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 September 30, 1999 or [ ]	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from __________________ to ___________________ Commission File Number: 000-2409 Com21, Inc. (Exact name of registrant as specified in its charter) Delaware 94-3201698 (State or other jurisdiction of (IRS Employer Identification No.) incorporation or organization) 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 21,500,930 as of September 30, 1999. COM21, INC. INDEX PART I: FINANCIAL INFORMATION Page Item 1 Financial Statements Condensed Balance Sheets - September 30, 1999 and December 31, 1998 3 Condensed Statements of Operations and Comprehensive Loss Three and Nine Month periods ended September 30, 1999 and 1998 4 Condensed Statements of Cash Flows - Nine Months Ended September 30, 1999 and 1998 5 Notes to Condensed Financial Statements 6 Item 2 Management's Discussion and Analysis of Financial Condition and Results of Operations 8 Item 3 Quantitative and Qualitative Disclosures About Market Risk 23 PART II: OTHER INFORMATION Item 1 Legal Proceedings 23 Item 2 Changes in Securities and Use of Proceeds 23 Item 3 Defaults Upon Senior Securities 24 Item 4 Submission of Matters to a Vote of Security Holders 24 Item 5 Other Information 24 Item 6 Exhibits and Reports on Form 8-K 24 Signature 25 In addition to historical information, this Form 10-Q contains forward-looking statements including statements regarding 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 March 10, 1999 as filed with the SEC. While this outlook represents our current judgement on the future direction of the business, such 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 as well as "Risk Factors" in Com21's Annual Report on Form 10-K dated March 10, 1999 as filed with the SEC. PART I: FINANCIAL INFORMATION Item 1 Financial Statements COM21, INC. CONDENSED BALANCE SHEETS (In thousands, except share and par value amounts) (Unaudited) September 30, December 31, 1999 1998 ASSETS Current assets: Cash and cash equivalents $ 35,235 $ 7,135 Short-term investments 75,879 58,609 Accounts receivable 14,530 4,834 Inventories 3,063 5,282 Prepaid expenses and other 1,974 586 --------- --------- Total current assets 130,681 76,446 Property and equipment, net 7,147 6,247 Other assets 256 255 --------- --------- Total Assets $138,084 $ 82,948 ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable $ 7,206 $ 4,033 Accrued compensation and related benefits 3,483 1,739 Deferred revenue 369 238 Other current liabilities 1,965 1,232 Current portion of capital lease and debt obligations 639 1,120 --------- --------- Total current liabilities 13,662 8,362 Deferred rent 303 284 Capital lease obligations 480 936 --------- --------- Total liabilities 14,445 9,582 Stockholders' equity: Common stock, $0.001 par value, 40,000,000 shares authorized; 21,500,930 and 18,685,560 issued and outstanding at September 30, 1999 and December 31, 1998 22 19 Additional paid-in capital 177,982 122,131 Deferred stock compensation (57) (82) Accumulated deficit (55,014) (48,699) Accumulated other comprehensive income (loss) 706 (3) --------- --------- Total stockholders' equity 123,639 73,366 --------- --------- Total Liabilities and Stockholders' Equity $138,084 $ 82,948 ========= ========= See notes to condensed financial statements. COM21, INC. CONDENSED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS (In thousands, except per share amounts) (Unaudited) Three Months Ended Nine Months Ended September 30, September 30, 1999 1998 1999 1998 --------- --------- --------- --------- Revenues $ 25,269 $ 13,686 $ 66,025 $ 29,417 Cost of revenues 16,316 8,486 40,177 18,940 --------- --------- --------- --------- Gross profit 8,953 5,200 25,848 10,477 --------- --------- --------- --------- Operating expenses: Research and development 7,728 4,692 21,657 13,362 Sales and marketing 4,126 2,615 11,319 6,722 General and administrative 1,060 1,286 2,856 2,681 --------- --------- --------- --------- Total operating expenses 12,914 8,593 35,832 22,765 --------- --------- --------- --------- Loss from operations (3,961) (3,393) (9,984) (12,288) Total other income, net 1,420 915 3,724 1,388 --------- --------- --------- --------- Loss before income taxes (2,541) (2,478) (6,260) (10,900) Provision for income taxes 0 5 55 14 --------- --------- --------- --------- Net loss (2,541) (2,483) (6,315) (10,914) Other comprehensive income, net of tax: Unrealized gain/(loss)on available for-sale investments (310) - 709 - --------- --------- --------- --------- Comprehensive loss $ (2,851) $ (2,483) $ (5,606) $(10,914) ========= ========= ========= ========= Net loss per share, basic and diluted $ (0.12) $ (0.14) $ (0.30) $ (1.09) ========= ========= ========= ========= Shares used in computation, basic and diluted 21,426 18,338 20,732 10,045 ========= ========= ========= ========= See notes to condensed financial statements COM21, INC. CONDENSED STATEMENTS OF CASH FLOWS (In thousands) (Unaudited) Nine Months Ended September 30, 1999 1998 --------- --------- Cash used in operating activities: Net loss $ (6,315) $(10,914) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization 2,897 2,517 Deferred rent 19 33 Gain on sales and maturities of investments (1,038) (27) Changes in operating assets and liabilities: Accounts receivable (9,696) (1,968) Inventories 2,219 (2,791) Prepaid expenses and other (1,388) (186) Other assets (1) (53) Accounts payable 3,173 796 Accrued compensation and related benefits 1,744 103 Deferred revenue 131 208 Other current liabilities 733 2,328 --------- --------- Net cash used in operating activities (7,522) (9,954) --------- --------- Cash used in investing activities: Purchases of investments, net (125,220) (28,950) Proceeds from sale of investment 109,697 5,057 Purchases of property and equipment (3,772) (2,294) --------- --------- Net cash used in investing activities (19,295) (26,187) --------- --------- Cash flows from financing activities: Proceeds from issuance of stock, net 55,854 62,909 Repayments under capital lease obligations (739) (792) Repayments on debt obligations (198) (384) --------- --------- Net cash provided by financing activities 54,917 61,733 --------- --------- Net change in cash and cash equivalents 28,100 25,592 Cash and cash equivalents at beginning of period 7,135 17,950 --------- --------- Cash and cash equivalents at end of period $ 35,235 $ 43,542 ========= ========= Non-cash investing and financing activities: Property and equipment acquired under capital lease $ - $ 675 ========= ========= Unrealized gain on available-for-sale investments $ (709) $ - ========= ========= Assets acquired through lease financing $ - $ 215 ========= ========= See notes to condensed financial statements COM21, INC. NOTES TO CONDENSED FINANCIAL STATEMENTS September 30, 1999 (Unaudited) 1. Unaudited Interim Financial Statements The accompanying unaudited financial statements have been prepared by the Company pursuant to the rules and regulations of the Securities and Exchange Commission (the "SEC"). Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. In the opinion of management, these unaudited financial statements include all adjustments necessary (consisting of normal, recurring adjustments) for a fair presentation of Com21's financial position as of September 30, 1999, the results of operations for the three and nine months ended September 30, 1999 and 1998 and cash flows for the nine months ended September 30, 1999 and 1998. The results of operations for the three and nine months ended September 30, 1999 are not necessarily indicative of the results to be expected for the fiscal year ending December 31, 1999. These financial statements should be read in conjunction with the financial statements and the accompanying notes included in the Company's Form 10-K dated March 10, 1999 as filed with the SEC. 2. Investments The fair value and the amortized cost of available-for-sale securities at September 30, 1999 and December 31, 1998 are presented in the tables below (in thousands): Unrealized Amortized Holding Gains Fair Cost at (Losses) at Value at 9/30/99 9/30/99 9/30/99 --------- --------- --------- Corporate Bonds and Equity Securities $ 30,073 $ 755 $ 30,828 Government Bonds 45,100 (49) 45,051 --------- --------- --------- Total $ 75,173 $ 706 $ 75,879 ========= ========= ========= Unrealized Amortized Holding Gains Fair Cost at (Losses) at Value at 12/31/98 12/31/98 12/31/98 --------- --------- --------- Corporate Bonds $ 30,803 $ 7 $ 30,810 Government Bonds 27,809 (10) 27,799 --------- --------- --------- Total $ 58,612 $ (3) $ 58,609 ========= ========= ========= Fair values are based on quoted market prices obtained from an independent broker. Available-for-sale securities are classified as current assets and all maturities are within one year. 3. Inventories Inventories consist of (in thousands): September 30, December 31, 1999 1998 --------- --------- Raw materials and sub-assemblies $ 437 $ 142 Work-in-process 1,101 1,361 Finished goods 1,525 3,779 --------- --------- $ 3,063 $ 5,282 ========= ========= 4. 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 computations (in thousands, except per share amounts): Three Months Ended September 30, 1999 1998 --------- --------- Net Loss (Numerator): Net loss, basic and diluted $ (2,541) $ (2,483) --------- --------- Shares (Denominator): Weighted average common shares outstanding 21,477 18,540 Weighted average common shares outstanding subject to repurchase (51) (202) --------- --------- Shares used in computation, basic and diluted 21,426 18,338 --------- --------- Net Loss Per Share, Basic and Diluted $ (0.12) $ (0.14) ========= ========= Nine Months Ended September 30, 1999 1998 --------- --------- Net Loss (Numerator): Net loss, basic and diluted $ (6,315) $(10,914) --------- --------- Shares (Denominator): Weighted average common shares outstanding 20,814 10,293 Weighted average common shares outstanding subject to repurchase (82) (248) --------- --------- Shares used in computation, basic and diluted 20,732 10,045 --------- --------- Net Loss Per Share, Basic and Diluted $ (0.30) $ (1.09) ========= ========= During the three months and nine months ended September 30, 1999 and 1998, the Company had securities outstanding which could potentially dilute basic EPS in the future, but were excluded in the computation of diluted EPS in such periods, as their effect would have been antidilutive due to the net loss reported in such periods. Such outstanding securities consist of the following at September 30, 1999: warrants to purchase 25,000 shares of common stock; 36,572 outstanding shares of common stock subject to repurchase; and options to purchase 3,352,295 shares of common stock. 5. Related Party Transactions In June 1999, the Company invested $1.0 million in the stock of a customer's initial public offering. Revenue for the third quarter of 1999 and the first nine months of 1999 included sales to this customer of $2.2 million and $7.1 million, respectively. The related accounts receivable balance for this customer at September 30, 1999 was $1.8 million. 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 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 regarding 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 dated March 10, 1999, and to the "Risk Factors" section contained herein 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 system solutions for the broadband access market. Our DOCSIS and ATM-based products enable cable operators and service providers to have the ability to deliver high-speed, cost-effective Internet applications to corporate telecommuters, small businesses, home offices and residential users. We were incorporated in June 1992 and shipped our first product in April 1997. We have sold approximately 268,000 cable modems and over 770 head-ends worldwide. Results of Operations Total Revenues - Total revenues increased 85% from $13.7 million in the third quarter of 1998 to $25.3 million in the third quarter of 1999, and increased 124% from $29.4 million for the first nine months of 1998 to $66.0 million for the first nine months of 1999. Our revenue growth was principally due to growth in cable modem revenue over the comparable quarter and nine month period in the prior year. Cable modem sales accounted for 82% of total revenue in the third quarter of 1999 as compared to 63% of total revenue in the third quarter of 1998 and 75% of total revenue for the first nine months of 1999 as compared to 53% for the first nine months of 1998. The average sales price of all cable modems declined moderately during the third quarter of 1999 as our lower priced DOCSIS (standard compliant modems) products were a greater proportion of total modem related revenue. We anticipate that the average sales price of cable modems will continue to decline during the remainder of 1999. The average sales price of headend equipment also declined moderately in the third quarter of 1999 due principally the mix of product sold. We anticipate that the average sales price of headend equipment will be relatively stable during the remainder of 1999. During the quarter ended September 30, 1999, international sales accounted for 48% of total revenues, decreasing slightly from the 51% experienced in the third quarter of 1998. During the nine months ended September 30, 1999, international sales accounted for 46% of total revenues, decreasing slightly from the 49% experienced in the first nine months of 1998. Gross Margins - Gross margins decreased from 38.0% in the third quarter of 1998 to 35.4% in the third quarter of 1999, but increased from 35.6% during the first nine months of 1998 to 39.1% during the first nine months of 1999. The decrease in margins from the third quarter of 1998 to the third quarter of 1999 is primarily due to the mix of product. As noted above cable modem sales accounted for 82% of total revenue in the third quarter of 1999 as compared to 63% of total revenue in the third quarter of 1998. Additionally, revenue from our DOCSIS cable modems became a more significant portion of our total cable modem revenue. Cable modems have lower margins than our other products and our DOCSIS cable modems currently have lower margins than our proprietary cable modems. The increase in margins during the first nine months of 1999 compared to the first nine months of 1998 is primarily a result of our cable modem cost reduction programs partially offset by the product mix shift toward cable modems. Gross margins decreased sequentially from 39.1% in the second quarter of 1999 to 35.4% in the third quarter of 1999. The decline is primarily related to product mix. Our cable modem products continued to become a greater portion of total revenue increasing from 78% of total revenue in the second quarter of 1999 to 82% of total revenue in the third quarter of 1999 and our DOCSIS cable modems were a greater portion of total cable modem revenue. During the fourth quarter of 1999 we anticipate both gross profit and gross margin percent to decline from: Increased sales of our DOCSIS cable modems. As these lower margin modems continue to become a higher percentage of our total revenue, we anticipate our total margin percent will decline. We do not anticipate making significant cost reductions to our DOCSIS modems until late in the first half of 2000. Price increases of flash memory which is a key component of our cable modems. Due to a worldwide shortage of flash memory, prices for flash memory have increased significantly. In order to fulfill demand for our cable modem products we have made purchases of flash memory on the spot market at a price that is substantially higher than we have experienced in the past. We have initiated relationships with additional suppliers of flash memory and anticipate volume shipments of flash memory from these suppliers during the first quarter of 2000. While we are currently unsure of the exact pricing from these additional suppliers, we anticipate that it will be well below the spot market prices but above the prices that we had experienced early in 1999. Competitive pricing offered by an increasing number of cable modem suppliers entering the market. Research and Development - Research and development expenses increased 64.7% from $4.7 million in the third quarter of 1998 to $7.7 million in the third quarter of 1999, and increased 62.1% from $13.4 million during the first nine months of 1998 to $21.7 million during the first nine months of 1999. The increase was attributable to higher costs related primarily to increased consultant and personnel costs. We expect these expenses to increase in absolute dollars in the future as we continue to invest in research and development in our basic products and expand into wireless markets. Sales and Marketing - Sales and marketing expenses increased 57.8% from $2.6 million in the third quarter of 1998 to $4.1 million in the third quarter of 1999, and increased 68.4% from $6.7 million during the first nine months of 1998 to $11.3 million during the first nine months of 1999. The increase was primarily due to higher costs associated with increased personnel in the sales and marketing organizations and added marketing programs. We expect sales and marketing expenses to continue to increase in absolute dollars in the future as we develop more marketing programs and product channels for our DOCSIS products. General and Administrative - General and administrative expenses decreased 17.6% from $1.3 million in the third quarter of 1998 to $1.1 million in the third quarter of 1999, but increased 6.5% from $2.7 million during the first nine months of 1998 to $2.9 million during the first nine months of 1999. The decrease from the third quarter of 1998 to the third quarter of 1999 is due to increased spending during the third quarter of 1998 on legal fees partially offset by increased spending on personnel during the third quarter of 1999. The increase from the first nine months of 1998 to the first nine months of 1999 is related to higher personnel related costs partially offset by the increased spending on legal fees during the first nine months of 1998. We expect general and administrative expenses to show a moderate increase in absolute dollars as we continue to add personnel and incur additional costs related to the growth of our business. Total Other Income, Net - Total other income, net increased from $.9 million in the third quarter of 1998 to $1.4 million in the third quarter of 1999, and increased from $1.4 million during the first nine months of 1998 to $3.7 million during the first nine months of 1999. The increase was attributable to earnings on higher cash balances available during the third quarter and the first nine months of 1999, due primarily to the net cash received of $62.8 million from the initial public offering of common stock in May 1998 and the net cash received of $54.3 million from the secondary offering of common stock in February 1999. Liquidity and Capital Resources At September 30, 1999, our cash, cash equivalents and short-term investments were $111.1 million, compared to $65.7 million at December 31, 1998, an increase of $45.4 million. The increase is primarily a result of cash generated from financing activities of $54.9 and unrealized gains on available-for-sale securities of $.7 million. The cash generated from financing activities is largely the result of the $55.9 million in net proceeds received from the public offering of common stock in February 1999 and from the exercise of stock options. These cash in-flows and unrealized gains were partially offset by cash outflows from operating activities of $6.5 million, excluding the gains on sales and maturities and investments of $1.0 million, and cash used in investing in property and equipment of $3.8 million. Our capital requirements primarily relate to the working capital requirements and investments in property and equipment. We have funded operations primarily through public offerings of common stock and private sales of common and preferred stock. Other than capital lease commitments, we have no material commitments for capital expenditures. However, we anticipate an increase in capital expenditures and lease commitments consistent with anticipated growth in operations, infrastructure and personnel. We intend to establish sales offices and lease additional space, which will require us to commit to additional lease obligations, purchase equipment and install leasehold improvements. We also intend to upgrade and invest in information technology which will increase capital expenditures. Going forward, we may make cash investments or exchange Com21 stock for investments in various companies to secure development resources or access to various product lines. We may also more aggressively pursue market opportunities that leverage our technology platform. These activities if pursued will result in a significant use of cash resources. We believe our current cash and cash equivalents and short-term investments will be sufficient to meet anticipated cash requirements for the next twelve months, although we may seek to raise additional capital during that time period. Year 2000 Readiness Many currently installed computer systems and software products are coded to accept only two digit entries in the date code field and cannot distinguish 21st century dates from 20th century dates. These date code fields will need to distinguish 21st century dates from 20th century dates to avoid system failures or miscalculations causing disruptions of operations, including, among other things, a temporary inability to process transactions, send invoices or engage in similar normal business activities. As a result, many companies' software and computer systems may need to be upgraded or replaced in order to comply with such "Year 2000" requirements. Our Year 2000 plan which is currently in progress will determine whether our products, internal systems, computers and software, and the products and systems of our critical vendors and suppliers are Year 2000 compliant. This plan is being implemented in the following four consecutive phases: I. Inventory and Data Gathering Phase: cataloging of products and systems and the products and systems of our critical vendors and suppliers; II. Testing Phase: determining whether cataloged products and systems are Year 2000 compliant; III. Replacement Phase: upgrading and replacement of non-compliant products and systems; and IV. Monitoring Phase: ongoing testing of our products and systems for Year 2000 compliance. Our Year 2000 plan has been implemented but not completed. To date, results of our Year 2000 plan are the following: Products. We have developed internal tests to ascertain whether our products are Year 2000 compliant. Based on these tests, we believe our current products are Year 2000 compliant and, to the extent necessary, all previously shipped products can be upgraded to become Year 2000 compliant with currently available software upgrades. We have finished the first three phases of our Year 2000 plan related to our products and are continuing on the fourth phase, the monitoring phase, on an on-going basis through the remainder of 1999. Vendors. Based on a survey of material vendors and suppliers we have ascertained our material vendors and suppliers appear to be Year 2000 compliant. We have received confirmations from material vendors indicating their expectation that the Year 2000 will not materially effect the supply of product to Com21. We continue to monitor our material vendors and suppliers concerning Year 2000 compliance. We have finished the first three phases of our Year 2000 plan related to our material parts vendors and suppliers and are continuing on the fourth phase, the monitoring phase, on an on-going basis through the remainder of 1999. Manufacturing and Infrastructure. We have cataloged and performed a review of our assembly and test equipment. Based on this survey we do not believe that there is a material financial impact related to the replacement or upgrade of any manufacturing or infrastructure equipment or software that is not Year 2000 compliant. We will continue replacing and upgrading any non-compliant equipment and software as well as monitoring of any new equipment or software added. Completion of all four phases of the Year 2000 plan related to our manufacturing equipment and software is expected to occur by late 1999. IT Systems. We conducted a survey of our information technology hardware and software and believe that all Year 2000 non-compliant hardware and software has been upgraded or replaced. We have finished the first three phases of our Year 2000 plan related to our IT Systems and are continuing on with the fourth phase, the monitoring of any additional software. We believe all four phases of the Year 2000 plan related to IT Systems will be completed by late 1999. Although we believe that our Year 2000 plan will identify all of our material Year 2000 issues, we cannot assure you that we will be able to identify, evaluate and resolve all these issues. Costs. We do not currently expect that costs associated with Year 2000 compliance will materially affect our operations or financial position. However, if we discover Year 2000 problems in the future, we may not be able to develop, implement, or test remediation or contingency plans in a timely or cost-effective manner. Risks. We believe that the risks of noncompliance could accelerate or delay purchases or replacement of our products and services. Failure of third party products, such as a breakdown in telephone, electric service or other utilities, e-mail, voicemail or the World Wide Web could cause a disruption in cable operators' service to customers. Disruptions in the services provided by banks, telephone companies and the U.S. Postal Service could negatively impact our business. Although our products are undergoing Year 2000 specific testing procedures, they may not contain the date codes necessary to operate in the year 2000. Any failure of these products to perform could result in the delay or cancellation of product orders and the diversion of managerial and technical resources from product development and other business activities to attend to Year 2000 issues. These events could have a material adverse effect on our business, operating results and financial condition. Contingency Plans. Until the completion of our Year 2000 plan, we do not believe that it is practical to develop comprehensive contingency plans. Even if these plans are completed and implemented in a timely manner they may be insufficient to address any third party failures. We cannot assure you that undetected internal and external Year 2000 issues will not materially impact our business, financial condition, results of operations and cash flows. See "Risk Factors - Our failure and the failure of our key suppliers and customers to be year 2000 compliant could negatively impact our business." 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 our company. Readers are referred to additional risks identified in the "Risk Factors" section contained in Com21's Annual Report on Form 10-K dated on March 10, 1999 as filed with the SEC. Our operating results 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. Our 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 our control. Factors that could cause our revenues to fluctuate include the following: - - key component shortages or failures from our suppliers in providing necessary materials - - delays in introducing cable modems that are CableLabs certified as meeting the Data-Over-Cable Service Interface Specification (DOCSIS); - - 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; - - the timing of upgrades of cable plants; - - variations in capital spending budgets of cable operators; - - delays in obtaining regulatory approval for commercial deployment of cable modem systems; - - general economic conditions and economic conditions specific to the cable and electronic data transmission industries; The amount and timing of our operating expenses generally will vary from quarter to quarter depending on the level of actual and anticipated business activities. Research and development expenses will vary as we develop new products. We have a limited backlog of orders, and total revenues for any future quarter are difficult to predict. Supply, manufacturing or testing constraints could result in delays in the delivery of our products. Any delay in the product deployment schedule of one or more of our cable operator customers would likely materially adversely affect our operating results for a particular period. A variety of factors affect our gross margin, including the following: - - the sales mix within a product group, proprietary vs. 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; - - the volume of products manufactured, and - - the distribution channel or customer mix. In the past we have experienced declines in the average selling price of our cable modems and headends. We expect average sales prices of both our modems and headends will continue to show decreases to meet competitive pressures, especially those pressures related to the introduction of DOCSIS modems. In addition, the sales mix between our headend equipment and modems also affects our gross margin. Sales of our cable modems yield lower gross margins than do sales of our headend equipment and sales of our DOCSIS cable modems currently yield lower margins than do sales of our proprietary cable modems. We anticipate that our sales mix will continue to be weighted toward cable modems and increasingly toward DOCSIS cable modems. If the price declines are not offset by a decline in the costs of manufacturing our cable modems or an increase in sales of higher margin telephone and office cable modems, our gross margin will be adversely affected. Because of these factors, our operating results in one or more future periods may not meet or exceed the expectations of securities analysts or investors. In that event, the trading price of our common stock would likely decline. We may not be able to produce sufficient quantities of our products because we obtain certain components from, and depend on, certain key sole suppliers. Certain parts, components and equipment used in our products are obtained from sole sources of supply. For example, our headend equipment incorporates a radio frequency modulation chip from one specific vendor, transmitter/receiver components from another, and an Asynchronous Transfer Mode switch, commonly known as an ATM in the telecommunications industry, from yet another. Also, our cable modems include sole-sourced chipsets, filters and other materials. Additional sole-sourced components may be incorporated into our equipment in the future. There is currently a worldwide shortage of flash memory, a key component in our cable modems. In order to fulfill demand for our cable modem products we plan on making purchases of flash memory on the spot market at a price that is substantially higher than we have experienced in the past. If we are unable to purchase flash memory at a high enough volume to meet demand, we will be unable to produce enough cable modems to meet our production and delivery schedules. We expect this shortage of flash memory will continue at least through the remainder of 1999. We do not have any long term supply contracts to ensure sources of supply. If we fail to obtain components in sufficient quantities when required, our business could be harmed. Our suppliers may enter into exclusive arrangements with our competitors, stop selling their products or components to us at commercially reasonable prices or refuse to sell their products or components to us at any price. Our inability to obtain sufficient quantities of sole-sourced components, or to develop alternative sources for components and/or products would materially adversely affect our business. We rely on several companies including: - - Advanced Micro Devices, Inc., ST Microelectronics, Inc., Hyundai, Inc., suppliers of flash memory; - - Broadcom Corp. and Newbridge Networks, Inc., suppliers of modulation, demodulation and MAC components; - - Atmel Corporation, the fabricator of our semiconductor devices; - - Virata Limited, a supplier of ATM switches; - - Hewlett-Packard Company, the supplier of HP Openview software; - - Wind River Systems, Inc., a supplier of embedded software; and - - Objectivity, Inc., a supplier of object-oriented database software. If any of these manufacturers or other sole source suppliers delay or halt production of any of their components, our business, operating results and financial condition could be materially adversely affected. We have a short operating history, have incurred net losses since our inception and expect future losses. We did not commence product shipments until April 1997. As a result, we have only a limited operating history upon which you may evaluate us and our prospects. We have incurred net losses since inception and expect to continue to operate at a loss through at least fiscal 1999. To achieve profitable operations on a continuing basis, we must successfully design, develop, test, manufacture, introduce, market and distribute our products on a broad commercial basis. Our ability to generate future revenues will depend on a number of factors, many of which are beyond our control. These factors include the following: - - the rate at which cable operators upgrade their cable plants; - - our ability and the ability of cable operators to coordinate timely and effective marketing campaigns with the availability of upgrades; - - cable operators' success in marketing data-over-cable services and our modems to subscribers; - - cable operators' success in setting prices for data transmission installation service; and - - cable operators' success and timeliness in the installation of subscriber site equipment. Due to these factors, we cannot forecast with any degree of accuracy what our revenues will be or how quickly cable operators will adopt our systems. Therefore, we may not achieve, or be able to sustain, profitability. We may not be able to produce sufficient quantities of our products because we depend on third-party manufacturers their suppliers and have limited manufacturing experience. We contract for the manufacture of cable modems and integrated circuit boards on a turnkey basis. CMC Industries and Sanmina build printed circuit assemblies for our headend products and Celestica manufactures our cable modems. 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. A number of risks are associated with our dependence on third-party manufacturers including: - - failure to meet our delivery schedules; - - quality assurance; - - manufacturing yields and costs; - - the potential lack of adequate capacity during periods of excess demand; - - increases in prices and the potential misappropriation of our intellectual property. 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. We may experience manufacturing or supply problems in the future. We are dependent on our manufacturers to secure components at favorable prices, but we may not be able to obtain additional volume purchase or manufacturing arrangements on terms that we consider acceptable, if at all. If we enter into a high- volume or long-term supply arrangement and subsequently decide that we cannot use the products or services provided for in the agreement, our business will be harmed. Any such difficulties could harm our relationships with customers. Certain of our current proprietary products are not compatible with products offered by our competitors. Both our proprietary products and 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. The Data-Over-Cable Service Interface Specification, the DOCSIS standard, has continued to achieve substantial market acceptance in North America. Conformance with the DOCSIS standard is being determined through certification tests performed by CableLabs. On September 2, 1999, CableLabs announced the result of the latest wave of certification for the DOCSIS cable modem. Our DOCSIS cable modem was not certified at this time. During October we submitted cable modems for certification testing by CableLabs with results to be announced during the second week of December 1999. The continuing evolution of the DOCSIS standard may cause us to incur additional costs associated with making our cable modems compliant with various versions of the standard. We cannot assure you that our DOCSIS cable modems will be CableLabs certified according to our anticipated schedule, or that if certified, that it will meet with market acceptance. Our failure to introduce a CableLabs certified modem could have an adverse affect on revenues and operations. The results of this announcement could affect the trading price of our stock. 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 current products. Our current products may not be in full compliance with the following relevant standards: - - Data-Over-Cable Service Interface Specification (DOCSIS); - - Digital Video Broadcast (DVB); There is a movement by some cable operators in Europe towards the DVB standard. If DVB achieves market acceptance customers may refuse to purchase our products. Additionally, different implementations of the same specification could slow deployment of our products if these differences cause our products not to be interoperable with other companies' products. The widespread adoption of DOCSIS, DVB or other standards outside North America could cause aggressive competition in the cable modem market and result in lower sales of our ComCONTROLLER headend products and lower revenues from licensing of our network management software. Any of these events would adversely affect our gross margin and our operating results. 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, would harm our business. 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 our competitors; - - bring products to market on a timely basis at competitive prices; and - - respond effectively to new technological changes or new product announcements by others. If our product development and enhancements take longer than planned, the availability of products would be delayed. 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 evolving and emerging industry standards. The technical 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. 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 customers or be compatible with changing technological requirements or standards. Most expenses must be incurred before the technical feasibility or commercial viability can be ascertained. Revenues from future products or product enhancements may not be sufficient to recover the development costs associated with the products or enhancements. We depend on cable operators and cable systems integrators for substantially all of our sales. We depend on cable operators and cable systems integrators to purchase our headend equipment and cable modems and to market data transmission service to end-users. Cable operators may not have enough programming channels over which they can offer these services. Even if a cable operator chooses to provide data transmission services, it may not choose our products to do so. Because we rely on cable operators and cable systems integrators to purchase and market our products, our sales may be unpredictable due to the varying marketing and deployment efforts of our cable operators and cable systems integrators. The future success of services providing data-over-cable transmission depends upon the ability of cable systems to support two-way communications. Many cable operators are in the process of upgrading, or have announced their intention to upgrade, their cable plants to hybrid fiber coaxial cable, commonly known as HFC in the telecommunications industry. The timing of this upgrade could affect our sales. Even after installation, we remain highly dependent on cable operators to continue to maintain their cable plants so that our products will operate at a consistently high performance level. Accordingly, the success and future growth of our business will be subject to economic and other factors affecting the cable television industry, particularly the industry's ability to continue to finance the substantial capital expenditures necessary to use our products effectively. 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, if the DOCSIS standard achieves widespread market acceptance, we anticipate that the North American cable modem market will shift to a consumer purchase model. If this occurs, we will 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 operator's reference sell our products. Consequently, 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. To the extent that large consumer electronics companies enter the cable modem market, their well-established retail distribution capabilities would provide them with a significant competitive advantage. 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. The market for high-speed data transmission services has several competing technologies which offer alternative solutions. Technologies which compete with our solution are: - - telephone company-related wireline technologies such as: 	dial-up (analog modems); 	digital subscriber line, known as DSL , ADSL, among others; 	integrated services digital network, known as ISDN; and - - wireless technologies such as: 	local multipoint distribution service, known as LMDS; 	multi-channel multipoint distribution service, commonly known as MMDS; 	direct satellite; and 	orthogonal frequency division multiplexed, commonly known as OFDM. Because of the widespread reach of telephone networks and the financial resources of telephone companies, competition from telephone company- related solutions is expected to be intense. Cable modem technology may not be able to compete effectively against wireline or wireless technologies. In addition, one of our competitors has developed a commercially available alternative modulation technology. 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. Our market is highly competitive and has many more established competitors. The market for our products is intensely competitive, rapidly evolving and subject to rapid technological change. Many of our current and potential competitors have been operating longer, have better name recognition, better 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 and devote substantially more resources to developing new or enhanced products than we do. If we fail to become CableLabs certified in a timely manner, our customers may choose another supplier for CableLabs certified cable modems, and our business, operating results and financial condition could be materially adversely affected. We must reduce the cost of our cable modems to remain competitive. Certain of our competitors' cable modems are priced lower than our cable modems. As headend equipment becomes more widely deployed, the price of cable modems and related equipment will continue to decline. In particular, the adoption of industry standards, such as the DOCSIS standard, will cause increased price competition for cable modems. We may not be able to continually reduce the costs of manufacturing our cable modems sufficiently to enable us to lower our modem prices and compete effectively with other cable modem suppliers. If we are unable to reduce the manufacturing costs of our cable modems, our gross margin and operating results would be harmed. Competition for qualified personnel in the cable networking equipment and telecommunications industries is intense, and we may not be successful in attracting and retaining these personnel. Our future success will depend, to a significant extent, on the ability of our management to operate effectively, both individually and as a group. We are dependent on our ability to retain and motivate high caliber personnel, in addition to attracting new personnel. Competition for qualified personnel in the cable networking equipment and telecommunications industries is intense, especially in the San Francisco Bay Area, and we may not be successful in attracting and retaining such personnel. We expect to add additional personnel in the near future. There may be only a limited number of people with the requisite skills to serve in those positions and it may become increasingly difficult to hire these people. We are actively searching for research and development engineers, who are in short supply. Our business will suffer if we encounter delays in hiring these additional engineers. Competitors and others have in the past and may in the future attempt to recruit our employees. We do not have employment contracts with any of our key personnel. We do not maintain key person life insurance on our key personnel. The loss of the services of any of our key personnel, the inability to attract or retain qualified personnel in the future or delays in hiring required personnel, particularly engineers, could negatively affect our business. Our failure to adequately protect our proprietary rights may adversely affect us. We rely on a combination of patent, copyright and trademark laws, and on trade secrets and confidentiality provisions and other contractual provisions to protect our proprietary rights. These measures afford only limited protection. We currently have eight issued U.S. patents and several pending patent applications. Our means of protecting our proprietary rights in the U.S. or abroad may not be adequate and competitors may independently develop similar technologies. Our future success will depend in part on our ability to protect our proprietary rights and the technologies used in our principal products. Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy aspects of our products or to obtain and use trade secrets or other information that we regard as proprietary. In addition, the laws of some foreign countries do not protect our proprietary rights as fully as do the laws of the U.S. Issued patents may not preserve our proprietary position. Even if they do, competitors or others may develop technologies similar to or superior to our own. If we do not enforce and protect our intellectual property, our business will be harmed. From time to time, third parties, including our competitors, have asserted patent, copyright and other intellectual property rights to technologies that are important to us. We expect that we will increasingly be subject to infringement claims as the number of products and competitors in the cable modem market grows and the functionality of products overlaps. The results of any litigation matter are inherently uncertain. In the event of an adverse result in any litigation with third parties that could arise in the future, we could be required to pay substantial damages, including treble damages if we are held to have willfully infringed, to halt the manufacture, use and sale of infringing products, to expend significant resources to develop non-infringing technology, or to obtain licenses to the infringing technology. Licenses may not be available from any third party that asserts intellectual property claims against us, on commercially reasonable terms, or at all. In addition, litigation frequently involves substantial expenditures and can require significant management attention, even if we ultimately prevail. For example, in January 1998, Hybrid Networks filed an action against us, accusing us of infringing certain of their patents. We settled this matter in the first quarter of 1999 through a patent cross-license agreement that will not materially impact our business or results of operations. However, there can be no assurance that we would be able to successfully resolve similar incidents in the future. Our failure to manage growth could adversely affect us. We have rapidly and significantly expanded our operations and anticipate that further significant expansion will be required to address potential growth in our customer base and market opportunities. To manage the anticipated growth of our operations, we will be required to: - - 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. We compete in for skilled personnel in a labor market where there is a shortage of qualified personnel and salary demands are above the norm. We must be able to continue to recruit and retain personnel, and failure to do so would result in us not meeting our anticipated growth goals. In addition, our management team may not be able to achieve the rapid execution necessary to fully exploit the market for our products and services. We may not be able to install management information and control systems in an efficient and timely manner, and our current or planned personnel, systems, procedures and controls may not be adequate to support our future operations. In the future, we may experience difficulties meeting the demand for our products and services. The installation and use of our products requires training. If we are unable to provide training and support for our products, the implementation process will be longer and customer satisfaction may be lower. We cannot assure you that our systems, procedures or controls will be adequate to support the anticipated growth in our operations. Any failure to manage growth effectively could materially adversely affect our business, operating results and financial condition. We depend on strategic relationships. Our business strategy relies to a significant extent on our strategic relationships with other companies. These relationships include: - - software license arrangements for our network management system; - - technology licensing agreements for certain products; - - development and OEM arrangements with certain suppliers for advanced products; - - marketing arrangements with Philips, Siemens, and others; and - - collaboration agreements with suppliers of routers and headend equipment to ensure the interoperability of our cable modems with these suppliers. These relationships may not be successful because we may not be able to continue to maintain, develop or replace them in the event any of these relationships are terminated. In addition, any failure to renew or extend any licenses between us and any third party may adversely affect our business. Our customer base is concentrated and the loss of one or more of our customers could cause our business to suffer. A relatively small number of customers (which include system integrators) have accounted for a large part of our revenues to date, and we expect that this trend will continue. 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' deployment schedules and budget considerations. In addition certain of our system integrators could develop and manufacture products that compete with us and therefore could no longer distribute our products. Because a limited number of cable operators 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 are controlled by a relatively small number of cable operators. The 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. We are subject to risks associated with operating in international markets. We expect that a significant portion of our sales will continue to be in international markets for the foreseeable future. We intend to expand operations in our existing international markets and to enter new international markets, which will demand management attention and financial commitment. In addition, a successful expansion of our international operations and sales in certain markets will require us to develop relationships with international systems integrators and distributors. We may not be able to identify, attract or retain suitable international systems integrators or distributors. We may not be able to successfully expand our international operations. Furthermore, 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. To the extent that we are unable to successfully do so, our growth in international sales will be limited and our operating results could be adversely affected. Our international sales to date have been denominated in U.S. dollars. We do not currently engage in any foreign currency hedging transactions. A decrease in the value of foreign currencies relative to the U.S. dollar could make our products more expensive in international markets. In addition to currency fluctuation risks, international operations involve a number of risks not typically present in domestic operations, including: - - changes in regulatory requirements; - - costs and risks of deploying systems 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; and - - the possibility of difficult accounts receivable collections. We are also subject to the risks associated with the imposition of legislation and regulations relating to the import or export of high technology products. We cannot predict whether charges or restrictions upon the importation or exportation of our products will be implemented by the U.S. or other countries. Future international activity may result in sales dominated by foreign currencies. Gains and losses on the conversion to U.S. dollars of accounts receivable, accounts payable and other monetary assets and liabilities arising from international operations may contribute to fluctuations in our operating results. Any of these factors could materially and adversely affect our business, operating results and financial condition. We may be subject to risks associated with acquisitions. We continually evaluate strategic acquisitions of other businesses and subscriber accounts. If we were to consummate an acquisition, we would be subject to a number of risks, including: - - difficulty in assimilating the acquired operations and personnel; - - limits on our ability to retain the acquired subscribers; - - disruption of our ongoing business; and - - limits on our ability to successfully incorporate acquired technology and rights into our service offerings and maintain uniform standards, controls, procedures, and policies. We may not be able to successfully overcome problems encountered with potential acquisitions. In addition, an acquisition could materially adversely affect our operating results by diluting our stockholders' equity, causing us to incur additional debt, or requiring us to amortize acquisition expenses and acquired assets. Our failure and the failure of our key suppliers and customers to be year 2000 compliant would negatively impact our business. The Year 2000 issue is the result of computer programs written using two digits rather than four to define the applicable year. Computer programs that have this date-sensitive software may recognize a date using "00" as the year 1900 rather than the year 2000. This could result in a system failure or miscalculations causing disruptions of operations, including, among other things, a temporary inability to process transactions, send invoices or engage in similar normal business activities. We are heavily dependent upon the proper functioning of our own computer or data-dependent systems. This includes, but is not limited to, our systems in information, business, finance, operations, manufacturing and service. Any failure or malfunctioning on the part of these or other systems could adversely affect our business in ways that are not currently known, quantifiable or otherwise anticipated by us. We currently have only limited information on the Year 2000 compliance of key suppliers and customers. The operations of our key suppliers and customers could be adversely affected in the event they do not successfully and timely achieve Year 2000 compliance. Our business and results of operations could experience material adverse effects if our key suppliers were to experience Year 2000 issues that caused them to delay manufacturing or shipment of key components to us. In addition, our results of operations could be materially adversely affected if any of our key customers encounter Year 2000 issues that cause them to delay or cancel substantial purchase orders or delivery of our products. While we have developed a plan to address Year 2000 issues, we may be unable to complete all phases of the plan in a timely manner or to upgrade any or all of our major systems in accordance with our plan. Even if we make upgrades, they may not effectively address the Year 2000 issue. If required upgrades are not completed in a timely manner or are not successful, we may be unable to conduct our business or manufacture our products. The systems of other companies on which our systems rely may not be converted in a timely manner. The failure to convert by another company, or the occurrence of a conversion that is incompatible with our systems would have a material adverse effect on our business. We intend to establish, but have not yet established a contingency plan detailing actions that will be taken in the event that the assessment of the Year 2000 issue is not successfully completed on a timely basis. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Year 2000 Readiness." We may be subject to product returns and product liability claims due to defects in our products. Our products are complex and may contain undetected defects, errors or failures. These errors have occurred in our products in the past and additional errors may be expected to occur in our products in the future. The occurrence of any defects, errors, or failures could result in delays in installation, product returns and other losses to us or to our cable operators or end-users. Any of these occurrences could also result in the loss of or delay in market acceptance of our products, which could have a material adverse effect on our business, operating results and financial condition. We would have limited experience with the problems that could arise with any new products that we introduce. Although we have not experienced any product liability claims to date, the sale and support of our products entail the risk of these claims. A successful product liability claim brought against us could have a material adverse effect on our business, operating results and financial condition. 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. In addition, the trading price of our common stock could be subject to wide fluctuations in response to quarterly variations in operating results, announcements of technological innovations or new products by us or our competitors, announcements by certification and standards bodies, developments with respect to patents or proprietary rights, changes in financial estimates by securities analysts and other events or factors. In addition, the stock market has experienced volatility that has particularly affected the market prices of equity securities of many high technology companies and that often has been unrelated or disproportionate to the operating performance of these companies. These broad market fluctuations may adversely affect the market price of our common stock. This Form 10-Q contains forward-looking statements. These statements are not guarantees of future performance and are subject to certain risks, uncertainties and other factors, some of which are beyond our control, are difficult to predict and could cause actual results to differ materially from those expressed or forecasted in the forward-looking statements. This Form 10-Q contains forward-looking statements that have been made under the provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are not historical facts but rather are based on current expectations, estimates and projections about our industry, our beliefs, and assumptions. Words such as "anticipates," "expects," "intends," "plans," "believes," "seeks," "estimates" and variations of these words and similar expressions are intended to identify forward-looking statements. These statements are not guarantees of future performance and are subject to certain risks, uncertainties and other factors, some of which are beyond our control, are difficult to predict and could cause actual results to differ materially from those expressed or forecasted in the forward-looking statements. These risks and uncertainties include those described in "Risk Factors" and elsewhere in this Form 10-Q as well as in the "Risk Factors" section of the Annual Report on Form 10-K dated March 10, 1999. Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect our management's view only as of the date of this Form 10-Q. We undertake no obligation to update these statements or publicly release the result of any revisions to the forward-looking statements that we may make to reflect events or circumstances after the date of this Form 10-Q or to reflect the occurrence of unanticipated events. ITEM 3 Quantitative and Qualitative Disclosures About Market Risk Interest Rate Sensitivity. Com21 maintains a short-term investment portfolio consisting mainly of government and corporate bonds purchased with an average maturity of less than one year. These available-for-sale securities are subject to interest rate risk and will fall in value if market interest rates increase. If market interest rates were to increase immediately and uniformly by 10 percent from levels at September 30, 1999, the fair value of the portfolio would decline by an immaterial amount. We generally have the ability to hold our fixed income investments until maturity and therefore we would not expect our operating results or cash flows to be affected to any significant degree by the effect of a sudden change in market interest rates on our securities portfolio. Com21 has fixed rate long-term debt of approximately $480,000 as of September 30, 1999, and a hypothetical 10 percent decrease in interest rates would not have a material impact on the fair market value of this debt. We do not hedge any interest rate exposures. PART II: OTHER INFORMATION Item 1	Legal Proceedings 	None Item 2	Changes in Securities and Use of Proceeds (d)	Use of Proceeds from Sales of Registered Securities. On February 23, 1999 the Company completed a public offering of its Common Stock, $0.001 par value. The managing underwriters in the Offering were Credit Suisse First Boston Corporation and Dain Rauscher Wessels (the "Underwriters"). The shares of Common Stock sold in the Offering were registered under the Securities Act of 1933, as amended, on a Registration Statement on Form S-1 (the "Registration Statement") (Reg. No. 333-79504) that was declared effective by the SEC on February 23, 1999. The Offering commenced on February 23, 1999 after all 3,000,000 shares (of which 2,480,000 shares were offered by the Company and 520,000 shares were offered by certain selling shareholders) of Common Stock registered under the Registration Statement were sold at a price of $23.50 per share. The aggregate price of the Offering amount registered was $70,500,000. In connection with the Offering, the Company paid an aggregate of $3,690,000 in underwriting discounts and commissions to the Underwriters. In addition, the following table sets forth an estimate of all expenses incurred in connection with the Offering, other than underwriting discounts and commissions. All amounts shown are estimated except for the registration fees of the SEC and the National Association of Securities Dealers, Inc. ("NASD"). SEC Registration fee $ 27,038 NASD filing fee 10,226 Nasdaq National Market listing fee 17,500 Printing and engraving expenses 225,000 Legal fees and expenses 340,000 Accounting fees and expenses 160,000 Blue Sky fees and expenses 5,000 Transfer Agent and Registrar fees 10,000 Miscellaneous 105,236 ----------- Total $900,000 After deducting the underwriting discounts and commissions and the estimated offering expenses described above, Com21 received net proceeds from the offering of approximately $54,329,600 and the selling stockholders received $11,580,400. As of September 30, 1999, Com21 has used the net proceeds from its public offering of Common Stock to invest in short-term, interest bearing, investment grade securities and has used its existing cash balances to fund the general operations of the Company. The proceeds will be used for general corporate purposes, including working capital and product development. A portion of the net proceeds may also be used to acquire or invest in complementary business or products or to obtain the right to use complementary technologies. Com21 has no agreements or commitments with respect to any such acquisition or investments and is not currently engaged in any material negotiations with respect to any such transaction. None of Com21's net proceeds of the offering were paid directly or indirectly to any director, officer, general partner of Com21 or their associates, persons owning 10% or more of any class of equity securities of the Com21, or an affiliate of Com21. Item 3	Defaults upon Senior Securities 	None Item 4	Submission of Matters to a Vote of Security Holders 	None Item 5	Other Information 	None Item 6	Exhibits and Reports on Form 8-K. 	a)	Exhibits 		 Exhibit 		 Number		Description 		 27.1		Financial Data Schedule 	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: November 12, 1999 By: /s/ David L. Robertson --------------------------- David L. Robertson Chief Financial Officer