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, 2001
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: 000-2409
COM21, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 94-3201698
(STATE OR OTHER JURISDICTION OF
INCORPORATION OR ORGANIZATION (IRS EMPLOYER IDENTIFICATION NO.)
750 TASMAN DRIVE
MILPITAS, CALIFORNIA 95035
(408) 953-9100
(ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF THE
REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES)
Indicate by check mark whether the registrant (1) has filed all reports required
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.
[X] Yes [ ] No
The number of outstanding shares of the registrant's Common Stock, $0.001 par
value, was 27,610,155 as of June 30, 2001.
================================================================================
2
COM21, INC.
INDEX
PART I: FINANCIAL INFORMATION PAGE
- ----------------------------- ----
ITEM 1 Financial Statements (Unaudited)
Condensed Consolidated Balance Sheets - June 30, 2001 and
December 31, 2000...........................................................3
Condensed Consolidated Statements of Operations and Comprehensive Loss -
Three and Six Months ended June 30, 2001 and 2000...........................4
Condensed Consolidated Statements of Cash Flows - Six Months Ended
June 30, 2001 and 2000......................................................5
Notes to Condensed Consolidated Financial Statements........................7
ITEM 2 Management's Discussion and Analysis of Financial Condition
and Results of Operations..................................................14
ITEM 3 Quantitative and Qualitative Disclosures About Market Risk.................34
PART II: OTHER INFORMATION
ITEM 1 Legal Proceedings..........................................................35
ITEM 2 Changes in Securities and Use of Proceeds..................................35
ITEM 3 Defaults Upon Senior Securities............................................35
ITEM 4 Submission of Matters to a Vote of Security Holders........................35
ITEM 5 Other Information..........................................................36
ITEM 6 Exhibits and Reports on Form 8-K...........................................36
Signature..................................................................36
In addition to historical information, this Form 10-Q contains forward-looking
statements including statements about our strategy, financial performance and
revenue sources that involve a number of risks and uncertainties, including
those discussed below at Risk Factors and in the Risk Factors section of Com21's
annual report on Form 10-K dated April 2, 2001 and as amended on July 31, 2001
as filed with the SEC. While this outlook represents our current judgement on
the future direction of the business, these risks and uncertainties could cause
actual results to differ materially from any future performance suggested below.
Readers are cautioned not to place undue reliance on the forward-looking
statements, which speak only as of the date of this Form 10-Q. Com21 undertakes
no obligation to publicly release any revisions to forward-looking statements to
reflect events or circumstances arising after the date of this document. See
Risk Factors below and Risk Factors in Com21's annual report on Form 10-K dated
April 2, 2001 and as amended on July 31, 2001 as filed with the SEC.
2
3
PART I: FINANCIAL INFORMATION
ITEM 1 FINANCIAL STATEMENTS
COM21, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PAR VALUE AMOUNTS)
(UNAUDITED)
JUNE 30, DECEMBER 31,
ASSETS 2001 2000
--------- ------------
Current assets:
Cash and cash equivalents $ 11,925 $ 25,237
Restricted cash 10,342 11,250
Short-term investments 1,730 9,427
Accounts receivable:
Trade 31,691 40,609
Other 8,390 10,159
Inventories 22,983 33,960
Prepaid expenses and other 1,119 4,188
--------- ---------
Total current assets 88,180 134,830
Investments 2,000 2,000
Property and equipment, net 10,679 16,690
Intangible assets, net 4,080 60,057
Other assets 625 788
--------- ---------
Total Assets $ 105,564 $ 214,365
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 31,507 $ 48,543
Accrued compensation and related benefits 2,139 4,447
Other current liabilities 6,810 7,045
Current portion of capital lease and debt obligations 9,141 11,312
--------- ---------
Total current liabilities 49,597 71,347
Deferred rent 471 371
Accrued restructuring costs 2,646 -
Capital lease obligations 404 9
--------- ---------
Total Liabilities 53,118 71,727
--------- ---------
Stockholders' equity:
Common stock, $0.001 par value, 160,000,000 shares
authorized; 27,610,155 and 24,679,217 issued and
outstanding at June 30, 2001 and December 31, 2000 28 25
Additional paid-in capital 272,065 263,803
Deferred stock compensation (112) (5,839)
Accumulated deficit (219,559) (115,072)
Accumulated other comprehensive income (loss) 24 (279)
--------- ---------
Total Stockholders' Equity 52,446 142,638
--------- ---------
Total Liabilities and Stockholders' Equity $ 105,564 $ 214,365
========= =========
See notes to condensed consolidated financial statements.
3
4
COM21, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------------- -------------------------
2001 2000 2001 2000
--------- --------- --------- ---------
Revenues $ 34,121 $ 51,358 $ 66,910 $ 92,914
Cost of revenues 32,052 37,322 61,183 66,314
Amortization of intangible assets 506 - 1,264 -
--------- --------- --------- ---------
Gross profit 1,563 14,036 4,463 26,600
--------- --------- --------- ---------
Operating expenses:
Research and development 6,189 10,209 15,650 18,499
Sales and marketing 4,636 6,549 12,017 12,670
General and administrative 3,638 2,024 8,279 3,619
Amortization of intangible assets 1,837 - 4,478 -
Stock-based compensation 448 351 1,456 749
Restructuring charges 67,365 - 67,452 -
--------- --------- --------- ---------
Total operating expenses 84,113 19,133 109,332 35,537
--------- --------- --------- ---------
Loss from operations (82,550) (5,097) (104,869) (8,937)
Other income, net 125 1,356 401 2,795
--------- --------- --------- ---------
Loss before income taxes (82,425) (3,741) (104,468) (6,142)
Income taxes - - 19 22
--------- --------- --------- ---------
Net loss (82,425) (3,741) (104,487) (6,164)
Other comprehensive loss, net of tax:
Unrealized gain (loss) on available-
for-sale investments 1,152 (392) 303 (596)
--------- --------- --------- ---------
Comprehensive loss $ (81,273) $ (4,133) $(104,184) $ (6,760)
========= ========= ========= =========
Net loss per share, basic and diluted $ (3.02) $ (0.17) $ (3.96) $ (0.28)
========= ========= ========= =========
Shares used in computation, basic
and diluted 27,268 21,931 26,381 21,847
========= ========= ========= =========
* Stock-based compensation:
Research and development $ 413 $ 191 $ 1,326 $ 383
Sales and marketing 12 3 29 3
General and administrative 23 157 101 363
--------- --------- --------- ---------
$ 448 $ 351 $ 1,456 $ 749
========= ========= ========= =========
See notes to condensed consolidated financial statements.
4
5
COM21, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
SIX MONTHS ENDED
JUNE 30,
-------------------------
2001 2000
--------- ---------
CASH USED IN OPERATING ACTIVITIES:
Net loss $(104,487) $ (6,164)
Adjustments to reconcile net loss to net cash
used in operating activities:
Stock-based compensation 1,456 749
Depreciation and amortization 8,748 2,075
Restructuring charges 67,452 -
Deferred rent 114 25
Gain on sales and maturities of investments (192) (362)
Changes in operating assets and liabilities:
Accounts receivable - trade 8,611 (13,043)
Accounts receivable - other 1,769 -
Inventories 8,803 (1,688)
Prepaid expenses and other 1,973 (1,173)
Other assets 138 (2,197)
Accounts payable (15,717) 6,857
Accrued compensation and related benefits (1,590) 250
Accrued restructuring costs 4,823 -
Other current liabilities (9,010) 1,689
--------- ---------
Net cash used in operating activities (27,109) (12,982)
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of investments - (53,806)
Proceeds from sale of investments 8,192 92,805
Purchases of property and equipment (806) (4,418)
--------- ---------
Net cash provided by investing activities 7,386 34,581
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from private equity financing, net 6,864 -
Proceeds from issuance of stock, net 292 -
Proceeds from exercise of stock options, net 49 2,965
Repayments under capital lease obligations (224) (324)
Repayments on debt obligations (1,478) -
Reduction in restricted cash 908 -
--------- ---------
Net cash provided by financing activities 6,411 2,641
--------- ---------
Net change in cash and cash equivalents (13,312) 24,240
Cash and cash equivalents at beginning of period 25,237 16,499
--------- ---------
Cash and cash equivalents at end of period $ 11,925 $ 40,739
========= =========
NONCASH INVESTING AND FINANCING ACTIVITIES:
Unrealized (gain) loss on available-for-sale investments $ (303) $ 596
========= =========
Property acquired under capital leases $ 476 $ 1,218
========= =========
Additional common stock related to GADline acquisition $ 963 $ -
========= =========
Warrants to purchase common stock $ 2,745 $ -
========= =========
5
6
See notes to condensed consolidated financial statements
6
7
COM21, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2001
(UNAUDITED)
1. UNAUDITED INTERIM FINANCIAL STATEMENTS
The accompanying unaudited condensed consolidated financial statements have been
prepared by Com21 pursuant to the rules and regulations of the Securities and
Exchange Commission (SEC). Certain information and footnote disclosures normally
included in annual consolidated financial statements prepared using accounting
principles generally accepted in the United States of America have been
condensed or omitted pursuant to these rules and regulations. In the opinion of
management, these unaudited condensed consolidated financial statements include
all adjustments necessary (consisting of normal, recurring adjustments) for a
fair presentation of Com21's financial position as of June 30, 2001, the results
of operations for the three and six months ended June 30, 2001 and 2000 and its
cash flows for the six months ended June 30, 2001 and 2000.
The results of operations for the three and six months ended June 30, 2001 are
not necessarily indicative of the results to be expected for the fiscal year
ending December 31, 2001. These financial statements should be read in
conjunction with the consolidated financial statements and the accompanying
notes included in Com21's Form 10-K dated April 2, 2001 and as amended on July
31, 2001 as filed with the SEC.
Certain prior year amounts in the accompanying financial statements have been
reclassified to conform to current year presentation. These reclassifications
had no effect on the financial position, results of operations or cash flows for
any of the periods presented.
2. NEW ACCOUNTING STANDARD
In June 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standard (SFAS) No. 141, Business Combinations and SFAS
No.142, Goodwill and Other Intangible Assets. SFAS No. 141 requires that all
business combinations initiated after June 30, 2001 be accounted for under the
purchase method and addresses the initial recognition and measurement of
goodwill and other intangible assets acquired in a business combination. SFAS
No. 142 addresses the initial recognition and measurement of intangible assets
acquired outside of a business combination and the accounting for goodwill and
other intangible assets after their acquisition. SFAS No. 142 provides that
intangible assets with finite useful lives be amortized and that goodwill and
intangible assets with indefinite lives will not be amortized, but will rather
be tested at least annually for impairment. Com21 will adopt SFAS No. 142 for
its fiscal year beginning January 1, 2002. Upon adoption of SFAS 142, Com21 will
stop the amortization of goodwill with an expected net carrying value of
$3,570,000 at the date of adoption and annual amortization of $1,020,000 that
resulted from business combinations completed prior to the adoption of SFAS 141.
Com21 will evaluate goodwill under SFAS No. 142 transition impairment test and
has not determined whether or not there is an impairment loss. Any transitional
impairment loss will be recognized as a change in accounting principle.
3. RESTRUCTURING CHARGES
In January 2001, Com21 announced a number of programs to reduce operating
expenses. These programs are designed to prioritize Com21 initiatives around
high-growth areas of our business, focus on profit contribution and reduce
expenses and capital spending. These restructuring
7
8
programs include workforce reductions, reorganization and closure of certain
business functions, and consolidation of excess facilities. As a result of the
restructuring efforts, Com21 recorded a restructuring charge of $67.4 million
for the three months ended June 30, 2001. In addition, Com21 recorded
restructuring charges of $416,000 and $87,000 in the quarters ended December 31,
2000 and March 31, 2001, respectively, related to reductions in workforce in
those periods.
A summary of the restructuring expenses for the six months ended June 30, 2001
is as follows (in thousand):
Accrual
Restructuring at June
Provision Utilized 30, 2001
------------- ----------- -----------
Workforce reduction $ 1,096 $ (884) $ 212
Closure of the Maryland development
center 4,704 (4,704) -
Spin-off of voice systems division 55,397 (55,397) -
Consolidation of facilities 6,255 (1,645) 4,610
----------- ----------- -----------
Total $ 67,452 $ (62,630) $ 4,822
=========== =========== ===========
Workforce reduction - The restructuring program resulted in the reduction of
approximately 300 employees across all business functions and operating units
including employees of the wireless business unit, Maryland development center
and corporate headquarters. The remaining balance of $212,000 related to
severance and fringe benefits will be disbursed in the third quarter of 2001.
The closure of the wireless business unit - In April 2001, we ceased development
in our wireless business unit to focus our efforts on projects with shorter
development cycles. All wireless employees were terminated and the facility
located in Long Island, New York was closed in May 2001.
The closure of Maryland development center (formerly known as BitCom) - As Com21
consolidated its facilities and focused on reducing expenses, the development of
ATM products was transferred to the facility in Cork, Ireland in April 2001. The
Maryland development center facility was closed and all employees were
terminated in May in 2001. This closure resulted in a restructuring charge of
$4.7 million relating primarily to the acceleration of deferred stock
compensation for terminated employees.
The spin-off of the voice systems division (formerly known as GADline) - In June
2001, Com21 sold the voice systems division to its management team and recorded
a charge of $55.4 million. Of the amount, $50.8 million relates to the
impairment of goodwill and purchased intangible assets, measured as the amount
by which the carrying amount exceeded the present value of the estimated future
cash flows for goodwill and purchased intangible assets. The $50.8 million
consists primarily of goodwill and technology capitalized in the GADline
acquisition.
The goodwill associated with the GADline acquisition is primarily related to
GADline's in-process voice technology. This technology was not fully developed
as of the spin-off, and Com21 does not currently plan to continue to fund this
technology, to develop alternative technology or to integrate any existing
GADline's voice technology in future products. As there
8
9
will be no future benefit to Com21 from the goodwill, the $36.0 million of
goodwill from the GADline acquistion was written off at the time of spin-off.
It was also determined at the time of the spin-off, through a review of Com21's
current product portfolio and future product roadmap, that the technologies
purchased from GADline were not and would not be utilized in Com21 products
subsequent to the spin-off. The technology behind GADline products includes, a
cable modem designed by GADline and an end to end network system providing voice
and data services over cable television lines. As Com21 has not integrated and
does not expect to integrate the technology into its product portfolio, and the
rights to this technology and these products were sold to the purchasers of the
voice systems division, the intangible asset of $12.4 million associated with
the purchased technology was written off.
The remaining $4.6 million of the charge associated with the spin-off of the
voice systems division includes a cash payment to the buyers of $1.3 million
which was paid at the time of separation and disposal of net intangible assets.
A convertible note received from the buyers was not valued as the estimated
recovery was zero.
Consolidation of excess facilities - The consolidation of excess facilities
includes the closure of the wireless business unit facility in Long Island, New
York, the Maryland development center, and a building in Milpitas, California
during the three months ended June 30, 2001. Com21 recorded a charge of $6.3
million related primarily to the net rental expense on non-cancelable leases and
the write-off of fixed assets and leasehold improvements. Estimated future lease
payments of $4.6 million are expected to be paid over the next 18 quarters.
4. INVENTORIES
Inventories consist of (in thousands):
JUNE 30, DECEMBER 31,
2001 2000
----------- -----------
Raw materials and sub-assemblies $ 9,587 $ 10,363
Work-in-process 1,405 5,477
Finished goods 11,991 18,120
----------- -----------
Total $ 22,983 $ 33,960
=========== ===========
5. LINE OF CREDIT
In December 2000, Com21 entered into a revolving line of credit agreement, for
working capital purposes, which allows Com21 to borrow up to the lesser of
$20,000,000 or 65% of Com21's eligible domestic and foreign accounts receivable.
At June 30, 2001, Com21 had $9,000,000 of principal outstanding under the
agreement. Borrowings under the line are secured by substantially all the assets
of Com21 and bear annual interest at the bank's prime rate (7.00% at June 30,
2001) plus 0.25%, which is payable monthly. The line expires on November 30,
2001 at which time all outstanding borrowings and unpaid interest are due. The
agreement as amended in March 2001, requires Com21 to comply with certain
financial covenants which include maintaining a minimum tangible effective net
worth of $70,000,000; a maximum debt-to-worth ratio of 1.00:1.00; a minimum
quick ratio of 1.00:1.00; maximum net loss of $2,500,000 excluding non-cash
charges and one time costs and expenses; and minimum unrestricted cash of
$5,000,000. At June 30, 2001, Com21 did not meet the minimum tangible effective
net worth, the maximum debt-to-worth and the maximum net loss covenants. A
waiver for these violations as of June 30, 2001 was received on July 20, 2001.
9
10
In replacement of the waiver received on July 20, 2001, the bank amended the
revolving line of credit arrangement in August 2001. The amendment reduced the
maximum borrowing to the lesser of $7,500,000 or 65% of Com21's eligible
domestic and foreign receivables until October 1, 2001, at which time the
percentage decreases to 55%. The bank increased the rate at which the borrowings
bear interest to the bank's prime rate plus 1.25%. The agreement amends the
financial covenants to a minimum tangible effective net worth of $35,000,000; a
maximum debt-to-worth ratio of 1.60:1.00; a minimum quick ratio of 0.85:1.00;
maximum net loss of $12,500,000 for the second quarter of 2001 excluding
non-cash charges up to $75,000,000 and $6,500,000 for the quarter ending
September 30, 2001; and minimum unrestricted cash of $5,000,000. As of August
10, 2001, Com21 has no availability for additional borrowings or draws under the
arrangement.
Additionally, the bank converted $1,500,000 of Com21's outstanding borrowings
under the line into a term loan. The term loan will expire on December 1, 2001,
bears interest rate at the bank's prime rate, and is payable monthly.
Com21 has also agreed to refinance the $7,500,000 revolving line of credit with
another lender by September 28, 2001. Com21 will be required to pay the bank a
monthly fee of $1,000 for extensions beyond the stipulated dates for the
replacement funding with another financial institution. As part of the
arrangement, Com21 has also agreed to seek additional equity funding.
6. COMMITMENTS AND LITIGATION
Com21's contract manufacturers have obtained or have on order substantial
amounts of inventory to meet Com21's revenue forecasts. If future shipments do
not use up the committed inventory, the contract manufacturers have the right to
charge for the fixed amount of excess inventories as well as a variable amount
for inventory carrying costs. These inventory commitments have a term of less
than one year as the revenue forecasts provided to the contract manufacturers
are for less than one year. At June 30, 2001, the commitment totaled
approximately $46.2 million. As of June 30, 2001, $10.3 million held in a
certificate of deposit is restricted for use as standby letter of credit on
purchases from a third-party contract manufacturer. The standby letter of credit
expire on April 30, 2002.
Com21 is subject to various legal proceedings and claims which arise in the
normal course of business. Com21 does not believe that any current litigation or
claims have any merit and intends to defend them vigorously; however, an
unfavorable resolution will have a negative impact on Com21's business,
operating results or financial condition.
7. STOCKHOLDERS' EQUITY
Net Loss Per Share -- The following is a reconciliation of the numerators and
denominators of the basic and diluted net loss per share (EPS) computations (in
thousands, except per share amounts):
THREE MONTHS
ENDED JUNE 30,
-----------------------
2001 2000
-------- --------
Net Loss (Numerator):
Net loss, basic and diluted $(82,425) $ (3,741)
-------- --------
Shares (Denominator):
10
11
Weighted average common shares outstanding 27,513 21,951
Weighted average common shares outstanding
subject to repurchase or forfeiture (245) (20)
-------- --------
Shares used in computation, basic and diluted 27,268 21,931
-------- --------
Net loss per share, basic and diluted $ (3.02) $ (0.17)
======== ========
SIX MONTHS
ENDED JUNE 30,
-------------------------
2001 2000
--------- ---------
Net Loss (Numerator):
Net loss, basic and diluted $(104,487) $ (6,164)
--------- ---------
Shares (Denominator):
Weighted average common shares outstanding 26,626 21,871
Weighted average common shares outstanding
subject to repurchase or forfeiture (245) (24)
--------- ---------
Shares used in computation, basic and diluted 26,381 21,847
--------- ---------
Net loss per share, basic and diluted $ (3.96) $ (0.28)
========= =========
During the three months and six months ended June 30, 2001 and 2000, Com21 had
securities outstanding which could potentially dilute basic EPS in the future,
but were excluded in the computation of diluted EPS in these periods, as their
effect would have been antidilutive due to the net loss reported in these
periods. These outstanding securities consist of the following at June 30, 2001:
245,011 outstanding shares of common stock subject to repurchase or forfeiture;
warrants to purchase 2,745,000 shares of common stock; and options to purchase
4,571,158 shares of common stock.
Common Stock - In January 2001, Com21 issued an additional 175,124 shares of
common stock to former GADline shareholders upon completion of certain
predefined development milestones included in the share purchase agreement. The
common stock was valued on the measurement date at $963,000. This amount was
recorded as additional goodwill in the first quarter of 2001 and will be
amortized over the remaining life of the intangible asset. All remaining
unearned milestone shares expired during the quarter ended March 31, 2001.
In January 2001, Com21 issued an additional 50,000 shares of common stock to
former BitCom employees upon completion of certain product development
milestones defined in the BitCom agreement. These shares were valued on the
measurement date at $263,000. This amount was recorded as stock-based
compensation in the first quarter of 2001. All remaining unearned milestone
shares expired during the quarter ended March 31, 2001.
Com21 completed a $7,650,615 equity financing with Fletcher International
Limited, or Fletcher. Pursuant to a subscription agreement, dated February 28,
2001, Fletcher agreed to purchase approximately 2,450,000 shares of Com21's
common stock at a price of $3.1227 per share and a warrant to acquire up to an
additional 2,450,000 shares of Com21's common stock. The offer and sale of these
securities were not registered under the Securities Act of 1933, as amended,
pursuant to the exemption provided by Regulation D and these securities may not
be offered or sold in the United States absent registration or an applicable
exemption from registration requirements. The warrant is immediately exercisable
and remains exercisable for a
11
12
period of seven years from the date of issuance at the exercise price of $9.0951
per share. The number of shares issuable upon exercise of the warrant and the
exercise price per share are subject to adjustment upon the occurrence of events
set forth in the warrant including: the issuance of additional securities at a
price below the greater of the market price of the common stock and the exercise
price of the warrant or the declaration of a stock split, dividend,
consolidation, recombination, reclassification or similar transaction. The fair
value of the warrant is approximately $2,500,000 and is recorded as additional
paid in capital. Com21 determined the value of the warrant using the
Black-Scholes option pricing model over the contractual term of the warrant with
the following assumptions: stock volatility, 75%; risk free interest rate, 5.4%;
and no dividends during the expected term. Net proceeds from the private equity
financing were $6,864,000.
According to the Agreement, Com21 was contractually obligated to issue
additional warrants of 5% of the outstanding shares of common stock and warrants
held by Fletcher if the shares issued to Fletcher were not registered by June 5,
2001. At June 5, July 5 and August 5, 2001 Com21 was required to issue an
additional 245,000, 257,250 and 270,113 of warrants, respectively. The Company
is required to continue to issue warrants monthly until such time as the shares
are registered. The fair value of the warrants, $330,000, $182,000, and $104,000
were determined using the Black-Scholes option pricing model over the
contractual term of the warrant with the following assumptions: stock
volatility, 75%; risk free interest rate, 5.4%; and no dividends during the
expected term.
8. SEGMENT INFORMATION
For purposes of segment reporting, Com21 aggregates operating segments that have
similar economic characteristics and meet the aggregation criteria of SFAS No.
131, "Disclosures about Segments of an Enterprise and Related Information."
Based on this criteria, there are three operating and reportable segments: ATM
Products, DOCSIS Products and Voice Products. The ATM Products segment develops,
manufactures, and markets the proprietary cable modems, ATM headend equipment
and network management software. The DOCSIS Products segment develops,
manufactures, and markets DOCSIS cable modems. The Voice Products segment (which
Com21 spun-off in June 2001), developed, manufactured, and marketed telephony
products for use on cable plants.
The following tables are the financial results the chief operating decision
maker, as defined by SFAS No. 131, utilizes in evaluating the performance of
Com21's reportable segments (in thousands):
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
--------------------------- -------------------------
2001 2000 2001 2000
------------ ------------ --------- ----------
Revenues:
ATM products $ 21,158 $ 34,667 $ 41,539 $ 67,197
DOCSIS products 12,811 16,691 24,718 25,717
Voice products 152 - 653 -
-------- -------- -------- --------
Total $ 34,121 $ 51,358 $ 66,910 $ 92,914
======== ======== ======== ========
Cost of Revenues:
ATM products $ 17,541 $ 21,047 $ 33,049 $ 41,089
DOCSIS products 14,668 16,275 27,356 25,225
Voice products 349 - 2,042 -
-------- -------- -------- --------
Total $ 32,558 $ 37,322 $ 62,447 $ 66,314
======== ======== ======== ========
12
13
Gross Profit:
ATM products $ 3,617 $ 13,620 $ 8,490 $ 26,108
DOCSIS products (1,857) 416 (2,638) 492
Voice products (197) - (1,389) -
-------- -------- -------- --------
Total $ 1,563 $ 14,036 $ 4,463 $ 26,600
======== ======== ======== ========
Com21's product lines differ primarily based on product functions. Headend
equipment controls the flow of data communications between cable modems and an
external network, such as the Internet or a corporate network. Cable modems send
and receive data over coaxial cable. Network management software facilitates
provisioning, fault isolation, network configuration, field inventory,
auto-discovery and performance for the headend equipment. For the three and six
months ended June 30, 2001 and 2000, Com21 recorded product revenue from sales
of headend equipment, cable modems and network management software as follows:
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
--------------------------- -------------------------
2001 2000 2001 2000
------------ ----------- ---------- ------------
Headend equipment $ 5,417 $ 11,499 $ 10,055 $ 16,988
Cable modems 28,725 39,657 56,677 75,354
Network management
software (21) 202 178 572
-------- -------- -------- --------
Product revenues $ 34,121 $ 51,358 $ 66,910 $ 92,914
======== ======== ======== ========
13
14
PART I: FINANCIAL INFORMATION
ITEM 2
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
You should read the following discussion in conjunction with Com21's unaudited
condensed consolidated financial statements and notes thereto. The results
described below are not necessarily indicative of the results to be expected in
any future period. Certain statements in this discussion and analysis, including
statements about our strategy, financial performance and revenue sources, are
forward-looking statements based on current expectations and entail various
risks and uncertainties that could cause actual results to differ materially
from those expressed in the forward-looking statements. Readers are referred to
the Risk Factors section contained in Com21's annual report on Form 10-K/A dated
July 31, 2001, and to the Risk Factors section below which identify important
risk factors that could cause actual results to differ from those contained in
the forward looking statements.
OVERVIEW
Com21, Inc., is a leading global supplier of broadband access solutions. Com21's
products enable domestic and international cable operators to provide
high-speed, cost-effective Internet access; reduce operating costs; and maximize
revenue opportunities in a variety of subscriber markets - including private
homes, corporate telecommuters, and small businesses. We develop and sell
headend equipment, subscriber cable modems, and network management software to
support the Asynchronous Transfer Mode, or ATM, Data Over Cable System Interface
Specification, or DOCSIS, European Data-Over-Cable System Interface, or
EuroDOCSIS, and Digital Video Broadcasting, or DVB standards. In the North
American market, we sell directly to cable operators such as Comcast
Communications, AT&T, Charter Communications, Cox Communications, and to systems
integrators such as HSA. Internationally, we sell primarily to systems
integrators such as Telindus, Furukawa and Siemens, who in turn sell to cable
operators.
During the first half of 2000, cable modem manufacturers experienced shortages
and long lead times for component materials such as flash memory and capacitors.
Due to these shortages, the production of cable modems was constrained. We
placed substantial orders for component material to ensure we would meet our
anticipated build plan, especially for our DOXport(R) 1110 modem that we
commenced shipping late in the third quarter of 2000. We believe cable operators
also overbought in the second and third quarters of 2000 to ensure they had
sufficient product to meet subscriber demand. During the fourth quarter of 2000,
the order rates from cable operators and corresponding revenues dropped sharply
resulting in lower demand as cable operators started to balance and bring down
their inventory levels. This slow down in sales in the fourth quarter of 2000
caused our finished goods inventory levels to increase substantially. During the
first six months of 2001, inventory declined 32% as we reduced the build rate of
our contract manufacturers, and managed our inventory levels, and revenues
leveled off. Although inventory declined, our contract manufacturers have begun
charging us for the carrying cost of inventory which they purchased on our
behalf.
In addition, at the end of 2000, cable operators began to lengthen their
accounts payable payments cycles as they managed their working capital more
tightly. Although we believe that distribution of cable modems will continue to
increase since subscriber growth for high speed Internet access is forecasted to
increase in 2001, some cable operators delayed ordering new equipment in early
2001 in order to use the existing levels of inventory. This caused a sequential
decrease in the amount of product that we shipped in North America in the six
months of 2001. Due to this oversupply of inventory by some manufacturers, price
competition has become more
14
15
intense which resulted in lower average selling prices and gross margin
pressures, especially on DOCSIS modems. We believe these factors are likely to
depress revenues and margins, and are likely to cause inventory levels to remain
higher than historical levels due to lower shipment rates. During the first six
months of 2001, we reduced the number of days of sales outstanding from 90 days
as of December 31, 2000 to 85 days as of June 30, 2001, by using more aggressive
collection efforts. We anticipate that accounts receivable balances will remain
at a relatively high level compared to historical levels as cable operators
manage working capital tightly.
In January 2001, Com21 announced a number of programs to reduce operating
expenses. These programs are designed to prioritize Com21 initiatives around
high-growth areas of our business, focus on profit contribution and reduce
expenses and capital spending. These restructuring programs include workforce
reductions, reorganization and closure of certain business functions, and
consolidation of excess facilities. As a result of the restructuring efforts,
Com21 recorded a restructuring charge of $67.4 for the three months ended June
30, 2001. In addition, the Company recorded restructuring charges of $416,000
and $87,000 in the quarters ended December 31, 2000 and March 31, 2001,
respectively, related to reductions in workforce in those periods.
The restructuring program resulted in the reduction of approximately 300
employees across all business functions and operating units including employees
of the wireless business unit, Maryland development center and corporate
headquarters. The remaining balance of $212,000 related to severance and fringe
benefits will be disbursed in the third quarter of 2001.
In April 2001, we ceased development in our wireless business unit to focus our
efforts on projects with shorter development cycles. All wireless employees were
terminated and the facility located in Long Island, New York was closed in May
2001.
As Com21 consolidated its facilities and focused on reducing expenses, the
development of ATM products was transferred from the Maryland development center
(formerly known as BitCom) to the facility in Cork, Ireland in April 2001. The
Maryland development center facility was closed and all employees were
terminated in May in 2001. This closure resulted in a restructuring charge of
$4.7 million relating primarily to the write-off of deferred stock compensation
for terminated employees.
In June 2001, Com21 sold the voice systems division (formerly know as GADline)
to its management team and recorded a charge of $55.4 million. Of the amount,
$50.8 million relates to the impairment of goodwill and purchased intangible
assets, measured as the amount by which the carrying amount exceeded the present
value of the estimated future cash flows for goodwill and purchased intangible
assets. The $50.8 million consists primarily of goodwill and technology
capitalized in the GADline acquisition.
The goodwill associated with the GADline acquisition is primarily related to
GADline's in-process voice technology. This technology was not fully developed
as of the spin-off, and Com21 does not currently plan to continue to fund this
technology, to develop alternative technology or to integrate any existing
GADline's voice technology in future products. As there will be no future
benefit to Com21 from the goodwill, the $36.0 million of goodwill from the
GADline acquistion was written off at the time of spin-off.
It was also determined at the time of the spin-off, through a review of Com21's
current product portfolio and future product roadmap, that the technologies
purchased from GADline were not and would not be utilized in Com21 products
subsequent to the spin-off. The technology behind
15
16
GADline products includes, a cable modem designed by GADline and an end to end
network system providing voice and data services over cable television lines. As
Com21 has not integrated and does not expect to integrate the technology into
its product portfolio, and the rights to this technology and these products were
sold to the purchasers of the voice systems division, the intangible asset of
$12.4 million associated with the purchased technology was written off.
The remaining $4.6 million of the charge associated with the spin-off of the
voice systems division includes a cash payment to the buyers of $1.3 million
which was paid at the time of separation and disposal of net intangible assets.
A convertible note received from the buyers was not valued as the estimated
recovery was zero.
The consolidation of excess facilities includes the closure of the wireless
business unit facility in Long Island, New York, the Maryland development
center, and a building in Milpitas, California during the three months ended
June 30, 2001. Com21 recorded a charge of $6.3 million related primarily to the
net rental expense on non-cancelable leases and the write-off of fixed assets
and leasehold improvements. Estimated future lease payments of $4.6 million are
expected to be paid over the next 18 quarters.
In the future, we may continue to reduce operating expenses to accommodate
potentially decreased revenues or gross margins, or discontinue some development
programs and product lines. This could result in reductions in work force,
restructuring charges, write offs of inventory carrying values or provisions for
the impairment of long-lived assets. Any of these factors could affect our
financial position, results of operations, cash flows or stock price.
We completed a $7,650,615 equity financing with Fletcher International Limited
(Fletcher). Pursuant to a subscription agreement, dated February 28, 2001,
Fletcher agreed to purchase approximately 2,450,000 shares of Com21's common
stock at a price of $3.1227 per share and a warrant to acquire up to an
additional 2,450,000 shares of Com21's common stock. The offer and sale of these
securities were not registered under the Securities Act of 1933, as amended,
pursuant to the exemption provided by Regulation D and these securities may not
be offered or sold in the United States absent registration or an applicable
exemption from registration requirements. The warrant is immediately exercisable
and remains exercisable for a period of seven years from the date of issuance at
the exercise price of $9.0951 per share. The number of shares issuable upon
exercise of the warrant and the exercise price per share are subject to
adjustment upon the occurrence of events set forth in the warrant including: the
issuance of additional securities at a price below the greater of the market
price of the common stock and the exercise price of the warrant or the
declaration of a stock split, dividend, consolidation, recombination,
reclassification or similar transaction. The fair value of the warrant is
approximately $2,500,000 and is recorded as additional paid in capital. Net
proceeds from the private equity financing were $6,864,000.
According to the agreement, Com21 was contractually obligated to issue
additional warrants of 5% of the outstanding shares of common stock and warrants
held by Fletcher if the shares issued to Fletcher were not registered by June 5,
2001. At June 5, July 5 and August 5, 2001 Com21 was required to issue an
additional 245,000, 257,250 and 270,113 of warrants, respectively. The Company
is required to continue to issue warrants monthly until such time as the shares
are registered. The fair value of the warrants, $330,000, $182,000, and $104,000
were determined using the Black-Scholes option pricing model over the
contractual term of the warrant with the following assumptions: stock
volatility, 75%; risk free interest rate, 5.4%; and no dividends during the
expected term.
16
17
Com21 was incorporated in Delaware in June 1992. Our principal executive offices
are located at 750 Tasman Drive, Milpitas, California 95035 and our telephone
number at that address is (408) 953-9100. We can also be reached at our Web site
http://www.com21.com. The contents of our website are not part of this report.
RESULTS OF OPERATIONS
Total Revenues - Total revenues decreased 34% from $51.4 million in the second
quarter of 2000 to $34.1 million in the second quarter of 2001, and decreased
28% from $92.9 million for the first six months of 2000 to $66.9 million for the
first six months of 2001. The decrease in revenues is due to a continuing
industry-wide downturn in broadband equipment purchases as cable operators
balanced inventories and capital expenditures. Although unit sales of all our
cable modem products increased a modest 2% from the second quarter of 2000, the
product mix shifted to include higher volumes of the lower priced DOCSIS modems
with lower volumes of the ATM products being shipped. In addition, the average
sales price of DOCSIS cable modems declined from the second quarter of 2000 due
to heavy price competition. The mix change combined with the decreasing average
selling prices resulted in the lower revenue level for the second quarter of
2001. We anticipate that the averages sales price of modems will continue to
decline during 2001.
Cable modem revenues accounted for 84% of total revenues in the second quarter
of 2001 as compared to 77% of total revenues in the second quarter of 2000 and
85% of total revenues for the six months of 2001 as compared to 81% of total
revenues for the six months of 2000. The average sales price of all cable modems
declined from the second quarter of 2000 to the second quarter of 2001 due to
planned price reductions, industry-wide price competition, and product mix as we
are selling more DOCSIS modems. The average sales price of headend equipment
also declined from the second quarter of 2000 to the second quarter of 2001 due
to planned price reductions. We anticipate continued pricing pressure on our
cable modems and headend equipment, and decline in our average sales price of
our cable modems and headend equipment.
During the quarter ended June 30, 2001 and 2000, international sales accounted
for 69% of total revenues. During the six months ended June 30, 2001,
international sales accounted for 73% of total revenues, increasing from the 67%
experienced in the first six months of 2000.
In the second quarter of 2000, revenues attributable to Siemens accounted for
18% while revenues attributable to Telindus accounted for 10% of total revenues.
In the second quarter of 2001, revenues attributable to Telindus, Comcast and
Furukawa accounted for 19%, 13% and 10%, respectively.
Gross Margins - Gross margins decreased from 27% in the second quarter of 2000
to 5% in the second quarter of 2001, and decreased from 29% during the first six
months of 2000 to 7% during the first six months of 2001. The decrease in
margins is primarily due to the following factors:
- The sale of more DOCSIS modems, which have lower gross margins
than our proprietary ATM modem. DOCSIS cable modem shipments
increased from 92,000 units or 50% of total Com21 modems shipped
in second quarter 2000 to 110,000 units or 59% of total Com21
modems shipped in second quarter 2001. The adoption of the
DOCSIS-based standard has caused considerable price pressure due
to the number of competitors in the marketplace.
17
18
- Carrying charges resulting from excess inventory at our contract
manufacturers.
- Write down of some of our component inventory to net realizable
value.
- Sales of high cost OEM DOCSIS modems and first generation DOCSIS
modems at clearance prices resulting in negative gross margins.
- Amortization of intangible assets as a result of the GADline
acquisition.
During 2001 we anticipate continued pressure on margins due to the following:
- Increased sales of our DOCSIS cable modems. If the mix of
shipments shifts to the lower margin DOCSIS modems, then our
total margin percentage will decline.
- Competitive pricing offered by entrenched suppliers to move
inventory and increase market share. As the industry continues
to move toward standardization of technology, we anticipate
increased pricing pressure.
We are taking steps to counter the impact of this price erosion by continuing
modem cost reduction programs.
As noted above cable modem sales accounted for 85% of total revenue in the first
half of 2001 as compared to 81% of total revenue in the first half of 2000.
Additionally, revenue from our DOCSIS cable modems has become a more significant
portion of our total cable modem revenue. Cable modems have lower margins than
our headend products and our DOCSIS cable modems currently have lower margins
than our proprietary cable modems.
Research and Development - Research and development expenses decreased 39% from
$10.2 million in the second quarter of 2000 to $6.2 million in the second
quarter of 2001, and decreased 15% from $18.5 million during the first six
months of 2000 to $15.7 million during the first six months of 2001. The
decrease in research and development expenses is due to our efforts to reduce
costs. These efforts involved workforce reduction, elimination of certain
development programs and closure and consolidation of research and development
facilities as we refocus our development efforts on key technology initiatives.
In 2001, we anticipate that research and development expenses will be less than
the 2000 level by about $14.0 million to $16.0 million.
Sales and Marketing - Sales and marketing expenses decreased 29% from $6.5
million in the second quarter of 2000 to $4.6 million in the second quarter of
2001, and decreased 5% from $12.7 million during the first six months of 2000 to
$12.0 million during the first six months of 2001. This decline is due to our
efforts to reduce costs which involved workforce reduction and a decrease in
expenditures on marketing programs. In 2001, we anticipate that sales and
marketing expenses will be less than the 2000 level by about $5.0 to $7.0
million.
General and Administrative - General and administrative expenses increased 80%
from $2.0 million in the second quarter of 2000 to $3.6 million in the second
quarter of 2001, and increased 129% from $3.6 million during the first six
months of 2000 to $8.3 million during the first six months of 2001. The increase
from the second quarter of 2000 to the second quarter of 2001 was related to
higher personnel related costs, increased rent, inclusion of expenses of our
GADline acquisition, professional fees, and insurance costs. We anticipate that
general and administrative
18
19
expenses in the subsequent quarters of 2001 will be approximately at the same
level as the second quarter of 2001.
Amortization of Intangible Assets - Amortization of intangible assets relating
to our July 2000 acquisitions of GADline and BitCom totaled an aggregate of $1.8
million for the three months ended June 30, 2001 and $4.5 for the six months
ended June 30, 2001. In connection with GADline and BitCom acquisitions, we
recorded intangible assets of $67.7 million, which is being amortized, on a
straight-line basis over useful lives of three to five years. During the second
quarter of 2001, we spun-off GADline and closed down BitCom which resulted in
the write-off of intangible assets of $51.6 million which is recorded as
restructuring charges.
Stock-Based Compensation - Stock-based compensation resulted primarily from the
amortization of deferred stock compensation generated from assumed unvested
options and restricted stock in our July 2000 acquisitions of GADline and BitCom
and the fair value of common stock issued to non-employees for services, and the
issuance of additional shares related to meeting defined milestones in January
2001. Deferred stock compensation is being amortized to expense over the vesting
period of the individual options. During the second quarter of 2001, we spun-off
GADline and closed BitCom which resulted in the acceleration of deferred stock
compensation for terminated employees of $4.4 million which is recorded as
restructuring charges.
Total Other Income, Net - Total other income, decreased 91% from $1.4 million in
the second quarter 2000 to $125,000 in second quarter 2001, and decreased 86%
from $2.8 million during the first six months of 2000 to $401,000 million during
the first six months of 2001. The decrease was attributable to lower interest
income on a declining cash and investments balance during 2000 and 2001, and
higher interest expense due to the line of credit existing in 2001 but not in
2000.
LIQUIDITY AND CAPITAL RESOURCES
At June 30, 2001, our cash, cash equivalents, and short-term investments were
$13.7 million excluding restricted cash of $10.3 million, compared to $34.7
million at December 31, 2000, a decrease of $21.0 million. The decrease is
primarily a result of cash used in operations of $27.1 million and cash used for
purchases of property and equipment of $806,000. Cash outflows from operations
is due primarily to a net loss of $26.9 million after non-cash items offset by
an decrease in accounts receivable, inventory, prepaid expenses and other assets
of $21.3 million and a decrease to accounts payable, accrued compensation and
related benefits and other current liabilities of $26.3 million. In the first
quarter of 2001, we raised $6.9 million net of related costs in a private equity
financing and had $8.0 million as proceeds from sale of investments.
During 2000 we generated net losses of approximately $56.1 million and for the
six months ended June 30, 2001, the net loss was $104.5 million. If we do not
increase revenues, improve margins and reduce operating expenses, we may also
incur net losses during future quarters. Because of a decline in our revenues in
the fourth quarter of 2000, we introduced measures to reduce operating expenses
that included reducing our workforce in December 2000, February and May 2001,
the closure of our Maryland development center and the wireless business unit
both in April 2001, and the spin-off of our voice product division (formerly
GADline) in June 2001. These measures resulted in a $67.4 million restructuring
charge recorded in the second quarter of 2001. Management continues to monitor
market conditions to assess the need to take further action, if necessary. Any
subsequent actions may result in additional work force reductions,
discontinuation of product lines, and provisions for impairment of long-lived
assets which could harm our results of operations and stock price.
19
20
At June 30, 2001, we had working capital of approximately $38.6 million. While
we have not changed our credit, collections and delinquencies policy, the market
decline during the second half of 2000 caused us to have difficulties in
receiving payment within our normal payment terms of net 30 days. However during
the first half of 2001, we were able to reduce the investment in accounts
receivable by reducing the average collection period and days of sales
outstanding from 90 days as of December 31, 2000 to 85 days at June 30, 2001 by
using more aggressive collection efforts. While we were able to reduce our
finished goods inventory, we expect inventory levels to remain at a higher level
over the next two quarters as we convert raw material to finished goods and then
ship to customers. We expect that our investments in accounts receivable and
inventories will continue to represent a significant portion of working capital.
Our principal source of liquidity as of June 30, 2001, consisted of
approximately $13.7 million of cash and cash equivalents and short-term
investments. We have executed a standby letter of credit for our contract
manufacturer, Celestica. If we fail to pay their invoices within 30 days,
Celestica can secure payment against the $10.3 million standby letter of credit
which expires on April 30, 2002. At June 30, 2001, we had outstanding borrowing
of approximately $9.0 million under our line of credit, which expires November
30, 2001. The agreement as amended in March 2001 requires Com21 to comply with
certain financial covenants which include maintaining a minimum tangible
effective net worth of $70,000,000; a maximum debt-to-worth ratio of 1.00:1.00;
a minimum quick ratio of 1.00:1.00; maximum net loss of $2,500,000 excluding
non-cash charges and one time costs and expenses; and minimum unrestricted cash
of $5,000,000. At June 30, 2001, Com21 did not meet the minimum tangible net
worth, the maximum debt-to-worth and the maximum net loss covenants. A waiver
for these violations as of June 30, 2001 was received on July 20, 2001.
In replacement of the waiver received on July 20, 2001, the bank amended the
revolving line of credit arrangement in August 2001. The amendment reduced the
maximum borrowing to the lesser of $7,500,000 or 65% of Com21's eligible
domestic and foreign receivables until October 1, 2001, at which time the
percentage decreases to 55%. The bank increased the rate at which the borrowings
bear interest to the bank's prime rate plus 1.25%. The agreement amends the
financial covenants to a minimum tangible effective net worth of $35,000,000; a
maximum debt-to-worth ratio of 1.60:1.00; a minimum quick ratio of 0.85:1.00;
maximum net loss of $12,500,000 for the second quarter of 2001 excluding
non-cash charges up to $75,000,000 and $6,500,000 for the quarter ending
September 30, 2001; and minimum unrestricted cash of $5,000,000. As of August
10, 2001, Com21 has no availability for additional borrowings or draws under the
arrangement.
Additionally, the bank converted $1,500,000 of Com21's outstanding borrowings
under the line into a term loan. The term loan will expire on December 1, 2001,
bears interest rate at the bank's prime rate, and is payable monthly.
Com21 has also agreed to refinance the $7,500,000 revolving line of credit with
another lender by September 28, 2001. Com21 will be required to pay the bank a
monthly fee of $1,000 for extensions beyond the stipulated dates for the
replacement funding with another financial institution. As part of the
arrangement, Com21 has also agreed to seek additional equity funding. In light
of our current financial situation and our history of operating losses, we
expect such financing to be available but at less favorable terms than our
present financing arrangement. Future alternative forms of financing may also
restrict Com21's operations or limit our ability to
20
21
respond quickly to changes in the market place. As previously announced, Com21
has engaged Dain Rauscher Wessels to help us evaluate alternative forms of
financing. These alternatives may include the sale of additional stock,
additional lines of credit, and the divestiture of certain business assets.
There can be no assurance, however, that any additional financing will be
available to us on acceptable terms, or at all, when required. If additional
funds are raised by issuing equity securities, significant dilution to existing
stockholders may result given the current price of our common stock. If
additional funds are not available, we may be required to delay, scale back, or
eliminate one or more of our research and development or manufacturing programs.
Accordingly, the inability to obtain this financing could harm our business,
financial condition, and results of operations.
We have been working with our key suppliers to secure favorable payment terms
including deferring some payments to later periods. Given the size and working
capital needs of our business, our recent history of losses, and the steps we
are taking to reduce these losses such as discussions with our key suppliers for
more favorable payment terms, we judge our current liquidity situation to be
adequate for the next twelve months. At present, we have no material commitment
for capital equipment purchases. However, our two largest contract manufacturers
have obtained or have on order inventory in the amount of $46.2 million as of
June 30, 2001 to meet our future build plans. If our future shipments do not use
up this inventory, these contract manufacturers have the right to charge us for
inventory carrying costs and to bill us for any excess component and finished
goods inventory. We are currently working with our contract manufacturers to
ensure an orderly production and payment plan.
RISK FACTORS
You should carefully consider the risks described below before making a decision
to invest in Com21. You may lose all or part of your investment. The risks and
uncertainties described below are not the only ones facing Com21.
COM21 MAY BE CHARGED FOR EXCESS INVENTORY HELD OR ON ORDER WITH OUR CONTRACT
MANUFACTURERS WHICH WOULD REDUCE OUR REVENUES.
Our contract manufacturers have obtained or have on order substantial amounts of
inventory to meet our revenues forecasts. If our future shipments do not use up
inventory, these contract manufacturers have the right to charge us for
inventory carrying costs and to bill us for any excess component and finished
goods inventory. Through June 30, 2001, we have been billed for inventory
carrying charges of approximately $1.4 million. As of June 30, 2001, our two
largest contract manufacturers had approximately $46.2 million of on hand
inventory and purchase commitments for materials and components used to
manufacture our products. We must fulfill these obligations even if demand for
our products is lower than we anticipate which could reduce our working capital
and have a negative impact on our financial position. We believe that within the
next 9 months, shipments of our modem products will create sufficient orders to
relieve our commitment to our contract manufacturers.
COM21 MAY BE UNABLE TO OBTAIN ADDITIONAL CAPITAL NEEDED TO OPERATE AND GROW OUR
BUSINESS, WHICH COULD WEAKEN OUR FINANCIAL CONDITION AND MAKE US UNABLE TO
DEVELOP OUR TECHNOLOGIES AND PRODUCTS.
We cannot assure you that any additional financing will be available to us on
acceptable terms, or at all, when required. As previously announced, Com21 has
engaged Dain Rauscher Wessels to help us evaluate alternative forms of
financing. These alternatives may include the sale of additional stock,
additional lines of credit, and the divestiture of certain business assets. If
additional funds are raised
21
22
by issuing equity securities, significant dilution to existing stockholders may
result given the current price of our common stock. If additional funds are not
available, we may be required to delay, scale back, or eliminate one or more of
our research and development or manufacturing programs.
As part of an agreement with our current bank lender, Com21 has agreed to seek
additional equity funding and to replace the $7,500,000 revolving line of credit
by September 28, 2001. We are seeking replacement funding with other financial
institutions in order to meet our agreement with the bank. In light of our
current financial situation and our history of operating losses, we expect such
financing to be available but it may be at less favorable terms than our present
financing arrangement. Future alternative forms of financing may also restrict
Com21's operations or limit our ability to respond quickly to changes in the
market place.
As of June 30, 2001 we had an accumulated deficit of approximately $219.6
million. If we do not increase revenues, improve margins and reduce operating
expenses, we may also incur net losses during future quarters. Because of a
decline in our revenues in the fourth quarter of 2000, we introduced measures to
reduce operating expenses that included reducing our workforce in December 2000
and February 2001, the closure of our Maryland development center (formerly
BitCom) and the wireless business unit both in April 2001, and the spin-off our
voice product division (formerly GADline). These measures resulted in a $67.4
million restructuring charge recorded in the second quarter of 2001. Management
continues to monitor market conditions to assess the need to take further
action, if necessary. Any subsequent actions may result in additional work force
reductions, restructuring charges, discontinuation of product lines, and
provisions for impairment of long-lived assets which could harm our results of
operations and stock price.
COM21'S REVENUES IN ONE OR MORE FUTURE PERIODS ARE LIKELY TO FLUCTUATE
SIGNIFICANTLY AND MAY FAIL TO MEET OR EXCEED THE EXPECTATIONS OF SECURITIES
ANALYSTS OR INVESTORS.
Com21's operating results are likely to fluctuate significantly in the future on
a quarterly and an annual basis due to a number of factors, many of which are
outside Com21's control. Supply of components, delays in getting new products
into high volume manufacturing, and manufacturing or testing constraints could
result in delays in the delivery of products and impact revenues and gross
margins.
Total revenues for any future quarter are difficult to predict. Delays in the
product distribution schedule of one or more of our cable operator customers
would likely reduce our operating results for a particular period.
Factors that could cause our revenues to fluctuate include:
- pressure to reduce prices;
- variations in the timing of orders and shipments of our
products;
- variations in the size of orders by our customers;
- new product introductions by us or by competitors;
- delays certifying standards-based products;
- general economic conditions and economic conditions specific to
the cable and electronic data transmission industries;
- cable operators' financial ability to purchase our products; and
- delays in obtaining CableLabs and regulatory approvals necessary
to sell our products.
22
23
FLUCTUATIONS IN OUR STOCK PRICE COULD IMPACT OUR RELATIONSHIPS WITH EXISTING
CUSTOMERS AND DISCOURAGE POTENTIAL CUSTOMERS FROM DOING BUSINESS WITH US.
Fluctuations in our stock price could lead to a loss of revenues due to our
inability to engage new customers and vendors and to renew contracts with our
current customers and vendors. Existing and potential customers and vendors may
perceive our fluctuating stock price as a sign of instability and may be
unwilling to do business with us. If this were to continue to occur, our
business, results of operations and financial condition could be harmed.
COM21'S GROSS MARGIN IN ONE OR MORE FUTURE PERIODS IS LIKELY TO FLUCTUATE
SIGNIFICANTLY AND MAY CAUSE OPERATING RESULTS TO FALL BELOW THE EXPECTATIONS OF
ANALYSTS AND INVESTORS.
Our operating results are impacted significantly by our ability to improve and
sustain gross margins. The factors which impact gross margins and cause them to
fluctuate from quarter to quarter include:
- pressures to reduce prices;
- changes in the cost of inventory;
- the sales mix within a product group, especially between
proprietary and DOCSIS modems;
- component prices we secure from our vendors;
- the average selling prices of our products;
- the effectiveness of our cost reduction efforts;
- the sales mix between our headend equipment and cable modems;
and
- the volume of products manufactured.
Additionally, our inability to reduce inventory levels may result in substantial
inventory-related charges including marking component inventory to current
market prices because of falling component prices, and significant excess and
obsolescence inventory write-offs because of slow moving inventory.
A reduction in gross margins would harm our operating results and reduce the
amount of cash flow generated from operations. Additionally, if operating
results did not satisfy the expectations of analysts or investors, the trading
price of our common stock would likely decline.
WE MUST REDUCE THE COST OF OUR CABLE MODEMS TO REMAIN COMPETITIVE.
Some of our competitors have assets and annual revenues that far exceed ours and
because of their financial status are able to offer cable modem products at
lower prices than we can offer cable modems. As headend equipment becomes more
widely distributed, the price of cable modems and related equipment will
continue to decrease. In particular, the adoption of industry standards, such as
the data-over-cable service interface specification, or DOCSIS, standard in
North America, has caused increased price competition for cable modems. To
remain competitive, we may have to lower the price of our modems in anticipation
of planned product cost reductions of our DOCSIS modems. We may not be able to
continually reduce the costs of manufacturing our cable modems or to secure
component parts at a low enough cost to enable us to lower our modem prices to
compete effectively. As we perform on our cost reduction program, we may not be
able to continue to certify our DOCSIS modems in a timely manner by
23
24
various standards bodies including CableLabs. If we are unable to continue to
reduce the manufacturing costs of our cable modems, our gross margin and
operating results could be harmed.
COM21 HAS A SHORT OPERATING HISTORY, HAS NOT MADE A PROFIT AND EXPECTS TO INCUR
LOSSES IN THE FUTURE.
We have not made a profit, and we expect to continue to operate at a loss
through fiscal year 2001. To achieve and subsequently maintain profitable
operations, we must successfully design, develop, test, manufacture, introduce,
market and distribute products on a broad commercial basis and secure higher
revenues and gross profits and contain our operating expenses. Our future
revenue will depend on a number of factors, many of which are beyond our
control. These factors include our ability to:
- reduce prices;
- manufacture products at acceptable quality standards;
- have product available when our customers need it;
- meet industry standards;
- respond to technology change; and
- have a strong competitive advantage.
Due to these factors, we cannot forecast with a degree of accuracy what our
revenues will be or how quickly cable operators will adopt our systems and buy
our cable modems. If we do not generate sufficient revenues and gross margins,
we may not achieve, or be able to sustain, profitability.
WE MAY NOT BE ABLE TO MAINTAIN OUR LISTING ON THE NATIONAL MARKET.
Our common stock is currently listed on the Nasdaq National Market. We must
satisfy a number of requirements to maintain its listing on the Nasdaq National
Market, including maintaining a minimum bid price for our common stock of $1.00
per share. As of July 30, 2001, the price of our common stock was $1.03. If the
common stock loses its Nasdaq National Market status, it would likely trade on
the Over the Counter Bulletin Board maintained by Nasdaq, which is viewed by
most investors as a less desirable, less liquid marketplace.
OUR FUTURE SUCCESS WILL DEPEND IN PART UPON OUR ABILITY TO ENHANCE OUR EXISTING
PRODUCTS AND TO DEVELOP AND INTRODUCE, ON A TIMELY BASIS, NEW PRODUCTS AND
FEATURES THAT MEET CHANGING CUSTOMER REQUIREMENTS AND EMERGING INDUSTRY
STANDARDS.
The market for cable modem systems and products is characterized by rapidly
changing technologies and short product life cycles. Our future success will
depend in large part upon our ability to:
- identify and respond to emerging technological trends in the
market;
- develop and maintain competitive products;
- enhance our products by adding innovative features that
differentiate our products from those of competitors;
- bring products to market on a timely basis at competitive
prices; and
24
25
- respond effectively to new technological changes or new product
announcements by others.
The technological innovations required for us to remain competitive are
inherently complex, require long development cycles, are dependent in some cases
on sole source suppliers and require us, in some cases, to license technology
from others. If our product development and enhancements take longer than
planned, the availability of products would be delayed. We must continue to
invest in research and development to attempt to maintain and enhance our
existing technologies and products, but we may not have the funds available to
do so. Even if we have sufficient funds, these investments may not serve the
needs of our customers or be compatible with changing technological requirements
or standards. Most costs must be incurred before we can determine the
technological feasibility or commercial viability. In addition, revenues from
future products or product enhancements may not be sufficient to recover the
development costs incurred by these products or enhancements.
We may not be successful in managing the transition from our current products to
our new and enhanced products. Product transitions contain a number of inherent
risks including obsolescence of product inventory, unavailability of product as
inventory of existing product is exhausted before availability of new product,
market acceptance of new products, undetected defects in new products, and
availability of components and parts in new products. If we are unable to
successfully manage the risks of the release and transition of new and enhanced
products, our revenues would be reduced.
THE MARKET IN WHICH WE SELL OUR PRODUCTS IS CHARACTERIZED BY MANY COMPETING
TECHNOLOGIES, AND THE TECHNOLOGY ON WHICH OUR PRODUCT IS BASED MAY NOT COMPETE
EFFECTIVELY AGAINST OTHER TECHNOLOGIES.
There are many different methods of getting high speed Internet access to the
end customers. These methods include:
- Regular dial up connection--using a telephone line and the
average 28K or 56K modem;
- Digital subscriber line/asymmetric digital subscriber line--a
digital high-speed modem connection offered by telephone
companies, this is also known as DSL or ADSL;
- Cable modems--high speed modem connections offered by cable
television companies;
- Wireless--high speed wireless local loop connections that work
similar to cell phones (digital subscriber line/asymmetric
digital subscriber line and cable modems can operate in a
wireless environment); and
- Fiber optics--strands of very pure glass capable of carrying
enormous volumes of data and voice traffic.
Because of the widespread reach of telephone networks and the financial
resources of telephone companies, competition from telephone-based solutions is
expected to be intense. Cable modem technology may not be able to compete
effectively against wireline or wireless technologies. Significant market
acceptance of alternative solutions for high-speed data transmission could
decrease the demand for our products if these alternatives are viewed as
providing faster access, greater reliability, increased cost-effectiveness or
other advantages.
25
26
COM21'S MARKET IS HIGHLY COMPETITIVE AND HAS MANY ESTABLISHED COMPETITORS.
The market for Com21's products is intensely competitive, rapidly evolving and
subject to rapid technological change. Our competitors include Motorola, Inc.,
Toshiba America, Inc., 3Com Corporation, RCA/Thomson, Scientific Atlanta, Inc.,
Ericsson, Terayon Communication Systems, Cisco Systems, Inc., and Nortel
Network, Inc.
We believe that our business is affected by the following competitive factors:
- costs;
- ease of installation;
- technical support and service;
- breadth of product line;
- conformity to industry standards; and
- implementation of additional product features and enhancements.
Many of our existing and potential competitors have been operating longer, have
better name recognition, more established business relationships and
significantly greater financial, technical, marketing and distribution resources
than we do. These competitors may undertake more extensive marketing campaigns,
adopt more aggressive pricing policies, undertake more vendor financing programs
or longer customer payment cycles and devote substantially more resources to
developing new or enhanced products than we do. Some competitors may sell their
modems at below cost to reduce excess inventories causing severe price
competition.
SUPPLY OF OUR PRODUCTS MAY BE LIMITED BY OUR ABILITY TO FORECAST DEMAND
ACCURATELY.
Our customers have increasingly been requiring us to ship product upon ordering
instead of submitting purchase orders far in advance of expected shipment dates.
This practice requires us to keep inventory on hand for immediate shipment. Any
significant cancellations or deferrals could adversely affect our business by
slowing our growth and decreasing our revenues. Additionally, cancellations or
deferrals could cause us to hold excess inventory, which could reduce our profit
margins and restrict our ability to fund our operations. In particular,
increases in inventory could cause a harmful effect on operations if this
inventory is not used or becomes obsolete. This risk could be realized in
inventory write-downs in any given period.
WE MAY BE SUBJECT TO PRODUCT RETURNS AND PRODUCT LIABILITY CLAIMS DUE TO DEFECTS
IN ITS PRODUCTS.
Our products are complex and may contain undetected defects, errors, design
deficiencies, or may have been manufactured incorrectly. Our products have
contained errors in the past and may contain errors in the future. As part of
our focus on customer support, we are evaluating a manufacturing error in one of
our cable modem products. We plan to test this product to determine the rate of
failure and, if necessary, we may repair a number of units. We have not yet
determined the potential costs of repairing these products. We believe this is
an issue with the manufacturing process of one of our contract manufacturers.
However, if we are not successful in negotiating with our contract manufacturer
to cover these costs, we may be subject to additional costs to repair or replace
these products in future periods. Defects, errors, or failures in our other
products could result in delayed shipments, returned products, and loss or delay
of market acceptance of our products. We could incur costs or losses in excess
of amounts that we have reserved for these events. Although we have not
experienced any product liability claims,
26
27
due to the highly technical nature of our products, such a risk exists. A
successful product liability claim brought against us could impair our business,
operating results and financial condition by forcing us to use cash and
personnel resources. This would limit our ability to grow the company and would
decrease our revenues.
OUR STOCK PRICE IS HIGHLY VOLATILE AND BROAD MARKET FLUCTUATIONS MAY ADVERSELY
AFFECT THE MARKET PRICE OF OUR COMMON STOCK.
The trading price of our common stock has fluctuated significantly since our
initial public offering in May 1998. The common stock price has fluctuated
between $15.5625 per share and $1.03 per share in the last twelve month period.
The price of our common stock could continue to be subject to wide fluctuations
in response a variety of factors including
- variations in quarterly earnings;
- announcements of technological innovations or new products by us
or our competitors;
- announcements by certification and standards bodies;
- the state of Com21's patents or proprietary rights; and
- changes in financial estimates by securities analysts.
Additionally, the stock market is volatile. This volatility has particularly
affected the stock prices of equity securities of many high technology companies
and, often, has been unrelated or disproportionate to the operating performance
of these companies. Our stock price has declined significantly and our stock
price may continue to decline because of these broad market and industry
factors, regardless of our actual operating performance. These broad market
fluctuations may lower the market price of Com21 common stock. Additionally,
Com21 may choose to structure acquisitions or other financing transactions by
issuing additional Com21 common stock, or warrants or options to purchase Com21
common stock that would dilute common stock outstanding. Although Com21's
management believes these types of transactions will increase the overall
long-term value of Com21, these transactions may initially decrease the market
price of our common stock.
WE MAY BE SUBJECT TO ADDITIONAL CREDIT RISK IN THE FORM OF TRADE ACCOUNTS
RECEIVABLE.
Our standard credit terms are net 30 days from the date of shipment, and we do
not require collateral or other security to support customer receivables. We may
require letters of credit from a customer before shipping an order if we
determine that the customer has not proven itself to be creditworthy. Due to the
overall market decline during the second half of 2000, we have had difficulties
in receiving payment within our net 30 day payment terms resulting in an
increase in the number of days of sales outstanding as compared to the first
half of 2000. Our days sales outstanding increased from 57 days at June 30, 2000
to 85 days at June 30, 2001.
COM21 IS DEPENDENT ON KEY PERSONNEL AND THE SUCCESSFUL PRODUCT MARKETING AND
DEVELOPMENT ACTIVITIES OF ITS PROPRIETARY PRODUCTS IN OUR CORK, IRELAND
FACILITY.
Our future operating results depend greatly upon the continued contribution of
key technical and senior management personnel. Future operating results also
depend on the ability to attract and retain these specially qualified
management, manufacturing, quality assurance, engineering, marketing, sales, and
support personnel. Competition for these personnel is intense, and Com21 may not
be successful in attracting or retaining these personnel. Only a limited number
of persons with the requisite skills to serve in these positions may exist and
it may be increasingly
27
28
difficult for us to hire these personnel. However, there is less competition for
these skilled workers in other countries. In February 2001, we began, and as of
the end of June 2001 we have completed, the transfer of the research and
development, product management and marketing functions for the proprietary
ComUNITY(R) Access product line to our facility in Cork, Ireland. We made this
transition to take advantage of the greater availability of qualified personnel
in Cork to support this product line. However, the loss of any key Cork employee
with technical, marketing or support knowledge may affect our ability to provide
timely development and support activities for the ComUNITY(R) Access product
line.
WE MAY NOT BE ABLE TO PRODUCE SUFFICIENT QUANTITIES OF OUR PRODUCTS BECAUSE WE
DEPEND ON THIRD-PARTY MANUFACTURERS, THEIR SUPPLIERS AND ORIGINAL EQUIPMENT
MANUFACTURERS AND HAVE LIMITED MANUFACTURING EXPERIENCE.
We contract for the manufacture of cable modems and integrated circuit boards on
a turnkey basis. Our future success will depend, in significant part, on our
ability to have others manufacture our products cost-effectively, in sufficient
volumes and to meet production and delivery schedules. Dependence on third-party
manufacturers presents a number of risks, including:
- not taking sufficient credit exposure on new product builds;
- lowering available credit limits;
- not providing sufficient payment terms;
- failure to meet delivery schedules;
- not building product which meet our quality standards;
- less than satisfactory manufacturing yields and costs;
- building product to meet our demand;
- difficulty in planning mix of units to be produced; and
- the potential misappropriation of our intellectual property if
the manufacturer were to market our products as its own.
Any manufacturing disruption could impair our ability to fulfill orders. We have
no long-term contracts or arrangements with any of our vendors that guarantee
product availability, the continuation of particular payment terms, or the
extension of credit limits. In the first half of 2000, we experienced supply
problems for components including flash memory, which limited our ability to
fulfill customer orders and had the effect of decreasing our revenues for that
period. We may also experience manufacturing or supply problems in the future.
We are dependent on our manufacturers to secure components at favorable prices,
and in sufficient volume. If our contract manufacturer fail to perform in any of
these areas, it could harm our relationships with customers. Failure to obtain
these components and supply our customers with product could decrease our
revenues.
COM21 MAY NOT BE SUCCESSFUL IN ATTRACTING AND RETAINING KEY PERSONNEL AND
MANAGEMENT.
Our future success depends, to a significant extent, on the ability of our
management to operate effectively, both individually and as a group. We must
retain and attract high caliber personnel. Competitors and others have in the
past and may in the future attempt to recruit Com21's employees. We do not have
employment contracts with any of our key personnel. We have experienced higher
turnover recently than in prior years and over the past five months have had to
lay off a number of employees, which may impact employee morale. We do not
maintain key person life insurance on key personnel. The loss of the services of
any of our key management or
28
29
personnel, the inability to attract or retain qualified personnel in the future
or delays in hiring required personnel, particularly engineers, could harm our
business by slowing research and development efforts and delaying product
development programs.
OUR STANDARDS-BASED PRODUCTS ARE SUBJECT TO EVOLVING INDUSTRY STANDARDS. IF OUR
PRODUCTS DO NOT COMPLY WITH ANY STANDARD THAT ACHIEVES MARKET ACCEPTANCE,
CUSTOMERS MAY REFUSE TO PURCHASE OUR PRODUCTS.
Early cable modem technology was not interoperable, meaning cable modem products
from different cable modem developers would not work together. For different
companies' products to work together, each company must meet an established
standard. For each standard, a certification body is established to certify that
a product does meet the standard. Cable operators are demanding certified
standards-based cable modem products for two primary reasons. First, a certified
product has proven to have the functionality they want. Second, certified
interoperable products give cable operators the freedom to buy products from a
variety of cable modem manufacturers, creating increased competition and driving
down prices.
Different standards are emerging in different parts of the world. In North
America, the DOCSIS standard has achieved substantial market acceptance. Cable
Television Laboratories, or CableLabs, performs certification for this DOCSIS
standard. The DOCSIS standard is an evolving standard and becomes more complex
and more difficult to comply with as it evolves. As we continue to enhance and
develop our DOCSIS products to meet the evolving DOCSIS standards, we may incur
additional costs. Additionally, we cannot assure you that enhancements or new
DOCSIS products will be CableLabs certified. Even if these products are
certified, we cannot assure you that they will be accepted by the market. In
Europe, there is movement by some cable operators towards either a digital video
broadcast or DVB standard or a European DOCSIS standard. We have developed DVB
cable modems, but we cannot assure you that these products will meet the
evolving standards or receive certification. Additionally, we cannot assure you
that if an European DOCSIS standard obtains widespread acceptance, Com21 will be
able to produce a cable modem to meet these specifications. The emergence or
evolution of industry standards, either through adoption by official standards
committees or widespread use by cable operators or telephone companies could
require us to redesign our products. The development of new competing
technologies and standards increases the risk that current or new competitors
could develop products that would reduce the competitiveness of our products. If
any of these new technologies or standards achieve widespread market acceptance,
any failure by us to develop new products or enhancements, or to address these
new technologies or standards, could harm our business.
THE ADOPTION OF STANDARDS COULD RESULT IN LOWER SALES OF COM21'S PROPRIETARY
PRODUCTS.
The widespread adoption of DOCSIS, DVB, European DOCSIS or other standards could
cause aggressive competition in the cable modem market and result in lower sales
of Com21's proprietary products which do not conform to these standards. As
cable operators move to standards based products, sales of Com21's proprietary
headend products, and revenues from licensing of its network management software
could decrease if our products do not meet the appropriate standards. This could
reduce our gross margin and our operating results.
WE RELY ON INDIRECT DISTRIBUTION CHANNELS FOR OUR PRODUCTS AND NEED TO DEVELOP
ADDITIONAL DISTRIBUTION CHANNELS.
Today, cable operators and systems integrators purchase cable modems from
vendors through direct and indirect sales channels. In North America, due to the
DOCSIS standard achieving
29
30
widespread market acceptance, we anticipate that the North American cable modem
market may at some point shift to a consumer purchase model. If this occurs, we
will likely sell more of our cable modems directly through consumer sales
channels. Our success will be dependent on our ability to market effectively to
end users, to establish brand awareness, to set up the required channels of
distribution and to have cable operators' reference sell our products. We have
begun to establish new distribution channels for our cable modems. We may not
have the capital required or the necessary personnel, or expertise to develop
these distribution channels, which could materially adversely affect our
business, operating results and financial condition. As large consumer
electronics companies enter the cable modem market, their well-established
retail distribution capabilities and brand would provide them with a significant
competitive advantage.
IF WE FAIL TO ADEQUATELY PROTECT OUR PROPRIETARY RIGHTS WE MAY BE UNABLE TO
SUCCESSFULLY COMPETE IN OUR INDUSTRY.
We depend on our proprietary technology. To protect our intellectual property
rights we rely on a combination of patent, copyright, trademark and trade secret
laws, and contractual restrictions on diclosure. However, any of our
intellectual proprietary rights could be challenged by third parties. Our means
of protecting our proprietary rights in the U.S. or abroad may not be adequate.
An unauthorized party may attempt to copy aspects of our products or to obtain
and use trade secrets or other proprietary information. Additionally, the laws
of some foreign countries do not protect Com21's proprietary rights as fully as
do the laws of the U.S. Issued patents may not preserve Com21's proprietary
position. Even if they do, competitors or others may develop technologies
similar to or superior to those of Com21. If we do not enforce and protect our
intellectual property, our business will be harmed. Also, due to the rapid pace
of technological change in the cable modem industry, many of our products rely
on key technologies developed by third parties, and we may not be able to
continue to obtain licenses from these third parties on favorable terms, if at
all.
OUR PRODUCTS MAY INFRINGE ON THE INTELLECTUAL PROPERTY RIGHTS OF THIRD PARTIES,
WHICH MAY RESULT IN LAWSUITS AND PROHIBIT US FROM SELLING OUR PRODUCTS.
Third parties may claim that we are infringing on their intellectual property.
Even if we do not believe that our products are infringing third parties'
intellectual property rights, these claims can be time-consuming, costly to
defend and divert management's attention and resources away from our business.
Claims of intellectual property infringement might also require us to enter into
costly royalty or license agreements. If we cannot or do not license the
infringed technology or substitute similar technology from another source, our
business could suffer. We may initiate claims or litigation against third
parties for infringement of our proprietary rights or to establish the validity
of our proprietary rights. Litigation to determine the validity of any claims,
whether or not the litigation is resolved in our favor, could result in
significant expense to us and divert the efforts of our technical and management
personnel from productive tasks. If there is an adverse ruling against us in any
litigation, we may be required to pay substantial damages, discontinued the use
and sale of infringing products, expend significant resources to develop
non-infringing technology or obtain licenses to infringing technology. Our
failure to develop or license a substitute technology could prevent us from
selling our products.
OUR FAILURE TO MANAGE OUR OPERATIONS COULD SLOW OUR GROWTH RATE OR GIVE RISE TO
INEFFICIENCIES WHICH WOULD REDUCE OUR REVENUES.
To drive costs out of our business and improve our operating efficiencies, we
may be required to:
30
31
- improve existing and implement new operational, financial and
management information controls, reporting systems and
procedures;
- hire, train and manage additional qualified personnel;
- expand and upgrade our core technologies and;
- effectively manage multiple relationships with our customers,
suppliers and other third parties.
Additionaly, we must be able to continue to recruit and retain personnel, and
failure to do so would result in our not achieving our operational goals. Also,
our management team may not be able to achieve the rapid execution necessary to
fully exploit the market for our products and services. In the future, we may
experience difficulties meeting the demand for our products and services. We
cannot assure you that our systems, procedures or controls will be adequate to
support the anticipated growth in our operations or that we will be able to
achieve the operational efficiencies needed to be competitive. Any failure could
materially cause us not to meet our operating revenues and cost objectives and
weaken our financial position.
COM21 DEPENDS ON STRATEGIC RELATIONSHIPS, AND IF WE ARE NOT ABLE TO FIND AND
MAINTAIN THESE RELATIONSHIPS, WE MAY NOT BE ABLE TO DEVELOP OUR TECHNOLOGIES OR
PRODUCTS WHICH COULD SLOW OUR GROWTH AND DECREASE OUR REVENUES.
Our business strategy relies to a significant extent on strategic relationships
with other companies. These relationships include:
- software license arrangements for our network management system;
- technology licensing agreements;
- development arrangements and agreements with original equipment
manufacturers for advanced products;
- marketing arrangements with system integrators and others; and
- collaboration agreements with suppliers of routers and headend
equipment to ensure the interoperability of our cable modems
with these suppliers' products.
The failure to maintain, develop or replace them if any of these relationships
are terminated and to renew or extend any license agreements with a third party
may harm our business.
COM21'S CUSTOMER BASE IS CONCENTRATED AND THE LOSS OF ONE OR MORE OF ITS
CUSTOMERS COULD CAUSE ITS BUSINESS TO SUFFER.
A relatively small number of customers have accounted for a large part of our
revenues, and we expect that this trend will continue. In the second quarter of
2001, our top five customers accounted for 57% of total revenues. We expect that
our largest customers in the future could be different from our largest
customers today due to a variety of factors, including customers' distribution
schedules and budget considerations. Additionally, some of our systems
integrators could develop and manufacture products that compete with our
products and therefore could no longer distribute our products. Because a
limited number of companies account for a majority of our prospective customers,
our future success will depend upon our ability to establish and maintain
relationships with these companies. We may not be able to retain our current
accounts or to obtain additional accounts. Both in the U.S. and internationally,
a substantial majority of households passed by cable access are controlled by a
relatively small number of companies. The
31
32
loss of one or more of our customers or our inability to successfully develop
relationships with other significant cable operators could cause our business to
suffer.
COM21 IS SUBJECT TO RISKS OF OPERATING IN INTERNATIONAL MARKETS.
For the second quarter of 2001, international sales accounted for 69% of total
revenues. We intend to enter new international markets, and we expect that a
significant portion of our sales will continue to be in international markets.
Because we sell primarily through systems integrators, a successful expansion of
our international operations and sales may require us to develop relationships
with new international systems integrators and distributors. If we are unable to
identify, attract or retain suitable international systems integrators or
distributors, we may not be able to successfully expand our international
operations. To increase revenues in international markets, we will need to
continue to establish foreign operations, to hire additional personnel to run
these operations and to maintain good relations with our foreign systems
integrators and distributors. If we are unable to successfully do so, our growth
in international sales will be limited which would reduce our operating results.
Additionally, international operations involve a number of risks not typically
present in domestic operations, including:
- changes in regulartory requirements;
- costs and risks of distributing system in foreign countries;
- licenses, tariffs and other trade barriers;
- political and economic instability;
- difficulties in staffing and managing foreign operations;
- potentially adverse tax consequences;
- difficulties in obtaining governmental approvals for products;
- the burden of complying with a wide variety of complex foreign
laws and treaties;
- the imposition of legislation and regulations on the import and
export of high technology products;
- fluctuations in foreign currency; and
- the possibility of difficult accounts receivable collections.
THE INDUSTRY IN WHICH WE COMPETE IS SUBJECT TO CONSOLIDATION.
There has been a trend toward industry consolidation for several years, which is
expected to continue through 2001. We expect this trend toward industry
consolidation to continue as companies attempt to strengthen or hold their
market positions in an evolving industry. We believe that industry consolidation
may provide increasingly stronger competitors that are better able to compete.
This could lead to more variability in operating results as we compete to be a
vendor solution and could harm our business, operating results and financial
condition. We believe that industry consolidation may lead to fewer possible
customers. If we are unable to maintain our current customers or secure
additional customers, our business could decrease.
OUR BUSINESS OPERATIONS MAY BE IMPACTED BY THE CALIFORNIA ENERGY CRISIS.
Our principal executive offices are located in the Silicon Valley in Northern
California. California has been experiencing an energy crisis that has resulted
in disruptions in power supply
32
33
and increases in utility costs to consumers and businesses throughout the State.
Should the energy crisis continue, Com21 together with many other Silicon Valley
companies, may experience power interruptions and shortages and be subject to
significantly higher costs of energy. Although we have not experienced any
material disruption to our business to date, if the energy crisis continues and
power interruptions or shortages occur in the future, they may cause a decline
in our business.
THE LOCATION OF COM21'S FACILITIES IS SUBJECT TO THE RISK OF EARTHQUAKES AND
OTHER NATURAL DISASTERS.
Com21's corporate headquarters, including some of its research and development
operations and our in-house manufacturing facilities, are located in the Silicon
Valley area of Northern California, a region known for seismic activity. A
significant natural disaster in the Silicon Valley, such as an earthquake or
power loss, could halt our business, weaken its financial condition and create
disappointing operating results.
33
34
ITEM 3 QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Interest Rate Sensitivity. Com21 is also subject to interest rate risk as of
June 30, 2001, related to variable rate debt obligations totaling $9,000,000.
The variable rate debt obligations are linked to the prime rate and the LIBOR
rate and any increases in these market interest rates will increase the
repayment obligation. If market rates were to increase immediately and uniformly
by 10 percent from levels at June 30, 2001, the fair value of the repayment
obligation would increase by $74,000.
Com21 also has fixed rate debt obligations of approximately $545,000 at June 30,
2001, that have no interest rate risk. The fixed rates on these obligations
ranged from 7% to 12% during the second quarter of 2001.
Market Price Risk. Com21 is also exposed to market price risk on investments in
marketable equity securities held as available-for-sale investments. These
investments are in publicly traded companies as well as private companies in the
volatile high-technology industry sector. A 50% adverse change in the equity
price would result in an approximate $1,865,000 decrease in the fair value of
the investments in the marketable equity security as of June 30, 2001.
Foreign Currency Risk. To date, our international sales have been denominated
solely in U.S. dollars, and accordingly, we have not been exposed to foreign
currency exchange rate fluctuations related to sales transactions. However, the
functional currency of our subsidiary in Ireland is the U.S. dollar and as the
local accounts are maintained in Irish pounds, we are subject to foreign
currency exchange rate fluctuations associated with remeasurement to U.S.
dollars. A hypothetical change of 10% in the foreign currency exchange rates
would not have a material impact on our consolidated financial position or
results of operations.
34
35
PART II: OTHER INFORMATION
ITEM 1 Legal Proceedings
On August 8, 2000, Telepoint, Inc. filed a demand for arbitration
against Com21 and BitCom, Inc., which Com21 acquired in July 2000,
with the American Arbitration Association (No. 72Y 181 812 00 HLT).
Telepoint, a customer of BitCom, claims damages of $10 million and is
seeking injunctive relief based on several causes of action.
Telepoint's claims center around a development agreement between
Telepoint and BitCom whereby BitCom was to develop a digital radio in
exchange for payment of $180,000 (and royalties). Com21 believes this
claim is without merit and intends to defend it vigorously. An
unfavorable resolution of this case could have a negative impact on
our business, results of operations, or financial condition.
ITEM 2 Changes in Securities and Use of Proceeds
According to the Agreement by and between Fletcher International Ltd.
and Com21, Inc. dated February 28, 2001, Com21 is contractually
obligated to issue additional warrants if the shares and warrants
issued to Fletcher were not registered by June 5, 2001. Com21 and
Fletcher amended the warrant such that on July 31, 2001, Com21 issued
an additional 502,250 warrants to Fletcher. Com21 is obligated to
issue additional 270,113 warrants on August 5, 2001 to Fletcher.
Com21 is required to continue to issue additional shares under the
warrant on a monthly until such time as the registration statement
becomes effective.
ITEM 3 Defaults upon Senior Securities
None
ITEM 4 Submission of Matters to a Vote of Security Holders
The following proposals were voted upon by Com21's stockholders at the annual
stockholders' meeting held on May 17, 2001:
1. THE FOLLOWING PERSONS WERE ELECTED AS DIRECTORS OF COM21 TO SERVE UNTIL
THE 2002 ANNUAL STOCKHOLDERS' MEETING AND UNTIL THEIR SUCCESSORS ARE ELECTED.
THESE PERSONS WERE QUALIFIED WITH THE VOTES INDICATED BESIDE THEIR RESPECTIVE
NAMES:
Schedule of votes cast for each director:
Votes For Votes Against
--------- --------------
Craig Soderquist 19,502,320 1,568,487
Paul Baran 19,702,681 1,368,126
James A. Gagnard 19,704,303 1,366,504
Jerald L. Kent 19,024,584 2,046,223
George A. Merrick 19,706,685 1,364,122
Daniel J. Pike 19,692,735 1,378,072
James Spilker Jr. 19,651,370 1,419,437
Susan H. Nycum 19,705,605 1,365,202
- -------
* There were no abstention nor brokers's votes.
35
36
2. A proposal to approve an amendment to Com21's 2000 Stock Option Plan to
increase the maximum number of shares of common stock by an additional 1,500,000
shares of common stock to 3,000,000 shares of common stock was approved by the
vote of 4,985,548 shares for; 4,032,456 shares withheld or voted against the
proposal; and 82,831 shares abstained.
3. A proposal to approve amendments to Com21's 1998 Employee Stock Purchase
Plan to (i) increase the maximum number of shares of common stock available for
issuance over the term of the purchase plan by an additional 650,000 shares of
common stock to 1,350,000 shares of common stock and (ii) eliminate the
requirement for stockholder approval in order to increase the limitation on the
number of shares of common stock which any one participant may purchase on any
semi-annual purchase date was approved by the vote of 7,747,014 shares for;
1,268,813 shares withheld or voted against the proposal; and 85,008 shares
abstained.
4. A proposal to ratify the appointment of Deloitte & Touche LLP as Com21's
independent auditors for the fiscal year ending December 31, 2001 was approved
by the vote of 20,696,727 shares for; 338,348 shares withheld or voted against
the proposal; and 35,732 shares abstained.
ITEM 5 Other Information
None
ITEM 6 Exhibits and Reports on Form 8-K.
a) Exhibits
Exhibit
Number Description
------- -----------
10.23 Shares purchase agreement among Com21, Inc., Com21
Israel, Ltd. And S.E. Nasan & Co., LLC.
b) Reports on Form 8-K
None.
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.
Com21, Inc.
Date: August 14, 2001 By: /s/CRAIG SODERQUIST
----------------------------------
Craig Soderquist
President, Chief Executive Officer
and Director
36
37
EXHIBIT INDEX
Exhibit
Number Description
------- -----------
10.23 Shares purchase agreement among Com21, Inc., Com21
Israel, Ltd. and S.E. Nasan & Co., LLC.