows
have been prepared in accordance with generally accepted accounting principles
for interim financial information and with the instructions to Form 10-Q and
Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the
information and footnotes required by generally accepted accounting principles
for complete financial statements. All adjustments considered necessary for fair
presentation have been included. Interim results are not necessarily indicative
of results for a full year. The information included in this Form 10-Q should be
read in conjunction with Management's Discussion and Analysis and the financial
statements and notes thereto included in the Company's financial statements for
the years ended December 31, 1997 and 1998, contained in the Company's Annual
Report on Form 10-K/A for the fiscal year ended December 31, 1998.
INVENTORY
Inventory consisted of the following:
December 31, 1998 June 30, 1999
----------------- -------------
Components and Subassemblies $ 9,346,646 $8,745,381
Work in process 252,000
Finished goods 922,501 1,360,823
Inventory allowance (275,118) (884,220)
----------- ----------
$10,246,029 $9,221,984
=========== ==========
CHANGES IN CAPITAL
On June 21, 1999, the Company raised $30,292,120, prior to fees and
expenses estimated at approximately $1,190,000 and including subscribed stock of
$1,070,000, from the private sale of 6,417,820 shares of common stock, and
42,373 shares of common stock issued in payment of certain additional fees,
along with warrants to purchase 6,417,820 shares of common stock with an
exercise price of $4.72 per share.
On or before June 18, 1999, all of the outstanding Series B Convertible
Preferred Stock were converted into shares of common stock.
7
8
In June, 1999, convertible promissory notes in the principal amount of
$2,000,000 were exchanged for 433,585 shares of common stock. As part of that
exchange, the noteholders surrendered certain warrants for 60,000 shares of
common stock for warrants to purchase 433,585 shares of common stock exercisable
at $4.72 per share.
In June, 1999, the Company issued additional warrants with an exercise
price of $4.72 to purchase an aggregate of 1,772,015 shares of common stock in
exchange for certain investors surrendering rights to receive additional shares
of common stock pursuant to certain options and "reset" rights.
See Part II, Item 2, for further information concerning these changes.
MANUFACTURING COSTS AND INVENTORY ADJUSTMENTS
In the third quarter of 1998, we began incurring manufacturing expenses
reflecting our progress to commercial production. These costs reflect the
expense of our manufacturing group, including personnel costs and allocated
overhead, production expenses not directly related to delivered systems, and
inventory adjustments, including revaluations and cost variations because of
changes in production yields, inventory obsolescences, inventory consumed in the
manufacturing process and capitalized manufacturing labor and overhead costs.
NET LOSS PER SHARE
Net loss per share is computed on the basis of the weighted average
number of shares of common stock outstanding. Because outstanding stock options,
warrants and other common stock equivalent shares are antidilutive, their effect
has not been included in the calculation of net loss per share.
8
9
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
PRELIMINARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
The information set forth in this Item 2 includes forward-looking
statements within the meaning of Section 27A of the Securities Act of 1933, as
amended, and Section 21E of the Securities Exchange Act, as amended, and is
subject to the safe harbor created by those sections. Factors that realistically
could cause results to differ materially from those projected in the
forward-looking statements are set forth under "Risk Factors" beginning on page
15. The following discussion should also be read in conjunction with the
Financial Statements and Notes thereto.
OVERVIEW
We design, develop and market high performance general purpose parallel
computer systems. The name for our computer systems, "MTA," is derived from the
form of computer system architecture on which it is based, known in the computer
industry as "multithreaded" architecture.
We have experienced net losses in each year of operations and expect to
incur substantial further losses until we make additional sales, and possibly
thereafter. We incurred net losses of approximately $15.8 million in 1997, $19.8
million in 1998 and $13.5 million in the first six months of 1999, compared to a
net loss of approximately $9.4 million in the first half of 1998. Our funding
from inception through June 30, 1999 has been primarily from the sale of
approximately $110.2 million of securities, research funding from the Defense
Advanced Research Projects Agency ("DARPA") of approximately $19.6 million, and
revenue of approximately $2.9 million.
In April 1998, we recognized our first revenue from product sales with
our delivery of a two-processor MTA system to the San Diego Supercomputer Center
("SDSC"). In January 1999, we recognized additional revenue from product sales
upon acceptance by SDSC of our upgrade of the MTA system at SDSC to four
processors. We delivered a further upgrade of the MTA system at SDSC to eight
processors in the second quarter of 1999, which SDSC accepted in July 1999.
Assuming receipt of purchase orders, we plan to upgrade the MTA system at SDSC
in stages to larger configurations as we receive production printed circuit
boards, integrated circuits and other components that we are able to integrate
into a commercially acceptable system. SEE "RISK FACTORS" BELOW BEGINNING ON
PAGE 15.
We generally recognize revenue from sales of MTA systems upon acceptance
of the system by the customer, although depending on sales contract terms,
revenue may be recognized upon shipment or delayed until clarification of
funding. We recognize
9
10
revenue from the maintenance of the MTA system ratably over the term of each
maintenance agreement, and service revenue as services are performed.
RESULTS OF OPERATIONS
THREE AND SIX MONTHS ENDED JUNE 30, 1998 AND 1999
REVENUE. We had revenue for the three months ended June 30, 1999, of
$260,000 compared to $1.5 million for the three months ended June 30, 1998; for
the respective six months periods, our revenues were $921,000 in 1999 compared
to $1.5 million in 1998. In the second quarter of 1998, we recognized $1.2
million upon the sale of a two-processor MTA system to SDSC, and in the first
quarter of 1999 we recognized $557,000 of revenue upon the upgrade of the MTA
system at SDSC to four processors. We had $238,000 and $320,000 of service
revenue for the three and six months ended June 30, 1999, compared to $282,000
and $303,000 for the three and six months ended June 30, 1998. Service revenue
was pursuant to a subcontract with SDSC to evaluate multithreaded architecture
for certain defense applications; this subcontract recently expired.
OPERATING EXPENSES. Our cost of product and other revenue decreased from
$1.2 million for the three months and six months ended June 30, 1998 to $21,000
for the three months ended June 30, 1999, and $601,000 for the six months ended
June 30, 1999. These revenues relate to the acceptances by SDSC of the
two-processor MTA system in the second quarter of 1998 and of the four-processor
MTA system in the first quarter of 1999. Our cost of product and other revenue
was high as a percentage of the revenue in all periods due to favorable pricing
terms provided to SDSC.
The cost of service revenue for the three months ended June 30, 1999,
was $121,000 compared to $233,000 for the three months ended June 30, 1998, and
$163,000 for the six months ended June 30, 1999, compared to $249,000 for the
six months ended June 30, 1998. The decrease in the second quarter of 1999 is
due to a decline in billings from our subcontractors.
Manufacturing costs and inventory adjustments were $1.6 million and $4.0
million for the three and six months ended June 30, 1999; although these costs
were classified as part of our research and development expenses in the first
half of 1998, we estimate that, if these costs had been separately reported,
they would have been approximately $1.2 million and $2.7 million for the three
and six months ended June 30, 1998. These costs reflect the expense of our
manufacturing group, including personnel costs and allocated overhead, of
approximately $816,000 and $1.8 million for the three and six months ended June
30, 1999, compared to an estimate of $590,000 and $1.1 million for the three and
six months ended June 30, 1998. The increase in both 1999
10
11
periods is due to increased personnel costs, which increased $18,000 in the
second quarter and $240,000 in the six month periods, and increased overhead
from the move to our new facilities in Seattle at the beginning of 1999, which
increased $209,000 in the second quarter and $431,000 in the six months ended
June 30, 1999, over the corresponding 1998 periods.
We also incurred production expenses not directly related to systems
delivered to SDSC of $110,000 and $359,000 for the three and six months ended
June 30, 1999, compared to an estimate of $184,000 and $419,000 for the six
months ended June 30, 1998, and net inventory adjustments of $716,000 and $1.9
million for the three and six months ended June 30, 1999, compared to estimates
$398,000 and $1.2 million for the three and six months ended June 30, 1998.
Research and development expenses reflect our costs associated with the
development of the MTA system, including the next generation system and related
software development; these expenses cover personnel expense, allocated
overhead, software, materials, and engineering expenses, including payments to
third parties. In the first half of 1998, research and development expenses also
included our manufacturing costs and inventory adjustments described above.
Research and development expenses increased from $3.6 million to $3.7 million
for the respective second quarters; for the first six months of 1998 and 1999,
they decreased from $7.9 million to $6.8 million. If the estimated manufacturing
costs and inventory adjustments described above are considered, however, then
research and development expenses increased from $2.4 million to $3.7 million in
the second quarter of 1998 to the second quarter of 1999, and increased from
$5.2 million to $6.8 million for the six months ended June 30, 1998 and 1999.
The increase in both 1999 periods is due in part to increased personnel expense
of $308,000 and $765,000, due to increase in personnel and higher wages, and
increased allocated costs of $319,000 and $803,000, primarily due to increased
overhead from the move to our new facilities in Seattle at the beginning of
1999.
Engineering expenses decreased slightly from $1.3 million for the six
months ended June 30, 1998, to approximately $1.0 million for the six months
ended June 30, 1999. We expect these expenses to increase in the second half of
1999 as we continue to migrate our integrated circuits from gallium arsenide to
CMOS (complementary metal-oxide silicon).
Marketing and sales expenses for the three months ended June 30, 1999,
increased 46% to $545,000 from $374,000 for the three months ended June 30,
1998. Marketing and sales expenses for the six months ended June 30, 1999,
increased 50% to $1.2 million from $784,000 for the six months ended June 30,
1998. The increase in both periods was due to increased personnel costs of
$36,000 and $85,000 for the three and six months ended June 30, 1999, over the
corresponding 1998 periods, and increased allocations during the respective 1999
periods of $135,000 and $308,000. We expect that
11
12
we will continue to increase our marketing and sales activities as we build
larger MTA systems for sale to industrial and commercial customers.
General and administrative expenses for the three months ended June 30,
1999, increased 26% to $638,000 from $505,000 for the three months ended June
30, 1998. General and administrative expenses for the six months ended June 30,
1999, increased 12% to $1.1 million from $980,000. The increase for both periods
was due to increased personnel costs of $32,000 and $64,000 for the three and
six month periods ending June 30, 1999, compared to the corresponding 1998
periods, and increased overhead allocations and other expenses of $101,000 and
$59,000 in the 1999 periods, including our move to our new facilities in Seattle
at the beginning of 1999. The lower amount for the six months is largely due to
lower expenditures in the first quarter of 1999 for legal, accounting and other
expenditures related to being a publicly held company. General and
administrative expenses are expected to increase commensurate with growth in our
operations.
RESEARCH FUNDING. We have been billing DARPA under a $1 million research
contract awarded in September 1995 and which expires in September 1999. For the
three months ended June 30, 1999, billings were approximately $25,000, a
decrease from $48,000 for the three months ended June 30, 1998. For the six
months ended June 30, 1999, billings were $72,000, a decrease from $76,000 for
the six months ended June 30, 1998.
OTHER INCOME (EXPENSE). Interest income for the three months ended June
30, 1999 decreased 21% to $50,000 from $64,000 for the three months ended June
30, 1998. Interest income for the six months ended June 30, 1999 decreased 61%
to $77,000 from $199,000 for the six months ended June 30, 1998. The decrease in
interest income for both 1999 periods is due to higher average cash balances in
the first half of 1998 from a financing completed in December 1997.
Interest expense for the three months ended June 30, 1999 increased 28%
to $87,000 from $68,000 for the three months ended June 30, 1998. Interest
expense for the six months ended June 30, 1999 increased 39% to $136,000 from
$98,000 for the six months ended June 30, 1998. The increase in interest expense
for both periods is due to promissory notes issued in a financing in the first
quarter of 1999.
The results for the first half of 1999 include non-cash interest expense
of approximately $278,000 associated with the value of the conversion feature of
certain convertible promissory notes issued in the first quarter of 1999, all of
which was recorded in the first quarter; the results also include a non-cash
expense for the value of detachable warrants issued in conjunction with the
convertible promissory notes, of which $249,000 was recognized in the second
quarter of 1999.
12
13
TAXES. We made no provision for federal income taxes as we have
continued to incur net operating losses.
PREFERRED STOCK. In the second quarter of 1999, all of our outstanding
preferred stock outstanding was converted to common stock. The dividends for the
first half of 1998 were accrued on our Series A Convertible Preferred Stock, and
were higher than that accrued during the comparable period of 1999 because we
had more shares of Preferred Stock outstanding.
YEAR 2000. Issues relating to the Year 2000 result from many computer
programs being written using two digits rather than four to define the
applicable year, so that the year "00" may be interpreted as the year 1900
rather than 2000. A related issue is the ability to recognize the Year 2000 as a
leap year. Software programs and embedded microcircuitry that have
date-sensitive features may have Year 2000 issues. These programs may include
software tools that we use in the development of the hardware and operating
systems of our MTA system, the software programs and embedded chips used in our
internal systems and software programs and equipment used in the normal
operation of our business. In addition, key suppliers may have issues relating
to the Year 2000 that could affect their ability to provide needed products and
services.
We are conducting a formal review of our products, our internal network
system, the hardware and software tools we are using and our key suppliers
regarding the potential impact on us regarding Year 2000 issues. The review is
being conducted by representatives from our finance, manufacturing, engineering,
purchasing and systems administration departments. We believe there is no
significant exposure relating to our MTA system and its Unix-based operating
system. We expect that our formal review will be largely completed as to other
matters by the end of the third quarter of 1999.
Based upon the responses to date and informal inquiries, we believe no
significant modifications to our internal network or computer systems are
necessary to address Year 2000 issues. We installed a materials requirement
planning II system in 1998 that is Year 2000 compliant. We have received
assurances that the services provided at our new offices in Seattle are Year
2000 compliant, except for one system that our landlord has replaced. Our review
is ongoing with respect to our other internal systems and the various software
development tools we use. We are making inquiries of our suppliers and service
providers to obtain assurances concerning their Year 2000 compliance and their
ability to continue to provide products and services to us which are Year 2000
compliant. We have assumed that basic public utilities will continue to be
available to us after January 1, 2000, and are not aware of any information to
the contrary. To date we have not identified any material deficiencies or
remediation requirements and have not budgeted for any remediation costs or
costs associated with responding to other parties' Year 2000 noncompliance. We
do not separately track the internal costs for our Year 2000 review, and current
and future
13
14
anticipated costs are expected to include only payroll and related costs for the
employees engaged in the review. We are reevaluating these positions
periodically as we continue our review.
At this point we cannot predict the effect of the Year 2000 issues on
our suppliers or the resulting effect on us. We have not yet developed a
contingency plan of operating in the event that critical systems of vendors,
suppliers or other third parties are not Year 2000 compliant, or that the
software development tools, software programs and equipment we use internally
are not Year 2000 compliant. We plan on completing a contingency plan once our
inquiries are completed and to have a contingency plan in place by the end of
the third quarter of 1999. If any of our critical systems are not Year 2000
compliant or if critical suppliers from whom we obtain products and services are
not Year 2000 compliant, then Year 2000 issues could have a material adverse
effect on our business, financial condition and results of operations.
LIQUIDITY AND CAPITAL RESOURCES
Since our inception in 1987 through June 30, 1999, our principal sources
of liquidity have been net proceeds from the sale of equity totaling $110.2
million, DARPA research funding and subcontracts totaling $19.6 million and
sales receipts of approximately $2.9 million. At June 30, 1999, we had $25.9
million in cash and had no bank line of credit.
Net cash used in operating activities was $12.4 million for the six
months ended June 30, 1999, an increase of $2.5 million from the $9.9 million
used in the six months ended June 30, 1998. Net operating cash flows were
primarily attributable to quarterly net losses, personnel costs and costs of
inventory. Cash used for personnel expenditures increased from approximately
$3.9 million in the first six months of 1998 to $4.8 million for the six months
of 1999; inventory purchases decreased from $3.4 million to $2.2 million. During
the second half of 1999, our operating activity expenses will depend primarily
upon personnel costs, the cost of inventory and third party engineering expenses
related to future implementations of the MTA system, primarily the conversion
from using gallium arsenide integrated circuits to using integrated circuits
made of complementary metal-oxide silicon, or CMOS.
We expect that personnel costs will continue to increase in 1999,
although not as rapidly as in previous periods as we have slowed the growth of
personnel pending the receipt of additional sales orders. Similarly, we plan
only modest inventory additions in the second half of 1999 pending receipt of
purchase orders. We anticipate that third party engineering expenses related to
the CMOS implementation of the MTA system to increase during the rest of 1999.
14
15
Net cash spent on investing activities for the three and six months
ended June 30, 1999 were approximately $319,000,and $710,000, respectively, and
consisted of additional property, plant and equipment, primarily for furniture
and fixtures, computers and electronic test equipment.
Net cash provided by financing activities for the six months ended June
30, 1999, consisted of approximately $35.8 million of cash raised, primarily
through the sale of common stock in private placements, including $29.0 million
in the second quarter. The offering fees and expenses of $1,190,000 relating to
the second quarter placement will be paid in the third quarter of 1999.
Our current cash resources and revenue from anticipated sales of MTA
systems are sufficient for us to conduct our planned operations for at least the
next twelve months. We believe that we will be cash-flow positive once we have
sales receipts of approximately $10 million per quarter; we do not anticipate
such level of sales prior to 2000, if then. Nevertheless, we may raise
additional funds in the second half of 1999 in order to enhance our financial
position for future operations. In addition, if we were not able to complete
development of a commercially acceptable MTA system, obtain acceptable hardware
components or complete the replacement of gallium arsenide integrated circuits
with of CMOS integrated circuits, we may need additional capital earlier than
planned. There can be no assurance that any additional financing will be
available on acceptable terms when needed or, if available, will be available on
satisfactory terms or that such financings will not be dilutive to our
shareholders. See "Risk Factors--We May Engage in Additional Financings That
May Be Dilutive to Existing Shareholders," below.
RISK FACTORS
The following factors should be considered in evaluating our business,
operations and prospects and may affect our future results and financial
condition.
FAILURE TO COMPLETE DEVELOPMENT OF A COMMERCIALLY ACCEPTABLE MTA SYSTEM WOULD
JEOPARDIZE OUR VIABILITY. Our inability to overcome the technical challenges
involved in integrating and completing MTA systems that satisfy internal
performance specifications and that are commercially acceptable would jeopardize
our viability as an ongoing business. The development of a new very high
performance computer system is a lengthy and technically challenging process and
requires a significant investment of capital and other resources. Several
companies in this market experienced extreme financial difficulty in the 1990s,
including Thinking Machines Corporation, Cray Computer Corporation, Kendall
Square Research Corporation and Supercomputer Systems, Inc. We first integrated
multiple MTA processors into commercially configured computer systems in 1998.
We have not yet achieved the level of stability required to meet stringent
commercial reliability standards and cannot be certain when, if ever, we will do
so.
15
16
OUR INABILITY TO OVERCOME THE TECHNICAL CHALLENGES OF COMPLETING THE DEVELOPMENT
OF THE MTA SYSTEM COULD CAUSE OUR BUSINESS TO FAIL. Continued delays in
completing the hardware components or software of our MTA system, or in
integrating the full system, could materially and adversely affect our business
and results of operations. From time to time during the development process of
the MTA system, we have been required to redesign certain components of the MTA
system because of previously unforeseen design flaws. For example, various
processor and network chip technologies that we thought were functional across
multiple configurations have subsequently been discovered to require additional
design features to function as intended and to achieve a fully operational
system scalable to multiple processors. We also continue to find certain flaws
or "bugs" in our proprietary UNIX-based system software, which require
correction. This redesign work, particularly on integrated circuits and printed
circuit boards, has been costly and caused delays in the development of our
prototype systems, in the delivery of our initial MTA system and in upgrades to
that system. We expect that additional modifications to the hardware components,
system software and the integrated system will be necessary as we build larger
MTA systems for the commercial market.
OUR INABILITY TO OBTAIN ACCEPTABLE HARDWARE COMPONENTS WILL DELAY OUR
DEVELOPMENT EFFORTS AND STRAIN OUR FINANCIAL RESOURCES. The manufacture of
components for the MTA system is a difficult and complex process, and few
companies can meet our design requirements. Manufacturing difficulties or
limitations of suppliers could result in:
o a limitation on the number of MTA systems that can be assembled using such
components;
o unacceptably high prices for those components, with a resulting loss of
profitability and loss of competitiveness for our products; and
o increased demands on our financial resources, requiring additional equity
and/or debt financings to continue business operations.
Our suppliers have previously experienced problems in manufacturing MTA system
components to our design and quality specifications. In prior years we have been
forced to redesign certain components for manufacture by alternative suppliers
because our original suppliers were unable to consistently manufacture
components of satisfactory quality. In 1997 and 1998, we experienced varying
(and sometimes "zero") yields of gallium arsenide integrated circuits, limited
and delayed deliveries of such integrated circuits, poor yields on packaged
integrated circuits and deliveries of a very limited number of reliable printed
circuit boards. Together, these supply constraints caused
16
17
substantial delays in our ability to deliver the initial MTA system to the San
Diego Supercomputer Center and to upgrade that system to larger configurations.
Although we work continually with our suppliers to solve these problems, we
cannot be certain that they will be able to manufacture the components to our
design and quality specifications.
OUR UNCERTAIN PROSPECTS FOR REVENUES AND EARNINGS COULD ADVERSELY AFFECT AN
INVESTMENT IN US. We cannot be certain that we will be successful in delivering
and receiving payments for any additional MTA systems, or whether we will be
able to generate additional sales or achieve a profitable level of operations in
the future. We have experienced net losses in each year of our operations. We
incurred net losses of approximately $15.8 million in 1997, $19.8 million in
1998 and $ 13.5 million in the first six months of 1999. We expect to incur
substantial further losses until we make sales on a regular basis. We do not
expect to have a profitable fiscal quarter prior to 2000, if then. Whether we
will achieve additional revenue, or any earnings, will depend upon a number of
factors, including:
o our ability to assemble production quality MTA systems in commercial
quantities;
o our ability to achieve broad market acceptance of the MTA system;
o the level of revenue in any given period;
o the terms and conditions of sale or lease for an MTA system;
o the MTA system model or models sold; and
o our expense levels and manufacturing costs.
OUT INABILITY TO COMPLETE THE REPLACEMENT OF OUR CURRENT INTEGRATED CIRCUITS
WITH CMOS INTEGRATED CIRCUITS COULD DELAY COMMERCIAL SALES AND RESULTING
REVENUES. Over the next two years we plan to replace in stages most of our
gallium arsenide integrated circuits with integrated circuits made of
complementary metal-oxide silicon, or CMOS. We believe that CMOS integrated
circuits will enable us to offer larger, more cost effective systems. For
example, the 24 gallium arsenide integrated circuits currently on each processor
board will be replaced by one CMOS microprocessor. This process requires the
redesign of most of our integrated circuits, integrated circuit packages and
printed circuit boards, which in turn involves significant effort by our
engineers and requires us to devote significant capital for non-recurring
engineering expenses, including payments to potential suppliers for design
assistance. If we encounter significant problems with this redesign, we may be
delayed substantially in delivering larger MTA systems, which would materially
and adversely affect the receipt of
17
18
revenues, working capital and results of operations. If we are successful in
producing CMOS components as planned, we may not be able, or desire, to use most
of the then remaining inventory of gallium arsenide components, and we may incur
a substantial expense in writing off such inventory.
OUR RELIANCE ON THIRD PARTY SUPPLIERS JEOPARDIZES OUR ABILITY TO MEET PRODUCTION
SCHEDULES AND TO SATISFY FUTURE CUSTOMER ORDERS. We subcontract the manufacture
of substantially all of our hardware components, including integrated circuits,
printed circuit boards, flex circuits and power supplies, on a sole or limited
source basis to third party suppliers. We obtain our gallium arsenide integrated
circuits primarily from Vitesse Semiconductor Corporation; printed circuit
boards from Multilayer Technology, Inc. and Johnson Matthey Electronics; flex
circuits from Compunetics, Inc.; power supplies from Ascom Energy Systems, Inc.;
uninterruptible power supplies from Piller, Inc.; cooling distribution units
from C.H. Bull Company; and our complentary metal-oxide silicon, or CMOS,
integrated circuits from Taiwan Semiconductor Manufacturing Company. We rely on
Cadence Design Systems, Inc., for significant design assistance on the
implementation of our CMOS integrated circuits. We are exposed to substantial
risks because of our reliance on these and other limited or sole source
suppliers. For example:
o if a reduction or interruption of supply of our components occurred, it could
take us a considerable period of time to identify and qualify alternative
suppliers, to redesign our products as necessary and to recommence
manufacture of the redesigned components;
o if we were ever unable to locate a supplier for a component, we would be
unable to assemble and deliver our products;
o one or more suppliers may make strategic changes in their product lines,
which may result in the delay or suspension of manufacture of our components
or systems; and
o some of our key suppliers are small companies with limited financial and
other resources, and consequently may be more likely to experience financial
difficulties than larger, well established companies.
A SUBSTANTIAL NUMBER OF OUR SHARES ARE ELIGIBLE FOR FUTURE SALE WHICH MAY
DEPRESS MARKET PRICES OF OUR STOCK AND HINDER OUR ABILITY TO OBTAIN ADDITIONAL
FINANCING. Sales of a substantial number of shares of our common stock in the
public market or the prospect of such sales could materially and adversely
affect the market price of the common stock. As of June 30, 1999, we had
outstanding:
18
19
o 23,778,546 shares of common stock,
o warrants to purchase another 14,421,330 shares of common stock,
o 8% Convertible Promissory Notes in the principal amount of $494,291,
convertible at $5.00 per share into 98,858 shares of common stock, and
o stock options to purchase an aggregate of 3,214,461 shares of common stock.
As part of the financing completed on June 21, 1999, we issued a warrant to
Terren S. Peizer exercisable for a minimum of 1,591,723 shares of common stock,
and such number is included in the 14,421,330 shares described above as issuable
upon exercise of outstanding warrants. On June 21, 2000, and in certain
circumstances prior to that date, such as if we were involved in a merger or
similar transaction or if we terminated our relationship with Mr. Peizer, the
number of shares subject to this warrant increases to 10% of our issued and
outstanding shares, on a fully diluted basis, with certain limited exceptions.
If this warrant had been so exercisable as of June 30, 1999, it would have
exercisable for a total of 4,445,415 shares.
Almost all of our outstanding shares of common stock may be sold without
substantial restrictions. All of the shares purchased under the option plans are
available for sale in the public market, subject in some cases to volume and
other limitations.
Sales in the public market of substantial amounts of our common stock,
including sales of common stock issuable upon the exercise of the warrants could
depress prevailing market prices for the common stock. Even the perception that
such sales could occur may impact market prices.
In addition, the existence of outstanding warrants and options may prove to
be a hindrance to our future equity financings. Further, the holders of the
warrants and options may exercise them at a time when we would otherwise be able
to obtain additional equity capital on terms more favorable to us. Such factors
could materially and adversely affect our ability to meet our capital needs.
WE MAY ENGAGE IN ADDITIONAL FINANCINGS THAT MAY BE DILUTIVE TO EXISTING
SHAREHOLDERS. Our present cash resources and revenue from anticipated sales of
MTA systems are now sufficient to finance our planned operations for the next
twelve months. Nevertheless, we likely will raise additional equity and/or debt
capital in the next twelve months to enhance our financial position for future
operations. In addition, if we were not able to complete development of a
commercially acceptable MTA system, obtain acceptable hardware components or
complete the replacement of CMOS integrated circuits, as described above, we may
need additional capital earlier than
19
20
planned. Financings may not be available to us when needed or, if available, may
not be available on satisfactory terms or may be dilutive to our shareholders.
OUR INABILITY TO SELL OUR MTA SYSTEMS AT EXPECTED PRICES WOULD ADVERSELY AFFECT
OUR GROWTH PROSPECTS AND FINANCIAL VIABILITY. Most of our potential customers
already own or lease very high performance computer systems. Some of our
competitors may offer trade-in allowances or substantial discounts to potential
customers, and we may not be able to match these sales incentives. We may be
required to provide discounts to make sales or to finance the leasing of our
products, which would result in a deferral of our receipt of cash for such
systems. These developments would reduce our revenues and delay profitability,
thereby materially and adversely affecting our business and results of
operations.
LACK OF GOVERNMENT FUNDING FOR SUPERCOMPUTER SYSTEMS WOULD ADVERSELY AFFECT OUR
BUSINESS AND INCREASE OUR CAPITAL REQUIREMENTS. The inability of U.S. and
foreign government agencies to procure additional high performance computer
systems, due to lack of funding or for any other reason, would materially and
adversely affect our business, results of operations and need for capital. We
have targeted U.S. and foreign government agencies and research laboratories for
our early sales. Our first sale was to the U.S. National Science Foundation for
installation at the San Diego Supercomputer Center. The U.S. Government
historically has facilitated the development of, and has constituted a market
for, new and enhanced very high performance computer systems. If the U.S.
government or foreign governments were to reduce or delay funding of certain
high technology programs employing high performance computing, then one of our
target markets would be seriously adversely affected.
THE ABSENCE OF THIRD-PARTY APPLICATION SOFTWARE TRANSLATED TO RUN ON THE MTA
SYSTEM COULD ADVERSELY AFFECT OUR ABILITY TO MAKE COMMERCIAL SALES. In order to
make sales to engineering and other commercial markets, we must be able to
attract independent software vendors to rewrite their software application
programs so that they will run on our MTA system. We also plan to modify and
rewrite third-party software applications to run on the MTA system ourselves to
facilitate the expansion of our potential markets. There can be no assurance
that we will be able to induce independent software vendors to rewrite their
applications, or that we will successfully rewrite third-party applications to
run on our MTA system, and the failure to do so could materially and adversely
reduce our revenues and delay profitability.
RAPID GROWTH COULD STRAIN OUR MANAGEMENT AND FINANCIAL RESOURCES. If we are
successful in manufacturing and marketing the MTA system, we believe that we
would undergo a period of rapid growth that could place a significant strain on
our
20
21
management, financial and other resources. Our ability to manage our growth will
require us:
o to continue to improve our operational and financial systems;
o to motivate and effectively manage our employees;
o to complete the implementation of a new financial, budgeting and management
information system; and
o to enhance internal control systems.
Our success will depend on our management's ability to make these changes and to
manage our operations effectively over the long term.
WE MAY BE UNABLE TO ATTRACT, RETAIN AND MOTIVATE KEY PERSONNEL, AND AS A RESULT
WE MAY NOT BE ABLE TO GROW AS WE EXPECT OR EFFECTIVELY IMPLEMENT OUR BUSINESS
PLAN. Our success also depends in large part upon our ability to attract, retain
and motivate highly skilled technical and marketing and sales personnel.
Competition for highly skilled management, technical, marketing and sales
personnel is intense, and we may not be successful in attracting and retaining
such personnel.
We are dependent on Burton J. Smith, our Chief Scientist, and James E.
Rottsolk, our Chief Executive Officer. The loss of either officer's services
could have a material impact on our ability to achieve our business objectives.
We are the beneficiary of key man life insurance policies on the lives of
Messrs. Smith and Rottsolk in the amount of $2 million and $1 million,
respectively. We have no employment contract with Mr. Smith or Mr. Rottsolk, or
with any other employee.
OUR QUARTERLY PERFORMANCE MAY VARY SIGNIFICANTLY AND COULD CAUSE OUR STOCK PRICE
TO BE VOLATILE. If we are able to attain market acceptance of the MTA system,
one or a few system sales may account for a substantial percentage of our
quarterly and annual revenue. This is due to the anticipated high average sales
price of the MTA system models and the timing of purchase orders and product
acceptances. Because a number of our prospective customers receive funding from
the U.S. or foreign governments, the timing of orders from such customers may be
subject to the appropriation and funding schedules of the relevant government
agencies. The timing of orders and shipments also could be affected by other
events outside our control, such as:
o changes in levels of customer capital spending;
o the introduction or announcement of competitive products;
21
22
o the availability of components; or
o currency fluctuations and international conflicts or economic crises.
Because of these factors, revenue, net income or loss and cash flow are likely
to fluctuate significantly from quarter to quarter.
OUR STOCK PRICE MAY BE VOLATILE. The trading price of our common stock could be
subject to significant fluctuations in response to, among other factors:
o changes in analysts' estimates;
o announcements of technological innovations by us or our competitors; and
o general conditions in the high performance computer industry.
In addition, the stock market is subject to price and volume fluctuations that
particularly affect the market prices for small capitalization, high technology
companies. These fluctuations are often unrelated to the operating performance
of these companies.
U.S. EXPORT CONTROLS COULD HINDER OUR SALES TO FOREIGN CUSTOMERS AND OUR FUTURE
PROSPECTS. The U.S. Government regulates the export of high performance computer
systems such as the MTA system. Delay or denial in the granting of any required
licenses could delay receipt of revenue, thereby materially and adversely
affecting our business and results of operations.
WE MAY NOT BE ABLE TO KEEP UP WITH RAPID TECHNOLOGICAL CHANGE. Our market is
characterized by rapidly changing technology, accelerated product obsolescence,
and continuously evolving industry standards. Our success will depend upon our
ability to complete development of the MTA system and to introduce new products
and features in a timely manner to meet evolving customer requirements. We may
not succeed in these efforts. Our business and results of operations will be
materially and adversely affected if we incur delays in developing our products
or if such products do not gain broad market acceptance. In addition, products
or technologies developed by others may render our products or technologies
noncompetitive or obsolete.
WE MAY BE UNABLE TO COMPETE SUCCESSFULLY IN THE HIGH PERFORMANCE COMPUTER
MARKET. The performance of our MTA system may not be competitive with the
computer systems offered by our competitors, and we may not compete successfully
22
23
over time against new entrants or innovative competitors at the lower end of the
market. Furthermore, periodic announcements by our competitors of new high
performance computer systems and price adjustments may materially and adversely
affect our business and results of operations.
Our competitors include established companies that are well known in the
high performance computer market and new entrants capitalizing on developments
in parallel processing and increased computer performance through networking.
The high performance computer market is highly competitive and has been
dominated by Cray Research, a division of Silicon Graphics, Inc. Other
participants in the market include IBM Corporation and Japanese companies such
as NEC Corporation, Fujitsu, Ltd., and Hitachi, Ltd. Each of these competitors
has broader product lines and substantially greater research, engineering,
manufacturing, marketing and financial resources than we do. A number of
companies have developed or plan to develop parallel systems for the high
performance computer market. To date, these products have been limited in
applicability and scalability and are often difficult to program. A breakthrough
in architecture or software technology could change this situation. Such a
breakthrough would materially and adversely affect our ability to sell MTA
systems and the receipt of revenue.
WE MAY NOT BE ABLE TO PROTECT OUR PROPRIETARY INFORMATION AND RIGHTS ADEQUATELY.
We rely on a combination of copyright and trade secret protection,
non-disclosure agreements and licensing arrangements to establish, protect and
enforce our proprietary information and rights. In addition, we have 15 patent
applications pending and plan to file additional patent applications. There can
be no assurance, however, that patents will be issued from the pending
applications or that any issued patents will protect adequately those aspects of
our technology to which such patents will relate. Despite our efforts to
safeguard and maintain our proprietary rights, there can be no assurance that we
will succeed in doing so or that our competitors will not independently develop
or patent technologies that are substantially equivalent or superior to our
technologies.
Although we are not a party to any present litigation regarding
proprietary rights, third parties may assert intellectual property claims
against us in the future. Such claims, if proved, could materially and adversely
affect our business and results of operations. In addition, even meritless
claims require management attention and cause us to incur significant expense.
The laws of certain countries do not protect intellectual property
rights to the same extent or in the same manner as do the laws of the United
States. Although we continue to implement protective measures and intend to
defend our proprietary rights vigorously, these efforts may not be successful.
23
24
IT MAY BECOME MORE DIFFICULT TO SELL OUR STOCK IN THE PUBLIC MARKET. Our common
stock is quoted on the Nasdaq National Market. In order to remain listed on this
market, we must meet Nasdaq's listing maintenance standards. If the bid price of
our common stock falls below $5.00 for an extended period, or we are unable to
continue to meet Nasdaq's standards for any other reason, our common stock could
be delisted from the Nasdaq National Market.
If our common stock were delisted, we likely would seek to list the
common stock on the Nasdaq SmallCap Market or for quotation on the American
Stock Exchange or a regional stock exchange. However, listing or quotation on
these markets or exchanges could reduce the liquidity for our common stock.
If our common stock were not listed or quoted on another market or
exchange, trading of the common stock would be conducted in the over-the-counter
market on an electronic bulletin board established for unlisted securities or in
what are commonly referred to as the "pink sheets." As a result, an investor
would find it more difficult to dispose of, or to obtain accurate quotations for
the price of, our common stock. In addition, a delisting from the Nasdaq
National Market and failure to obtain listing or quotation on such other market
or exchange would subject our securities to so-called "penny stock" rules that
impose additional sales practice and market-making requirements on
broker-dealers who sell and/or make a market in such securities. Consequently,
removal from the Nasdaq National Market and failure to obtain listing or
quotation on another market or exchange could affect the ability or willingness
of broker-dealers to sell and/or make a market in the common stock and the
ability of purchasers of the common stock to sell their securities in the
secondary market. In addition, if the market price of the common stock falls to
below $5.00 per share, we may become subject to certain penny stock rules even
if our common stock is still quoted on the Nasdaq National Market. While such
penny stock rules should not affect the quotation of our common stock on the
Nasdaq National Market, such rules may further limit the market liquidity of the
common stock and the ability of investors to sell the common stock in the
secondary market.
WE DO NOT ANTICIPATE DECLARING ANY DIVIDENDS. We have not previously paid any
dividends on our common stock and for the foreseeable future we intend to
continue our policy of retaining any earnings to finance the development and
expansion of our business.
CERTAIN PROVISIONS OF OUR ARTICLES AND BYLAWS COULD MAKE A PROPOSED ACQUISITION
WHICH IS NOT APPROVED BY OUR MANAGEMENT MORE DIFFICULT. Certain provisions of
our Restated Articles of Incorporation and Restated Bylaws could make it more
difficult for a third party to acquire us. These provisions could limit the
price that certain
24
25
investors might be willing to pay in the future for our common stock. For
example, our Articles and Bylaws provide for:
o a staggered Board of Directors, so that only two or three of our seven
directors are elected each year;
o removal of a director only for cause and only upon the affirmative vote of
not less than two-thirds of the shares entitled to vote to elect
directors;
o the issuance of preferred stock, without shareholder approval, with rights
senior to those of the common stock;
o no cumulative voting of shares;
o calling a special meeting of the shareholders only upon demand by the
holders of not less than 30% of the shares entitled to vote at such a
meeting;
o amendments to the Articles of Incorporation require the affirmative vote
of not less than two-thirds of the outstanding shares entitled to vote on
the amendment, unless the amendment was approved by a majority of
"continuing directors" (as that term is defined in our Articles);
o special voting requirements for mergers and other business combinations,
unless the proposed transaction was approved by a majority of continuing
directors;
o special procedures to bring matters before our shareholders at our annual
shareholders' meeting; and
o special procedures for nominating members for election to the Board of
Directors.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Substantially all of our cash equivalents and marketable securities are
held in money market funds or commercial paper of less than 90 days that is held
to maturity. Accordingly we believe that the market risk arising from our
holdings of these financial instruments is minimal. All of our current contract
payments are payable in U.S. dollars, and consequently we do not have any
foreign currency exchange risks. We do not hold any derivative instruments and
have not engaged in hedging transactions.
25
26
PART II. OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES
1. On June 21, 1999, we raised $30,292,120, prior to fees and expenses
estimated at approximately $1,190,000 and including subscribed
shares of $1,070,000, in a private placement of 6,417,820 shares of
our common stock to a group of 18 institutional investors and 18
accredited investors (the "June 1999 Private Placement") and 42,373
shares of common stock issued in payment of additional fees. We sold
the shares at a price of $4.72 per share, above the closing bid
price of $4.71875 on Friday, June 18, 1999, the last trading day
preceding the closing of the financing.
2. On June 21, 1999, we issued warrants to purchase 6,417,820 shares to
the investors in the June 1999 Private Placement. The warrants are
exercisable at an exercise price of $4.72 per share, and expire on
June 21, 2002. The warrants may be exercised only for cash. The
warrants contain common antidilution protection for stock splits,
stock dividends and recapitalizations and if we sell shares of
common stock in private transactions below the exercise price of the
warrants or market price for our common stock.
3. On or prior to June 18, 1999, the holders of all of the outstanding
shares of our Series B Convertible Preferred Stock converted those
shares into shares of common stock pursuant to the terms of the
Series B Convertible Preferred Stock.
4. In September and December 1998, three institutional investors,
Advantage Fund II Limited, Genesee Fund Ltd. - Portfolio B and Koch
Industries, Inc., had purchased 800,000 shares of our common stock
for an aggregate of $8,000,000 and received warrants to purchase an
aggregate of 161,344 shares of common stock. The investors had the
right to receive additional shares of common stock or warrants to
purchase additional shares of common stock if the market price for
our common stock was below certain specified levels on certain
dates. Pursuant to these "reset" rights, we subsequently issued
additional warrants to purchase an aggregate of 1,370,311 shares of
common stock. In June 1999, these investors agreed to eliminate
their right to receive additional shares of common stock, including
warrants to purchase additional shares of common stock, pursuant to
these "reset" provisions, and the right to require us to redeem,
upon the occurrence of specified events, those securities, in return
for the issuance of warrants for the purchase of 731,628 shares of
common stock. These warrants have the same terms as the warrants
issued in the June 1999 Private Placement. In addition, the exercise
price of the warrants to purchase an aggregate of 161,344 shares
issued in
26
27
September and December 1998 was reduced from $6.00 per share to
$4.72 per share.
5. In March 1999, the Banca del Gottardo of Lugano, Switzerland,
purchased 1,111,111 shares of our common stock for $5,000,000, and
received warrants to purchase 1,111,111 shares of common stock. We
also issued an aggregate of 103,889 shares and warrants to purchase
225,000 shares of common stock in connection with services rendered
in the financing, including 85,889 shares and warrants to purchase
200,000 shares of common stock to the Banca del Gottardo. The Banca
del Gottardo also had certain "reset" rights with respect to these
shares of common stock and warrants and the option to purchase
another $5,000,000 of shares of common stock and warrants. In June
1999, the Banca del Gottardo agreed to eliminate the right to
receive additional shares of common stock and warrants and the
option to purchase additional shares of common stock and warrants in
return for the issuance of warrants to purchase 1,040,387 shares of
common stock. These warrants have the same terms as the warrants
issued in the June 1999 Private Placement. In addition, the exercise
price of the warrants issued in March 1999 was reduced from $5.16
per share to $4.72 per share.
6. From February 23, 1999 through March 31, 1999, we issued
Subordinated Convertible Promissory Notes (the "Notes") in the
aggregate principal amount of $2,491,291, and warrants to purchase
74,829 shares of our common stock, to eleven accredited investors,
consisting of two vendors and nine individuals. The Notes were
convertible at $5.00 per share. In June 1999, all but one investor
(a vendor), with a Note in the principal amount of $494,291,
exchanged their Notes and warrants for shares of common stock and
new warrants on the terms of the June 1999 Private Placement. In
this transaction, we issued an aggregate of 433, 585 shares of
common stock and warrants to purchase 433,585 shares of common
stock, and the Noteholders surrendered their Notes and prior
warrants to purchase 60,000 shares of common stock.
7. In June, 1999, we issued, as part payment of certain placement fees
in the June 1999 Private Placement, 42,373 shares of common stock
and warrants to purchase 212,000 shares of common stock. These
warrants have the same terms as the warrants issued in the June 1999
Private Placement.
8. In June, 1999, we issued a warrant to purchase 1,591,723 shares of
Common Stock to Terren S. Peizer, who paid $200,000 to us for the
warrant. This warrant becomes exercisable on June 21, 2000, for half
of the shares then covered by the warrant, and then becomes
exercisable ratably thereafter over the next twelve months, becoming
fully exercisable on June 21, 2001. The warrant expires on June 21,
2009. The number of shares covered by this warrant increases on June
21, 2000, to 10% of the Company's outstanding
27
28
shares of common stock then outstanding, calculated on a fully
diluted basis, with certain exceptions including stock options
granted after June 1, 1999, and shares of common stock sold after
March 31, 1999 for a per share price of $12.00 or higher. In certain
events, such as a merger or consolidation in which we are not the
surviving entity, a sale of all or substantially all of our assets
or if we terminate our relationship with Mr. Peizer, the vesting
provisions accelerate. The number of shares covered by the warrant
increases if our Board removes Mr. Peizer as Chairman of the Board
prior to the Annual Meeting of Shareholders in 2002 or if a
registration statement covering the resale of the underlying shares
is not filed within three months after issuance. On June 21, 2000,
the exercise price of the warrant becomes the lesser of $4.95 per
share, the initial exercise price, or 105% of the market value of
our common stock on June 21, 2000. The warrant may be exercised for
cash or pursuant to a "cashless" exercise feature pursuant to which
the holder surrenders shares with a market value, at the time of
exercise, equal to the exercise price of the shares then being
acquired.
The transactions described in paragraphs (1), (2), (4), (5), (7) and (8)
above were exempt from registration under the Securities Act of 1933 pursuant to
Sections 4(2) and 4(6) of that Act, and the transactions described in paragraph
(3) and (6) above were exempt from registration under the Securities Act of 1933
pursuant to Section 3(a)(9) of that Act.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
The annual meeting of shareholders was held on May 5, 1999. At the meeting the
following actions occurred:
1. Kenneth W. Kennedy and James E. Rottsolk were elected as directors for three
year terms expiring in 2002, each receiving at least 13,177,841 votes (or 98.7%
of the votes cast). David N. Cutler, Daniel J. Evans, Burton J. Smith and John
W. Titcomb, Jr. continue to serve as directors.
2. An amendment to our Restated Articles of Incorporation increasing the number
of authorized shares of common stock to 50,000,0000 shares was approved by the
shareholders, with 13,161,873 shares voting in favor (91.9) %), 166,766 shares
voting against (1.2%), 21,708 shares abstaining (.2%%), and 978,354 shares not
voting (6.8%)
3. The 1999 Stock Option Plan was approved by shareholders, with 6,233,016
shares voting in favor (95.1%), 293,350 shares voting against (4.5%) and 29,905
shares abstaining (.5%). There were 7,772,430 shares of broker and other
non-votes.
28
29
4. Amendments to the 1995 Stock Option Plan were approved by shareholders, with
6,003,720 shares voting in favor (94.8%), 284,519 shares voting against (4.5%)
and 46,946 shares abstaining (.7%). There were 7,993,516 shares of broker and
other not-votes.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
27.1 Financial Data Schedule
(b) Reports on Form 8-K
A report on Form 8-K for an event of May 21, 1999 was filed on
July 21, 1999, reporting certain amended "Risk Factors" as previously
filed in our Form 10-Q, and the Company's amended Articles of
Incorporation and Bylaws under "Other Events."
A report on Form 8-K for an event of June 21, 1999 was filed on
June 30, 1999, reporting the Company's sale of common stock and warrants
under "Other Events."
A report on Form 8-K for an event of June 25, 1999 was filed on
June 29, 1999, reporting a change in the Company's Board of Directors
under "Other Events."
ITEMS 1, 3 AND 5 OF PART II ARE NOT APPLICABLE AND HAVE BEEN OMITTED.
29
30
SIGNATURES
In accordance with the requirements of the Securities Exchange Act of
1934, the registrant caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
TERA COMPUTER COMPANY
August 13, 1999 By: /s/ JAMES E. ROTTSOLK
James E. Rottsolk
Chief Executive Officer
/s/ KENNETH W. JOHNSON
Kenneth W. Johnson
Chief Financial Officer
/s/ PHILISSA SARGIN
Philissa Sargin
Chief Accounting Officer
30