UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
(Mark One)
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the quarterly period ended September 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 No. 333-64483
DIVA Systems Corporation
(Exact name of Registrant as specified in its charter)
Delaware 94-3226532
(State or other jurisdiction of (IRS Employer
Incorporation or organization) Identification Number)
800 Saginaw Drive
Redwood City, CA 94063
(Address of principal executive offices)
(650) 779-3000
(Registrant's telephone number, including area code)
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. [_] Yes [X] No
The number of shares of Registrant's classes of Common Stock at October 31,
2001 was:
Title of each class
-------------------
Common Stock, $.001 par value 18,247,372
Class C Common Stock, $.001 par value 857,370
DIVA SYSTEMS CORPORATION
Quarterly Report on Form 10-Q
Table of Contents
Quarter Ended September 30, 2001
PART I - FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements (Unaudited)
Condensed Consolidated Balance Sheet at September 30, 2001 and
June 30, 2001 1
Condensed Consolidated Statement of Operations for the three months
ended September 30, 2001 and 2000 2
Condensed Consolidated Statement of Cash Flows for the three months
ended September 30, 2001 and 2000 3
Notes to Condensed Consolidated Financial Statements 4
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations 5
Item 3. Quantitative and Qualitative Disclosures About Market Risk 12
PART II - OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds 26
Item 6. Exhibits and Reports on Form 8-K 26
Signatures 27
PART I
ITEM 1. FINANCIAL STATEMENTS
DIVA SYSTEMS CORPORATION AND SUBSIDIARIES
Condensed Consolidated Balance Sheets
(in thousands, except per share data)
(unaudited)
September 30, June 30,
Assets 2001 2001
------------------ -----------------
Current assets:
Cash and cash equivalents $ 19,739 $ 19,146
Short-term investments 6,373 14,169
Accounts receivable 9,969 15,090
Inventory 12,230 15,947
Prepaid expenses and other current assets 1,085 775
------------------ -----------------
Total current assets 49,396 65,127
Property and equipment, net 11,477 12,433
Debt issuance costs, net 4,152 4,652
Deposits and other assets 600 597
------------------ -----------------
Total assets $ 65,625 $ 82,809
================== =================
Liabilities, Redeemable Warrants and Stockholders' Deficit
Current liabilities:
Accounts payable $ 10,584 $ 14,440
Other current liabilities 3,713 5,127
Deferred revenue 3,294 2,126
Current portion of capital lease obligation 754 738
------------------ -----------------
Total current liabilities 18,345 22,431
Notes payable 367,069 355,517
Redeemable put warrants 5,993 7,326
Long - term portion of lease payable 97 292
Deferred rent 904 892
------------------ -----------------
Total liabilities 392,408 386,458
------------------ -----------------
Redeemable warrants 4,621 5,364
------------------ -----------------
Commitments and contingencies
Stockholders' deficit:
Preferred stock, $0.001 par value; 80,000,000 shares authorized;
25,120,851 and 25,120,851 shares issued and outstanding
as of September 30, 2001, and June 30, 2001, respectively.
Common stock, $0.001 par value; 165,000,000 shares authorized; 25 25
19,088,041 and 19,086,839 shares issued and outstanding as
of September 30, 2001, and June 30, 2001, respectively. 19 19
Additional paid-in capital 148,274 147,682
Deferred compensation (2,783) (3,592)
Accumulated deficit (476,939) (453,147)
------------------ -----------------
Total stockholders' deficit (331,404) (309,013)
------------------ -----------------
Total liabilities, redeemable warrants and stockholders' deficit $ 65,625 $ 82,809
================== =================
See accompanying notes to interim condensed consolidated financial statements.
DIVA SYSTEMS CORPORATION AND SUBSIDIARIES
Condensed Consolidated Statements of Operations
(in thousands, except per share data)
(unaudited)
Three Months Ended
September 30,
2001 2000
----------------- ---------------
Revenues:
Product $ 4,481 $ 35
License 2,781 36
Service 1,169 314
----------------- ---------------
Total revenues 8,431 385
Cost of revenues:
Cost of product revenue 7,270 185
Cost of service revenue 1,418 1,048
----------------- ---------------
Total cost of revenues 8,688 1,233
----------------- ---------------
Negative gross margin 257 848
----------------- ---------------
Operating expenses:
Operations 704 1,815
Engineering and development 3,427 8,011
Sales and marketing 1,333 1,472
General and administrative 5,650 5,505
Depreciation and amortization 1,334 1,522
Warrant expense (benefit) 154 (181)
Amortization of stock compensation 501 1,128
----------------- ---------------
Total operating expenses 13,103 19,272
----------------- ---------------
Operating loss 13,360 20,120
----------------- ---------------
Other (income) expense:
Interest income (309) (711)
Gain on sale of investments -- (12,896)
Interest expense 10,741 5,294
----------------- ---------------
Total other (income)/expense, net 10,432 (8,313)
----------------- ---------------
Net loss 23,792 11,807
Decrement of redeemable warrants (743) (2,404)
----------------- ---------------
Net loss attributable to
common stockholders $ 23,049 $ 9,403
================= ===============
Basic and diluted net loss per share: $ 1.21 $ .50
================= ===============
Shares used in per share computation 19,088 18,670
================= ===============
See accompanying notes to interim condensed consolidated financial statements.
2
DIVA SYSTEMS CORPORATION AND SUBSIDIARIES
Condensed Consolidated Statement of Cash Flows
(in thousands)
(unaudited)
Three Months Ended
September 30,
2001 2000
------------ -----------
Cash flows from operating activities:
Net loss $(23,792) $(11,807)
Adjustments to reconcile net loss to net
cash used in operating activities:
Depreciation and amortization 1,334 1,522
Inventory reserves -- 931
Amortization of debt issuance costs and
accretion of discount on notes payable 10,719 5,857
Amortization of deferred stock compensation 501 1,128
Warrant expense (benefit) 154 (181)
Changes in operating assets and liabilities:
Accounts receivable 5,121 (11,699)
Inventory 3,717 (4,903)
Other assets (310) 558
Accounts payable (3,856) 1,046
Other current liabilities (1,414) (1,187)
Deferred revenue 1,168 (32)
Deferred rent 12 30
-------- --------
Net cash used for operating activities (6,646) (18,737)
-------- --------
Cash flows from investing activities:
Purchases of property and equipment (381) (911)
Proceeds from sale of short-term investments 7,796
Purchases of short-term investments -- (3,931)
-------- --------
Net cash provided by (used in) investing activities 7,415 (4,842)
-------- --------
Cash flows from financing activities:
Issuance of preferred stock, net -- 5,000
Exercise of stock options 3 150
Payments on capital lease (179) (165)
-------- --------
Net cash provided by (used in) financing activities (176) 4,985
-------- --------
Net increase (decrease) in cash and cash equivalents 593 (18,594)
Cash and cash equivalents at beginning of period 19,146 66,253
-------- --------
Cash and cash equivalents at end of period $ 19,739 $ 47,659
======== ========
Supplemental disclosures of cash flow information:
Noncash investing and financing activities:
Revaluation of put warrants associated with the 1996 notes $ (1,333) $ (4,663)
======== ========
Decrement of redeemable warrants $ (743) $ (2,404)
======== ========
Deferred compensation expense associated with stock options $ (308) $ 1,665
======== ========
See accompanying notes to interim condensed consolidated financial statements.
3
DIVA SYSTEMS CORPORATION AND SUBSIDIARIES
NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note 1--The Company And Basis Of Presentation
DIVA Systems Corporation (the "Company") is a leading provider of digital
video-on-demand products and services. The Company's principal operations
consist of selling, licensing, manufacturing and providing operational support
for its video-on-demand products and services.
The interim unaudited financial statements as of September 30, 2001, and
for the three months ended September 30, 2001 and 2000 have been prepared on
substantially the same basis as the Company's audited financial statements for
the year ended June 30, 2001 and include all adjustments, consisting only of
normal recurring adjustments that, in the opinion of management, are necessary
for a fair presentation of the financial information set forth herein. The
results of operations for current interim periods are not necessarily indicative
of results to be expected for the current year or any other period.
These interim unaudited financial statements should be read in
conjunction with the Company's annual financial statements, included in the
Company's Form 10-K for the year ended June 30, 2001 (Fiscal 2001).
Note 2--Basic and Diluted Net Loss Per Share
Basic and diluted net loss per share is computed using net loss adjusted
for the accretion of the redeemable warrants and the weighted-average number of
outstanding shares of common stock. Potentially dilutive securities, including
options, warrants, restricted common stock, and preferred stock (amounting to
42,056,510 and 44,775,430 shares of common stock at September 30, 2001 and 2000,
respectively) have been excluded from the computation of diluted net loss per
share because the effect of this inclusion would be antidilutive. Information
pertaining to potentially dilutive securities is included in Notes 5, 6 and 7 of
notes to consolidated financial statements included in the Company's Fiscal 2001
Form 10-K.
Note 3--Revenue Recognition Policy
The Company's contracts are generally multiple-element arrangements with
a network operator involving a combination of video-on-demand hardware products,
licenses for system software and navigator applications and selected content and
operational services. The Company recognizes revenue in accordance with the
American Institute of Certified Public Accountants Statement of Position 97-2
(SOP 97-2), "Software Revenue Recognition," and Statement of Position 98-9 (SOP
98-9), "Software Revenue Recognition, with Respect to Certain Transactions." SOP
97-2 generally requires revenue earned on software arrangements involving
multiple elements to be allocated to each element based on the relative fair
values of the elements. The fair value of an element must be based on vendor
specific objective evidence, which is generally determined by the price charged
when the element is sold separately. SOP 98-9 requires recognition of revenue
using the residual method in a multiple element arrangement when fair value does
not exist for one or more of the delivered elements in the arrangement.
4
Under the residual method, revenue for the undelivered elements is deferred and
subsequently recognized in accordance with SOP 97-2.
The Company adopted Staff Accounting Bulletin No. 101, "Revenue
Recognition in Financial Statements" (SAB 101), amended by SAB 101A and 101B as
of April 1, 2001, which provides guidance on the recognition, presentation and
disclosure of revenue in financial statements filed with the Securities and
Exchange Commission. SAB 101 outlines the basic criteria that must be met to
recognize revenues and provides guidance for disclosure related to revenue
recognition policies. The adoption of SAB 101 did not have a material impact on
the Company's consolidated financial position or its results of operations.
Prior to January 2001, all hardware and software elements were
deliverable over the term of the contract and evidence of the fair value of the
individual elements in our agreements did not exist. As a result, upon the
delivery of the Company's video-on-demand hardware products, revenue was
recognized to the extent of the cost of these hardware products. Any remaining
product revenue was amortized on a straight-line basis over the remaining term
of the agreement. The Company recognized license revenues over the term of the
agreement based on the number of subscribers.
All of the Company's installations since January 2001 have been made
under agreements whereby all hardware and software elements are delivered upon
completion of installation and the training of cable network personnel.
Accordingly, the Company has recognized product revenue and licensing revenue
upon completion of the equipment installation at a customer's site, which
includes completion of technical training, according to the residual method.
Consequently, the fair value of the maintenance element, determined by the
maintenance renewal fee, is deferred and amortized over the maintenance period,
which is generally one year.
The Company provides services on a fee-for-service basis, whereby
service revenue is recognized when the services are performed. If the services
are provided on a revenue sharing basis, service revenue is recognized based on
program purchases by subscribers.
The Company provides limited warranty rights to its customers. Estimated
warranty obligations are provided by charges to operations in the period in
which the related revenue is recognized. To date, the estimated warranty
obligations have not been considered significant.
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
The following discussion of our financial condition and results of
operations should be read in conjunction with the Consolidated Financial
Statements and the related notes included elsewhere in this Form 10-K. This
discussion contains forward-looking statements that involve risks and
uncertainties. Our actual results may differ materially from the results
discussed in the forward-looking statements. Factors that might cause such a
difference includes, but are not limited to, those discussed below. The
forward-looking statements contained herein are made as of the date hereof, and
we assume no obligation to update such forward-looking statements or to update
the reason actual results may differ materially from those anticipated in such
forward-looking statements. Forward-looking statements are statements identified
with an asterisk (*). All forward-looking statements attributable to us or
persons
5
acting on our behalf are expressly qualified in their entirety by the cautionary
statements set forth above and in "--Factors Affecting Operating Results."
Overview
We are a leading provider of interactive, on-demand television products
and services. Our video-on-demand service operates on industry-standard digital
set-top boxes and operating systems, providing a flexible and cost-effective
interactive television solution for cable and other broadband network operators,
which we refer to as network operators. We have commercially deployed our
video-on-demand service with several network operators in North America. In
addition to our video-on-demand products and services we developed and beta
tested an interactive program guide as a stand-alone product. To date, we have
neither commercially deployed nor are we actively marketing our interactive
program guide technology. On June 30, 2001 we ceased further development
activities related to our interactive program guide technology and reduced our
development workforce accordingly. Since our inception, we have devoted
substantially all of our resources to developing our video-on-demand and other
interactive products and services, establishing industry relationships, carrying
out marketing activities, negotiating deployment agreements and establishing the
operations necessary to support the commercial deployment of our video-on-demand
products and services.
Through September 30, 2001, we have generated some revenues and incurred
significant losses and substantial negative cash flow, primarily due to
engineering and development expenditures and other costs required to develop our
video-on-demand products and services. Since our inception through September 30,
2001, we have an accumulated deficit of $476.9 million and have not achieved
profitability on a quarterly or annual basis. We expect to continue to incur
substantial net losses and negative cash flow for at least the next few years,
requiring us to raise additional capital. In addition, we have limited cash
reserves and uncertainty exists concerning our ability to raise additional
capital and continue as a going concern.* Our historical revenues and
expenditures are not necessarily indicative of, and should not be relied upon as
an indicator of, revenues that may be attained or expenditures that may be
incurred by us in future periods.*
Revenues
Revenue is comprised of three components: product revenue resulting from
the sale of our video-on-demand hardware platform; licensing revenue resulting
from the licensing of our system software and navigator applications; and
service revenue resulting from programming services and operational support
services.
Our contracts are generally multiple-element arrangements with a network
operator involving a combination of video-on-demand hardware products, licenses
for system software and navigator applications, and selected content and
operational services. As a result, we recognize revenue in accordance with the
American Institute of Certified Public Accountants Statement of Position 97-2
(SOP 97-2), "Software Revenue Recognition," and Statement of Position 98-9 (SOP
98-9), "Software Revenue Recognition, with Respect to Certain Arrangements." SOP
97-2 generally requires revenue earned on software arrangements involving
multiple elements to be allocated to each element based on
6
the relative fair values of the elements. The fair value of an element must be
based on vendor specific objective evidence, which generally is determined by
the price charged when the element is sold separately. SOP 98-9 requires
recognition of revenue using the residual method in a multiple element
arrangement when fair value does not exist for one or more of the delivered
elements in the arrangement. Under the residual method, the total fair value of
the undelivered elements is deferred and subsequently recognized in accordance
with SOP 97-2.
Prior to January 2001, all hardware and software elements were
deliverable over the term of the contract and evidence of the fair value of the
individual elements in our agreements did not exist. As a result, upon the
delivery of our video-on-demand hardware products, revenue was recognized to the
extent of the cost of these hardware products and any remaining product revenue
was amortized on a straight-line basis over the remaining term of the agreement.
We recognized license revenues over the term of the agreement based on the
number of subscribers.
All of our installations since January 1, 2001 have been made under
agreements whereby all hardware and software elements are delivered upon
completion of installation and the training of network operator personnel.
Accordingly, for the three months ended September 30, 2001, we recognized
product revenue and licensing revenue upon completion of the equipment
installation at a customer's site, which includes technical training, according
to the residual method. Consequently, the fair value of the maintenance element,
determined by the maintenance renewal fee, is deferred and amortized over the
maintenance period, which is generally one year.
We provide services on a fee-for-service basis, whereby service revenue
is recognized when the services are performed. If the services are provided on a
revenue sharing basis, service revenue is recognized based on program purchases
by subscribers.
Cost of Revenues
Cost of Product Revenues. Cost of revenue consists of contract
manufacturing costs, component and material costs, warranty costs, and other
direct product expenditures associated specifically with the sale of our
video-on-demand hardware and software products. Included in cost of product
revenues are allocations of certain manufacturing overhead expenses. We expect
our cost of revenue to increase in the future due to increased sales volume of
our video-on-demand hardware and software products.*
Cost of Service Revenues. Cost of service revenue consists of license
fees paid to content providers, costs related to the acquisition and production
of digitally encoded programming content, duplication and distribution expenses
and other expenditures associated specifically with content management.
Operating Expenses
Operations. Operations expense includes the cost of field operations,
both for initial launches and for ongoing support of our installed
video-on-demand systems. These costs include personnel and other costs for
technical support, customer service training, installation, launch support, and
maintenance costs. In addition, operations expense includes personnel and other
costs which support our ongoing manufacturing relationships for our
video-on-demand hardware products with third-party manufacturers.
7
Engineering and Development. Engineering and development expense
consists of salaries, consulting fees, prototype hardware and other costs to
support product development. Our engineering and development efforts involve
ongoing system software development, hardware development, system integration
and new technology. To date, the most substantial portion of our operating
expenses has been engineering and development expense. We expect to continue to
incur significant engineering and development expenditures as we continue to
enhance our video-on-demand products and services.* We believe these
expenditures are necessary to remain competitive, to assure that our products
and services comply with industry standards and to offer new products and
services to our customers.
Sales and Marketing. To date, our sales and marketing expense has
consisted of the costs of marketing our video-on-demand products and services to
network operators and their customers. It also includes costs related to
business development and marketing personnel, travel expenses, trade shows,
consulting fees and promotional costs. We expect that direct marketing costs
will not represent a significant component of total sales and marketing expense,
as most network operators will take responsibility for marketing video-on-demand
services to their subscribers.* To the extent we provide these services, they
will likely be performed under individual service agreements with the network
operators and, accordingly, the related expenses will fluctuate with revenues.
Our future sales and marketing costs will consist primarily of market
development and product management expenses.*
General and Administrative. General and administrative expense consists
primarily of salaries and related expenses of management and administrative
personnel, professional fees and general corporate and administrative expenses.
In addition, general and administrative expense includes costs associated with
the development, support and growth of our management information system
infrastructure.
Depreciation and Amortization. Depreciation and amortization expense
includes depreciation of property and equipment, including our video-on-demand
hardware. Generally, depreciation is calculated using the straight-line method
over the estimated useful lives of the assets, which range from three to five
years. Historically, depreciation expense has been a significant component of
our operating expenses. This resulted from the significant investment in capital
equipment necessary to deploy our end-to-end video-on-demand service. We expect
depreciation expense to decrease as a component of operating expense in the
future as network operators purchase the various video-on-demand hardware
components directly from us.*
Warrant Expense. Warrant expense represents the cost of the warrants
issued to customers and to strategic business partners based on their estimated
fair value, as determined using the Black-Scholes option pricing model, at the
earlier of the grant date or the date it becomes probable that the warrants will
be earned.
Amortization of Deferred Stock Compensation. Deferred stock compensation
represents the difference between the estimated fair value of our common stock
for accounting purposes and the option exercise price of such options at the
grant date.
8
Other Income and Expense. Other income and expense primarily consists
of interest income and interest expense. Interest income consists of earnings on
cash, cash equivalents and short-term investments. Gain on sale of investments
consists of proceeds from the sale of an investment in common stock held by us.
Interest expense consists primarily of accreted interest on our outstanding debt
and revaluation of redeemable put warrants.
Results of Operations
Revenue
Total revenue for the three months ended September 30, 2001 was $8.4
million compared to $385,000 for the three months ended September 30, 2000. The
increase in total revenue is the result of an increase in the number of system
deployments and an increase in the number of subscribers. During the three
months ended September 30, 2001 we deployed our video-on-demand products,
software and services in eleven sites representing approximately $10.4 million
in product shipments and services. A portion of this is deferred and unbilled
and not recognized as revenue for the three months ended September 30, 2001.
There were no deployments in the September 30, 2000 quarter.
Product revenue. Product revenue was $4.5 million and $35,000 for the
three months ended September 30, 2001 and 2000, respectively.
License revenue. License revenue was $2.8 million and $36,000 for the
three months ended September 30, 2001 and 2000, respectively. License revenue is
the fee for our system manager software and navigator application.
Service revenue. Service revenue was $1.2 million and $314,000 for the
three months ended September 30, 2001 and 2000, respectively.
Cost of Revenues
Cost of Product Revenue. Cost of product revenue was $7.3 million and
$185,000 for the three months ended September 30, 2001 and 2000, respectively.
The increase in cost of product revenue was the result of an increase in sales
of our video-on-demand products. Included in cost of product revenue for the
three months ended September 30, 2001 was an allocation of $794,000 related to
indirect costs from operations overhead.
Cost of Service Revenues. Cost of service revenues was $1.4 million and
$1.0 million for the three months ended September 30, 2001 and 2000,
respectively. The increase in cost of service revenues was primarily
attributable to an increase in the number of commercial sites deployed with our
video-on-video products and services and a corresponding increase in the number
of subscribers, and costs associated with the acquisition of new titles in our
content library.
Operating Expenses
Operations. Operations expense was $704,000 and $1.8 million for the
three months ended September 30, 2001 and 2000, respectively. The decrease in
operations expense was due primarily to the
9
allocation of $794,000 in overhead costs related to the manufacturing of our
video-on-demand hardware products to cost of product revenues, a decrease in
travel to customer sites and a reduction in personnel related to our
manufacturing operations.
Engineering and Development. Engineering and development expense was
$3.4 million and $8.0 million for the three months ended September 30, 2001 and
2000, respectively. The decrease in engineering and development expense was
primarily attributable to a decrease in development personnel, outside
consultants and other engineering expenses in connection with the development of
certain hardware products and our interactive program guide. In addition,
engineering and development expenses for the three months ended September 30,
2000 included $1.1 million in development related expenses pursuant to a
development contract with a third party. There was no similar expense for the
three months ended September 30, 2001.
Sales and Marketing. Sales and marketing expense was $1.3 million and
$1.5 million for the three months ended September 30, 2001 and 2000,
respectively. The decrease in sales and marketing expense was primarily due to a
decrease in marketing and promotional activities in the United Kingdom.
General and Administrative. General and administrative expense was $5.6
million and $5.5 million for the three months ended September 30, 2001 and 2000,
respectively. The increase in general and administrative expense was primarily
due to $810,000 in legal expenses related to our debt restructuring activities,
which was offset by a decrease in other general legal expenses and overall
decreases in other general and administrative activities.
Depreciation and Amortization. Depreciation and amortization expense
was $1.3 million and $1.5 million for the three months ended September 30, 2001
and 2000, respectively.
Warrant Expense (Benefit). Warrant expense (benefit) was $154,000 and
($181,000) for the three months ended September 30, 2001 and 2000, respectively.
Warrant expense (benefit) relates to the costs associated with warrants issued
to customers and strategic business partners. Charges in the three months ended
September 30, 2001 and 2000, and in future periods, depends in part on
the achievement of specified performance milestones by our customers and
strategic business partners.
Amortization of Deferred Stock Compensation. Amortization of deferred
stock compensation expense was $501,000 and $1.1 million for the three months
ended September 30, 2001 and 2000, respectively. Deferred stock compensation
expense was related to stock options granted to employees and consultants.
Other Income and Expenses
Interest income was $309,000 and $711,000 for the three months ended
September 30, 2001 and 2000, respectively. The decrease in interest income was
the result of a decrease in cash and cash equivalent balances, which are
invested in short-term, interest bearing accounts and a decrease in short-term
investments. Gain on sale of investments was $12.9 million for the three months
ended September 30,
10
2000, and was attributable to the sale of common stock of PMC-Sierra, Inc. that
we previously acquired. There was no similar transaction during the three months
ended September 30, 2001. Interest expense was $10.7 million and $5.3 million
for the three months ended September 30, 2001 and 2000, respectively. Included
in interest expense for the three months ended September 30, 2001 and 2000 was a
credit of $1.3 million and $4.7 million, respectively, for valuation of the put
warrants associated with the 1996 notes.
Provision for Income Taxes
We have not provided for or paid federal income taxes due to our net
losses. As of June 30, 2001, we had net operating loss carryforwards of
approximately $267.5 million to offset future income subject to federal income
taxes and $115.2 million available to offset future California taxable income.
As of June 30, 2001, we also had net operating loss carryforwards in various
other states. The extent to which such loss carryforwards can be used to offset
future taxable income may be limited because of ownership changes pursuant to
Section 382 of the Internal Revenue Code of 1986, as amended.
Liquidity and Capital Resources
From our inception through September 30, 2001, we have financed our
operations primarily through the gross proceeds of private placements totaling
approximately $108.3 million of equity and $250.0 million of high yield debt
securities, net of repayments. As of September 30, 2001, we had cash and cash
equivalents and short-term investments totaling $26.1 million.
On February 19, 1998, we received $250.0 million in gross proceeds from
an offering of 463,000 units consisting of senior discount notes with an
aggregate principal amount at maturity of $463.0 million and warrants to
purchase an aggregate of 2,778,000 shares of common stock. The notes are senior
unsecured indebtedness, and rank pari passu with our unsubordinated unsecured
indebtedness. The notes are senior to subordinated indebtedness, but effectively
will be subordinated to any future secured indebtedness at least to the extent
of the collateral of such indebtedness.
The indenture governing our senior discount notes imposes operating and
financial restrictions on us and our subsidiaries. These restrictions in certain
cases significantly limit or prohibit our ability directly and through our
subsidiaries to incur additional indebtedness, create liens upon assets, apply
the proceeds from the disposal of assets, make investments, make dividend
payments and other distributions on capital stock and redeem capital stock.
These covenants have limited our ability to perform certain activities in the
past and may limit our ability to finance our operations or engage in other
business activities that may be in our best interest in the future.
The senior discount notes were sold at a significant discount, and must
be repaid at maturity on March 1, 2008. Commencing September 1, 2003, we will be
required to make semi-annual interest payments of $29.2 million. There are no
principal payments due on the senior discount notes prior to maturity on March
1, 2008. We have had a number of discussions with a committee of holders of our
senior discount notes, which represents over 50% of the outstanding senior
discount notes, and their financial and legal advisors. To date these
discussions have focused on a restructuring of our senior
11
discount notes and our future funding requirements. We have also approached
several other potential strategic and financial partners about raising
additional capital to fund our operations. There can be no assurance that such
discussions will result in a restructure of our outstanding indebtedness or any
additional funding commitment.
We expect to require significant working capital and incur significant
operating expenses in the future.* Working capital requirements include
inventory expenditures for our video-on-demand products and general capital
expenditures associated with our anticipated growth. Our working capital needs
will, in part, be determined by the rate at which network operators purchase and
introduce our video-on demand products and services. In addition to working
capital, we intend to make significant expenditures for continued development
and enhancement of our video-on-demand technology, development of new services
and other expenses associated with the delivery of our video-on-demand products
and services.* Our actual cash requirements may vary from expectations and will
depend on numerous factors and conditions, many of which are outside of our
control.
We believe our cash, cash equivalents and short-term investments will
be sufficient to fund our operations through March 31, 2002.* Thereafter, we
will need to raise additional funds through debt or equity financing, selling
assets, or entering into strategic relationships, and there can be no assurance
that we will be able to perform any of the foregoing on favorable terms, or at
all.* We may also need to raise additional funds in order to respond to
unforeseen technological or marketing hurdles or to take advantage of
unanticipated opportunities. Although we are currently pursuing initiatives to
raise additional funds, we have no present commitments or arrangements assuring
us of any additional capital and there can be no assurance that we will be able
to obtain additional capital on acceptable terms, or at all. Failure to
successfully address our ongoing liquidity requirements will have a material
adverse effect upon our business. In the event that we are unable to obtain
additional capital, we will be required to take actions that will harm our
business and our ability to achieve sufficient cash flow to service our
indebtedness, including, potentially, ceasing certain or all of our operations.
To the extent we raise additional cash by issuing equity securities, our
existing stockholders will be diluted.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Market Risk Disclosures
The following discussion about our market risk disclosures contains
forward-looking statements. Forward-looking statements are subject to risks and
uncertainties. Actual results could differ materially from those discussed in
the forward-looking statements. We are exposed to market risk related to changes
in interest rates, foreign currency exchange rates and derivatives.
Interest Rate Sensitivity
We maintain a short-term investment portfolio consisting mainly of
income securities 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. We 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.*
12
Our short-term investments have generally been available-for-sale.
Gross unrealized gains and losses were not significant as of September 30, 2001.
The following table presents the principal amounts and related
weighted-average yields for our fixed rate investment portfolio (in thousands,
except average yields) at September 30, 2001.
Carrying Average
Amount Yield
---------- ---------
U.S. government obligations $ 5,677 3.23%
Commercial paper 9,220 3.02%
Certificates of deposits 2,188 2.94%
Money market instruments 2,654 3.08%
Auction rate preferred stock certificates 6,373 4.69%
----------
Total $26,112
==========
Included in cash and cash equivalents $19,739
Included in short-term investments 6,373
----------
Total $26,112
==========
Foreign Currency Risks
We believe that our exposure to currency exchange fluctuation risk is
insignificant because our transactions with international vendors are generally
denominated in U.S. dollars, which is considered to be the functional currency
for our company and subsidiaries. The currency exchange impact on intercompany
transactions for the three months ended September 30, 2001 was $14,000.
Factors Affecting Operating Results
Our ability to continue as a "going concern" is uncertain
Our consolidated financial statements have been prepared on the
assumption that we will continue as a going concern, which contemplates the
realization of assets and liquidation of liabilities in the normal course of
business. The independent accountants' report on our financial statements as of
and for the fiscal year ended June 30, 2001, included in our Form 10-K, includes
an explanatory paragraph which states that since inception we have incurred net
operating losses and negative cash flows, and working capital and stockholders'
deficits, that raise substantial doubt about our ability to continue as a
13
going concern. Investors in our securities should review carefully the report of
the independent accountants in our Form 10-K for Fiscal 2001. We expect our
losses and negative cash flow to continue, which will require us to obtain
additional capital. It is uncertain whether we will be able to such obtain
additional capital on acceptable terms, or at all. Further, if future financing
requirements are satisfied through the issuance of equity or debt securities,
investors may experience significant dilution in terms of their percentage
interest in DIVA. Commencing on September 1, 2003, we will be required to make
cash interest payments on our outstanding senior notes. In addition, we believe
our cash, cash equivalents and short-term investments will only be sufficient to
satisfy our cash requirements through March 31, 2002.* In the event that we are
unable to successfully commercially deploy our video-on-demand products and
services and implement our business strategy, obtain additional capital or
generate sufficient operating cash flows to fund our working capital needs and
make interest payments on our outstanding debt, we may be unable to continue as
a going concern.
If we do not obtain additional funds in the near future, we will be required to
take actions that will harm our business, including potentially ceasing certain
or all of our operations.
We will require additional funds in order to continue the development,
sale, licensing and provisioning of our video-on-demand products and services
and, commencing on September 1, 2003, to make cash interest payments on our
indebtedness. We have made and expect to continue to make significant
investments in working capital in order to fund development activities, sell our
video-on-demand products and services and fund operations. We expect to continue
to incur significant operating losses and expect that our operating cash flow
will be negative for at least into calendar 2003. We believe our cash, cash
equivalents and short-term investments will be sufficient to fund our operations
through March 31, 2002.* Thereafter, we will need to raise additional funds
through debt or equity financing, selling assets, or entering into strategic
relationships, and there can be no assurance that we will be able to perform any
of the foregoing on favorable terms, or at all.* We may also need to raise
additional funds in order to respond to unforeseen technological or marketing
challenges or to take advantage of unanticipated opportunities. In addition to
our recent discussions with a committee of holders of our senior discount notes,
we have also approached several potential strategic and financial partners about
raising additional capital to fund our operations. We currently have no
commitments or arrangements assuring us of any additional funds and there can be
no assurance that we will be able to obtain additional capital on acceptable
terms, or at all.* Failure to successfully address our ongoing liquidity
requirements will have a material adverse effect upon our business. In the event
that we are unable to obtain additional capital, we will be required to take
actions that will harm our business and our ability to achieve sufficient cash
flow to service our indebtedness, including, potentially, ceasing certain or all
of our operations. To the extent we raise additional cash by issuing equity
securities, our existing stockholders will be diluted.
We will require a significant amount of cash to service our indebtedness, and
our ability to generate cash depends on many factors beyond our control
We expect to continue to generate substantial net losses and negative
cash flow for the next few years. We may be unable to achieve a level of cash
flow from operations sufficient to permit us to pay the principal and interest
on our current indebtedness and any additional indebtedness we may incur. The
senior discount notes were sold at a significant discount and must be repaid at
maturity on March 1, 2008. Commencing September 1, 2003, we will be required to
make semi-annual interest payments of $29.2 million. Our ability to make
scheduled debt service payments will depend upon our ability to
14
achieve significant and sustained growth in our cash generated from operations
and to complete necessary additional financing.
If we are unable to generate sufficient cash from operations to service
our indebtedness, we will be required to restructure or refinance such
indebtedness or raise additional capital through additional debt or equity
financing, selling assets, or entering into strategic relationships. There can
be no assurance that we will be able to perform any of the foregoing on
favorable terms, or at all. In the event that we are unable to restructure or
refinance our indebtedness or obtain additional capital, we will be required to
take actions that will harm our business, including, potentially, ceasing
certain or all of our operations. We have had a number of discussions with a
committee of holders of our senior discount notes, which represents over 50% of
our outstanding senior discount notes, and their financial and legal advisors.
To date, these discussions have focused on a restructuring of our senior
discount notes and our future funding requirements. There can be no assurance
that such discussions will result in a restructuring of our outstanding
indebtedness or any additional funding commitment. We have also approached
several other potential strategic and financial partners about raising capital
to fund our operations. There can be no assurance that these potential investors
will provide any additional funding. We may not be able to effect any new
financing strategy or funding commitments on satisfactory terms, if at all. If
we fail to satisfy our obligations with respect to our indebtedness, this could
result in a default under the indenture governing our senior discount notes. In
the event of a default, the holders of indebtedness would have enforcement
rights, including the right to accelerate the debt and the right to commence an
involuntary bankruptcy proceeding against us. Absent successful commercial
deployments of our interactive products and services, ongoing technical
development and enhancement of our solution and significant growth of our cash
flow or other successful attempts to raise cash such as the sale of assets or
equity or debt financing, we would not be able to service our indebtedness.
Our leverage is substantial and will increase, making it more difficult to
respond to changing business conditions
We are highly leveraged. As of September 30, 2001 we had senior
discount notes payable of approximately $367.1 million. The senior discount
notes accrete at the rate of 12 5/8% per annum, compounded semi-annually. The
senior discount notes were sold at a significant discount and must be repaid at
maturity on March 1, 2008 at the aggregate par value of $463.0 million. The
degree to which we are leveraged could have important consequences to us and our
investors, including, but not limited to, the following:
. our ability to obtain additional financing in the future for working
capital, operating expenses in connection with system deployments,
development and enhancement of our video-on-demand products and services,
capital expenditures, acquisitions and other general corporate purposes may
be materially limited or impaired;
. our cash flow, if any, will not be available for our business because a
substantial portion of our cash flow must be dedicated to the payment of
principal and interest on our indebtedness;
. the terms of future permitted indebtedness may limit our ability to redeem
our outstanding senior discount notes in the event of a change of control;
and
. our high degree of leverage may make us more vulnerable to economic
downturns, may limit our ability to withstand competitive pressures and may
reduce our flexibility in responding to changing business and economic
conditions.
15
Our indebtedness contains restrictive covenants that could significantly limit
our ability to engage in business activities that may be in our best interest
The indenture governing our senior discount notes imposes operating and
financial restrictions on our subsidiaries and us. These restrictions in
specified cases significantly limit or prohibit our ability to:
. incur additional indebtedness;
. create liens upon assets;
. apply the proceeds from the disposal of assets;
. make investments;
. make dividend payments and other distributions on capital stock; and
. redeem capital stock.
These covenants have limited our ability to perform certain activities
in the past and may limit our ability to finance our operations or engage in
other business activities that may be in our best interest in the future.
We are an early stage company with limited revenues and a history of losses, we
expect to continue to incur substantial losses and negative cash flow and we may
never achieve or sustain profitability
We are an early stage company with limited commercial operating
history. We have generated revenues of $29.2 million and have incurred net
losses of $476.9 million from our inception through September 30, 2001. We
expect to continue to incur substantial losses and experience substantial
negative cash flow for at least the next few years as we continue to develop our
operations capability and sell and license our video-on-demand products and
services. We do not expect to generate substantial revenues unless and until our
video-on-demand products and services are deployed at a significant number of
additional cable systems and a significant number of viewers access our
video-on-demand and other interactive services enabled by our technology. If we
do not achieve and sustain profitability in the future, we may be unable to
continue our operations.
Our prospects should be considered in light of the risks, expenses and
difficulties frequently encountered by companies in their early stage of
development, particularly companies in new and rapidly evolving markets. Our
future success depends on a number of factors, including the following:
. the extent to which cable operators deploy digital set-top boxes;
. our ability to enter into agreements for the sale and license of our
video-on-demand products and services;
. the extent to which consumers accept and use interactive, on-demand
television enabled by our video-on-demand products and services;
. our ability to continue integrating our software and hardware with other
digital applications and services selected by network operators in the
United States and internationally, including set-top boxes, application
managers and set-top box operating systems, cable system components and
electronic program guides;
16
. the extent to which third-party cable equipment suppliers integrate their
headend products with our equipment and reduce the cost and physical space
requirements for their equipment;
. our ability to further reduce the physical space requirements for our video
server and other headend equipment;
. our ability to continue technical development of our video server, our
access equipment, our service software and our other video-on-demand system
components in order to reduce their manufacturing cost and enhance their
functionality;
. our ability to operate existing contracted video-on-demand deployments with
acceptable system performance and viewer acceptance; and
. our ability to outsource, on favorable economic terms, certain hardware and
service components to third parties, some of whom may be competitors, so
that we can continue to provide our video-on-demand solution.
Because we have a limited operating history, we have limited historical
financial data on which to base planned operating expenses, and investors may
find it difficult to evaluate our business and future prospects
Our limited operating history makes it very difficult to evaluate our
business and future prospects. As a result of our limited operating history, it
is difficult for us to accurately forecast our revenues, and we have limited
meaningful historical financial data on which to base planned operating
expenses. We are unable to accurately forecast our revenues because:
. we participate in an emerging market;
. several of our current video-on-demand deployment agreements with network
operators are for selected systems, and we are unable to predict whether
they will be expanded to cover additional systems;
. changes in network operators' financial condition or priorities may result
in delayed or slowed deployments under existing or future agreements;
. we cannot predict the rate at which cable subscribers will accept and
utilize video-on-demand;
. we expect to sign new sales, service and licensing agreements on an
irregular basis, if at all, and there may be long periods of time during
which we do not enter into new agreements or expanded arrangements; and
. we have a lengthy sales cycle, which makes it difficult to forecast the
quarter during which a sale will occur.
We expect our financial results to fluctuate significantly because we depend on
a small number of relatively large orders and other factors
Our quarterly operating results will fluctuate significantly in the
future as a result of a variety of factors, either alone or in combination. In
the short term, we expect our quarterly revenues to be significantly dependent
on a small number of relatively large orders for our products and services. As a
result, our quarterly operating results may fluctuate significantly if we are
unable to complete one or more substantial sales in any given quarter. Factors
that will affect our quarterly results, many of which are outside our control,
include:
. the timing of deployments by network operators of our video-on-demand
products and services;
17
. competitive pressure, which may cause us to change our pricing structures;
and
. demand for and viewer acceptance of video-on-demand and other interactive
services.
A significant portion of our operating expenses are relatively fixed
and necessary to develop our business. These expenses are largely independent of
the revenue generated in any given quarter from sales of products and services
to network operators. To the extent that increased expenses are not subsequently
followed by increased revenues, our operating results will suffer. If revenue
falls below expectations in any quarter, the adverse impact of the revenue
shortfall on operating results in that quarter may be increased by our inability
to adjust fixed spending to compensate for the shortfall.
Due to these and other factors, we believe that period-to-period
comparisons of our operating results may not be meaningful or indicative of
future performance. You should not rely on our results for any one quarter as an
indication of our future performance. It is likely that in some future quarters
or years our operating results will fall below the expectations of securities
analysts or investors.
If we do not achieve broad deployment of our video-on-demand products and
services, our business will not grow
Our future success depends in large part on our ability to sell our
digital video-on-demand products and services to a broad base of cable systems,
on terms that will generate a profit. We believe that most network operators
will deploy interactive platforms purchased from more than one supplier.
Accordingly, we believe that network operators will initially commit a limited
number of their cable systems to two or more competitors in order to evaluate
their interactive products and services. We believe that network operators will
not commit to broad deployments of our video-on-demand solution until they have
completed evaluation of our products and services as well as those of
competitors. Our ability to achieve broad network operator deployments will
depend on our success in demonstrating that:
. our interactive products and services are reliable and scalable and
integrate with products and services provided by other industry suppliers
chosen by the network operator;
. video-on-demand is a compelling consumer product and viewers will purchase
video-on-demand content at prices and in quantities that will justify the
network operator's investment in our video-on-demand products and services
rather than alternative entertainment services such as pay-per-view and
near-video-on-demand;
. our video-on-demand products are compatible with industry standards as they
evolve; and
. our technology enables the network operator to add new revenue-generating
services.
If we are unable to persuade network operators to purchase our products
or services and deploy video-on-demand and other interactive services broadly in
their cable systems, the growth of our business will suffer.
If the existing commercial deployments of our video-on-demand service with
network operators are not expanded, our results of operations and our reputation
will suffer
Our existing deployments with Charter and AT&T currently serve a small
percentage of each company's basic subscriber base. These network operators may
not continue these deployments beyond the terms of our existing agreements, and
they may choose not to broadly deploy our video-on-demand
18
solution in existing or additional cable systems. In the past, we had limited
scope video-on-demand trials with other network operators that did not result in
broad deployments. If we are unable to add a substantial number of cable systems
to the existing contracts with the network operators currently deploying our
products and services, and if video-on-demand is not broadly deployed in each
cable system under contract, our results of operations will suffer. In addition,
our reputation and our ability to enter into agreements with other network
operators could be impaired.
Our products and services will not achieve widespread adoption unless network
operators deploy digital set-top boxes and roll out and market video-on-demand
service to subscribers, all of which are beyond our control
Our ability to achieve widespread adoption of our video-on-demand
products and services depends on a number of other factors, many of which are
beyond our control, including:
. the rate at which network operators upgrade deploy digital set-top boxes;
. the ability of network operators to provide timely and effective marketing
campaigns coordinated with the launch of video-on-demand;
. the ability of network operators to maintain their cable infrastructure and
headends in accordance with system specifications provided by us;
. the success of network operators in marketing video-on-demand service;
. the prices that network operators set for video-on-demand movies and other
content and for installation or activation of video-on-demand service;
. the speed at which network operators can complete the installations
required to initiate service for new subscribers;
. the quality of customer and technical support provided by us, network
operators, and by other third parties whose products are integrated with
ours; and
. the availability and quality of content delivered to subscribers through a
video-on-demand service.
We expect rapid technological developments to occur in our industry and,
accordingly, must continue to enhance our current products as well as develop
new technologies, or competitors could render our products and services obsolete
We expect rapid technological developments to occur in the market for
interactive home video entertainment products and services. As a result, we have
modified and expect to continue to modify our engineering and development plans.
These modifications have resulted in delays and increased costs. Furthermore, we
expect that we will be required to continue to enhance our current interactive
products and services and develop and introduce increased functionality and
performance to keep pace with technological developments and consumer
preferences. In addition, we may not be successful in developing and marketing
product and service enhancements or new services that respond to technological
and market changes, and we may experience difficulties that could delay or
prevent the successful development, introduction and marketing of such new
product and service enhancements. Our failure to successfully develop these
products could harm our business. We have encountered delays in product
development, service integration and field tests, and other difficulties
affecting both software and hardware components of our system and our ability to
operate successfully over hybrid fiber-coaxial plant. In addition, many of our
competitors have substantially greater resources than us to devote to further
technological and new product development. Technological and market changes or
other
19
significant developments by our competitors may render our video-on-demand
products and services obsolete.
Our lengthy sales cycle may cause fluctuations in our operating results
We believe that the purchase of our video-on-demand products and
services involves a significant commitment of capital and other resources by a
network operator. In many cases, the decision to purchase our products and
services requires network operators to change their established business
practices and conduct their business in new ways. As a result, we need to
educate network operators on the use and benefits of our products and services,
which can require significant time and resources without necessarily resulting
in revenues. In addition, network operators generally must consider a wide range
of other issues before committing to purchase and incorporate our technology
into their offerings and obtain approval at a number of levels of management.
Our sales cycle has ranged from six months to a number of years. Our lengthy
sales cycle limits our ability to forecast the timing and amount of specific
sales.
The market for our video-on-demand products and services is intensely
competitive, and our current and potential competitors have significantly
greater resources than we do. Consequently, we may not be able to compete
effectively, which would harm our operating results
Competition in both the video-on-demand market and the broader market
for in-home video entertainment is intense and subject to rapid technological
change. We expect competition in the market for video-on-demand products and
services to intensify in the future. We categorize our video-on-demand
competitors as follows:
. server manufacturers, such as Concurrent, nCUBE and SeaChange;
. software providers, such as Prasara and Scientific-Atlanta; and
. system integrators, such as Time Warner and Scientific-Atlanta.
We provide products and services that compete in all three categories.
Although none of our video-on-demand competitors offer products and services in
all of these categories, some of them may form alliances in order to develop an
integrated end-to-end video-on-demand system that may be more attractive to
network operators and their subscribers than ours. Some of our video-on-demand
competitors have long-standing business relationships with network operators and
may be able to use those relationships to gain a competitive advantage over us.
In addition, we may pursue strategic partnerships in order to decrease our
operating and capital expenditures on a going forward basis, which may include
outsourcing certain of the elements necessary to deploy our video-on-demand
solution to third parties, including our competitors. To the extent that any
outsourced element fails to perform to specification or is subject to
manufacturing or other delays, the performance, reliability and market
acceptance of our video-on-demand solution may be impaired. These factors may
adversely affect our ability to compete effectively, even against the
competitors to which elements of our video-on-demand solution may be outsourced.
In addition to video-on-demand competitors, we compete in the market
for in-home video entertainment. We believe our competitors fall into three
groups:
20
. companies that provide in-home video entertainment over cable networks,
including providers of pay-per-view and near-video-on-demand;
. companies that deliver in-home video entertainment over networks, such as
regular telephone lines, digital subscriber lines, or DSL, satellite or the
Internet, and some providers of video streaming technology; and
. companies that enable the viewer to store and access content on an
"on-demand" basis, including providers of personal video recorders, such as
TiVo, UtlimateTV and Replay TV, and companies that rent and sell
videotapes.
Many of our competitors and potential competitors have longer operating
histories, greater name recognition and significantly greater financial,
technical, marketing and distribution resources than we have. As a result, they
may be able to respond to new or emerging technologies and changes in customer
requirements faster than we do. They may also be able to devote greater
resources to the development, promotion and sale of their products and services
and may do so in a more effective manner. We may be unable to compete
successfully against current or future competitors, and competitive pressures
that we face may harm our business.
If we fail to manage our growth effectively, our ability to implement our
business strategies may be limited
In order to execute our business strategy, we must meet aggressive
engineering, integration, product delivery and installation targets. The growth
in our business has placed and is expected to continue to place significant
demands on our management, operating, development, third party manufacturing,
assembly, test and financial and accounting resources. Our ability to manage
growth effectively will require continued implementation of and improvements to
our operating, manufacturing, development and financial and accounting systems
and will require us to expand and continue to train and manage our employee
base. These demands likely will require the addition of new management personnel
and the development of additional expertise by existing management personnel.
Our systems, procedures or controls or financial resources may be inadequate to
support our operations, and our management may be unable to keep pace with this
growth. If we are unable to manage our growth effectively, our business ability
to successfully implement our business strategies will suffer.
If we are unable to adequately protect or enforce our intellectual property
rights, we could suffer competitively, incur costly litigation expenses or lose
valuable assets
Our future success depends, in part, on our ability to protect our
intellectual property and maintain the proprietary nature of our technology
through a combination of patents, licenses and other intellectual property
arrangements. We have been awarded patents and have filed applications and
intend to file additional applications for patents covering various aspects of
our video-on-demand products and services. Any patents issued may be challenged,
invalidated or circumvented, and the rights granted under any patents might not
provide proprietary protection to us. We may not be successful in maintaining
these proprietary rights, and our competitors may independently develop or
patent technologies that are substantially equivalent or superior to our
technologies. To the extent we integrate our products with those of third
parties, including competitors, we may be required to disclose or license
intellectual property to those companies, and these companies could appropriate
our technology or otherwise improperly exploit the information gained through
this integration. If we
21
believe third parties are infringing our intellectual property, we may be forced
to expend significant resources enforcing our rights or suffer competitive
injury.
If third parties claim that we infringe their intellectual property, our ability
to use some technologies and products could be limited, and we may incur
significant costs to resolve these claims
From time to time, we have received notices from third parties claiming
infringement of intellectual property rights. Although we do not believe that we
infringe any third party's intellectual property rights, we could encounter
similar claims or litigation in the future. Because patent applications in the
United States are not publicly disclosed until the patent has been issued,
applications may have been filed that, if issued as patents, would relate to our
products. In addition, we have not completed a comprehensive patent search
relating to the technology used in our video-on-demand products and services.
Parties making claims of infringement may be able to obtain injunctive
or other equitable relief that could effectively block our ability to provide
our products and services in the United States and internationally and could
result in an award of substantial damages. In the event of a successful claim of
infringement, our customers and we may be required to obtain one or more
licenses from third parties, which may not be available at a reasonable cost or
at all. The defense of any lawsuit could result in time consuming and expensive
litigation regardless of the merits of such claims, and damages, license fees,
royalty payments and restrictions on our ability to provide our video-on-demand
products or services, any of which could harm our business.
We rely on several sole or limited source suppliers and manufacturers, and our
production will be seriously harmed if these suppliers and manufacturers are not
able to meet our demand and alternative sources are not available
We subcontract manufacturing of our hardware to a single contract
manufacturer. We do not have a contract with this manufacturer and operate on a
purchase order basis. Because of the complexity of our hardware components,
manufacturing and quality control are time-consuming processes. Our contract
manufacturer may be unable to meet our requirements in a timely and satisfactory
manner, and we may be unable to find or maintain a suitable relationship with
alternate qualified manufacturers. Our reliance on a third-party manufacturer
involves a number of additional risks, including the absence of guaranteed
capacity and reduced control over delivery schedules, quality assurance,
production yields and costs. In the event we are unable to obtain such
manufacturing on commercially reasonable terms, our production would be
seriously harmed.
Various subassemblies and components used in our video server and
access equipment are procured from single sources and others are procured only
from a limited number of sources. Consequently, we may be adversely affected by
worldwide shortages of components, significant price increases, reduced control
over delivery schedules, and manufacturing capability, quality and cost.
Although we believe alternative suppliers of products, services, subassemblies
and components are available, the lack of alternative sources could harm our
ability to deploy our video-on-demand systems. Manufacturing lead times can be
as long as nine months for some critical components. Therefore, we may require
significant working capital to pay for such components well in advance of both
hardware
22
orders and revenues. Moreover, a prolonged inability to obtain components could
harm our business and could result in damage to network operator relationships.
Various software elements used in our products are licensed from single
providers. Consequently, we may be adversely affected by significant price
increases, claims that such licensed software infringes the intellectual
property of other third parties, or failure of licensors to update their
products or offer updated products at a reasonable cost. Although we believe
alternative suppliers of software products are available, the lack of
alternative sources could harm our ability to sell, maintain or update our
interactive products and services.
If we are unable to acquire programming content on reasonable terms, our ability
to derive revenues from video-on-demand deployments will be limited
In those network operator deployments where we provide programming
content, our success will depend, in part, on our ability to obtain access to
sufficient movies (including new releases and library titles), special interest
videos and other programming content on commercially acceptable terms. Although
we have entered into arrangements with major movie studios and other content
providers, we may not be able to continue to obtain the content. In addition,
for content we do procure, we may not be able to make the content available to
video-on-demand customers during the segment of time available to other
video-on-demand providers and to programmers such as pay-per-view providers.
Studios may require us to make prepayments prior to the time that customers pay
for viewing a title or require us to enter into long-term contracts with
significant minimum payments. Further, studios may increase the license fees
currently charged to us. If we are unable to obtain timely access to content on
commercially acceptable terms, our ability to obtain revenue from deployments
where we provide content will be limited. Further, to the extent that major
movie studios pursue announced efforts to restrict or eliminate content made
available for video-on-demand delivery, video-on-demand as a product may not be
broadly deployed, and all providers of video-on-demand products and services,
including us, may not be able to sell interactive products and services to
network operators. If availability of compelling video-on-demand content,
including first run movies, is restricted or eliminated, the ability for us to
obtain revenue from sales of interactive products and services may be
significantly limited.
Competition for qualified personnel is intense in technology industries such as
ours, and we may not be able to maintain or expand our business if we are unable
to hire and retain sufficient technical, sales, marketing and managerial
personnel
Competition for qualified personnel in technology industries is
intense, particularly in Silicon Valley. We may not be able to attract and
retain qualified personnel in the future. If we are unable to hire and retain
sufficient technical, sales and marketing and managerial personnel, our business
will suffer. Our future success depends in part on the continued service of our
key engineering, sales, marketing, manufacturing, finance and executive
personnel. If we fail to retain and hire a sufficient number and type of
personnel, we will not be able to maintain and expand our business.
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We intend to expand our video-on-demand products and services internationally
and these efforts may not be successful in generating revenues sufficient to
offset the associated expense
International deployments may require adaptation of our products to perform
on technical platforms that may differ depending on the country in which our
interactive products and services are deployed. We expect to expend significant
financial, operational and managerial resources to do so. If our revenues from
international operations do not meet our expectations, our operating results
will be adversely affected. We face risks inherent in conducting business
internationally, including:
. unexpected changes in regulatory requirements and tariffs that may be imposed
on our services;
. difficulties and costs of staffing and managing international operations;
. differing technology standards and difficulties in obtaining export and
import licenses;
. longer payment cycles, difficulties in collecting accounts receivable and
longer collection periods;
. political and economic instability;
. fluctuations in currency exchange rates;
. imposition of currency exchange controls;
. potentially adverse tax consequences; and
. reduced protection for intellectual property rights in some countries.
Any of these factors could adversely affect our international operations
and, consequently, our business and operating results. Specifically, our failure
to manage our international growth successfully could result in higher operating
costs than anticipated, or could delay or preclude our ability to generate
revenues in key international markets.
Network operators are subject to government regulations that could require us to
change our products and services
In the United States, the Federal Communications Commission, or FCC, has
broad jurisdiction over network operators. The FCC does not regulate us, but
requirements imposed on network operators could force us to undertake
development that would consume significant resources and require changes to our
products and services. If we do not change our products so that they comply with
FCC rules, or if our products are not integrated with ones that comply with FCC
requirements, our products and services will not be broadly deployed, and our
business will suffer.
In addition, video-on-demand services in Canada and in the United Kingdom
and other European Union members are licensed in a variety of ways. We are
seeking to determine how best to offer our video-on-demand products and services
in Canada, the United Kingdom and other European Union countries. We may not be
able to obtain distribution rights to movie titles in non-U.S. jurisdictions
under regulatory and financial arrangements acceptable to us.
Insiders have significant influence over our efforts
Our major stockholders and directors, together with entities affiliated
with them, own approximately 74% of our outstanding Common Stock (assuming
conversion of all outstanding Preferred Stock into Common Stock) at September
30, 2001. Accordingly, these stockholders have
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significant influence over our affairs. This concentration of ownership could
have the effect of delaying or preventing a change in control of DIVA.
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PART II OTHER INFORMATION
Item 1, Item 3, Item 4 and Item 5 are not applicable with respect to the
current reporting period.
Item 2. Changes in Securities and Use of Proceeds
During the three months ended September 30, 2001, we issued and sold an
aggregate of 1,202 shares of Common Stock to our employees for an aggregate
purchase price of $3,000 pursuant to exercises of options under our 1995 and
1998 Stock Plans.
Item 6. Exhibits and Reports on Form 8-K:
a. Exhibits.
None.
b. Reports on Form 8-K.
No reports on Form 8-K were filed with the Securities and
Exchange Commission during the quarter ended September 30,
2001.
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SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934,
the Registrant has duly caused this Report to be signed on its behalf by the
undersigned, thereunto duly authorized.
DIVA SYSTEMS CORPORATION
By: /s/ WILLIAM M. SCHARNINGHAUSEN
-------------------------------------
William M. Scharninghausen
Senior Vice President, Finance and Administration,
and Chief Financial Officer
Dated: November 14, 2001
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