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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
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FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE YEAR ENDED DECEMBER 31, 2000
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 (NO FEE REQUIRED)
FOR THE TRANSITION PERIOD FROM __________ TO ____________
COMMISSION FILE NUMBER: 333-94271
TELOCITY DELAWARE, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 77-0467929
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
10355 N. DEANZA BOULEVARD 95014
CUPERTINO, CALIFORNIA (Zip Code)
(Address of principal executive offices)
(408) 863-6600
(Registrant's telephone number,
including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filled 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 [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
As of December 31, 2000, 81,623,140 shares of Registrants Common Stock,
$0.001 par value, were issued and outstanding.
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TELOCITY DELAWARE INC.
FORM 10-K
DECEMBER 31, 2000
TABLE OF CONTENTS
PAGE
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PART I
Item 1. Business.................................................... 2
Item 2. Properties.................................................. 27
Item 3. Legal Proceedings........................................... 27
Item 4. Submission of Matters to a Vote of Security Holders......... 27
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters......................................... 27
Item 6. Selected Financial Data..................................... 28
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................... 28
Item 7A. Quantitative and Qualitative Disclosure About Market Risk... 36
Item 8. Financial Statements and Supplementary Data................. 36
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure.................................... 36
PART III
Item 10. Directors and Executive Officers of the Registrant.......... 36
Item 11. Executive Compensation...................................... 39
Item 12. Security Ownership of Certain Beneficial Owners and
Management.................................................. 45
Item 13. Certain Relationships and Related Transactions.............. 54
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form
8-K......................................................... 58
Signatures.................................................. 60
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BUSINESS
PART I
SAFE HARBOR
All statements in this discussion that are not historical are
forward-looking statements within the meaning of Section 21E of the Securities
Exchange Act, including statements regarding Telocity's "expectations,"
"beliefs," "hopes," "intentions," "strategies," or the like. Such statements are
based on management's current expectations and are subject to a number of
factors and uncertainties that could cause actual results to differ materially
from those described in the forward-looking statements. Telocity cautions
investors that there can be no assurance that actual results or business
conditions will not differ materially from those projected or suggested in such
forward-looking statements as a result of various factors, including, but not
limited to, the risk factors discussed in this Form 10-K.
Telocity expressly disclaims any obligation or undertaking to release
publicly any updates or revisions to any forward-looking statements contained
herein to reflect any change in our expectations with regard thereto or any
change in events, conditions, or circumstances on which any such statements are
based.
ITEM 1. BUSINESS OVERVIEW
We develop, market and deliver to the residential market interactive
online services and content designed for use over high-speed, or broadband,
connections. These broadband connections allow our customers to enjoy services
and content that they could not access with traditional slower speed Internet
connections. Although we currently deliver our services to customers using
digital subscriber line, or DSL, technology, in the future we intend to utilize
the technology we have developed to deliver these services and content over a
variety of broadband technologies from a managed nationwide network to and
throughout the home. Our goal is to become a leading provider of broadband
access services, content and home networking services to the residential market.
On December 21, 2000, we entered into an agreement with HUGHES
Electronics Corporation (HUGHES), whereby HUGHES will acquire us for a total
purchase price of approximately $178 million in cash. Under the terms of the
merger agreement, a subsidiary of HUGHES has commenced a cash tender offer to
purchase all of the outstanding shares of our common stock at a price per share
of $2.15; if the tender offer is closed, the agreement provides for a follow-on
merger with the HUGHES subsidiary with our remaining stockholders receiving
$2.15 per share in cash. There can be no assurance that the tender offer will be
consummated; the closing of the tender offer is subject to customary conditions.
If the tender offer is not completed for any reason, we may be forced to
discontinue operations, as we only have enough cash on hand to continue
operations until April 15, 2001. See additional discussion regarding our
proposed sale to HUGHES in Item 7 of this Form 10- K -- "Management Discussion
and Analysis of Financial Condition and Results of Operations."
In order to ensure we have sufficient access to funding during the
period prior to the consummation of our merger with HUGHES, HUGHES has agreed to
provide unsecured interim financing of $20 million, pursuant to a convertible
subordinated note; $20 million of this balance was drawn down by us during
February and March, 2001.
We currently generate revenue by selling monthly subscriptions for our
basic service package that may include activation and other one-time fees, and
to date we have not received revenue from any of the content provided through
our website. Revenues from these services for the year ended December 31, 2000
and 1999 were $9.4 million and $187,000, respectively. For a single monthly fee,
a customer receives our current basic service package, which consists of
always-connected Internet access, e-mail accounts, storage space and hosting for
Web pages, and 60 minutes of remote access to the Internet each month when the
customer is away from home. During November 2000, we began accepting orders for
our first value-
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added service package, "Connect & Protect(TM)," which allows subscribers to
easily network several home computers and benefit from increased firewall
security features. As our business develops and we begin to offer additional
services for incremental recurring fees, we expect to become less dependent on
revenues from our basic service package, and we expect our operating margins to
increase as we believe these additional services and content can be added at a
lower cost than our current basic services.
We have developed a service deployment system, our platform, which
delivers broadband online services directly to our customers' homes. Our
platform consists of a managed network, our residential gateway, user interface
software, customer care and support services, and automated billing and
provisioning systems. Our managed network includes communications lines and
facilities, which we lease through network agreements, as well as our network
operations center and operational support system, which we own and operate.
Through our network operations center and operational support system, we are
able to monitor our services throughout the network to ensure a high level of
performance. We designed our platform so that we can offer a growing number of
services that we can remotely configure from our network operations center to
address each customer's preferences. We believe our platform allows for the
rapid addition of customers while minimizing our associated costs and overhead.
From a customer's perspective, the first component of our service
deployment platform is our proprietary residential gateway. The gateway is a
unique hardware device that combines a digital subscriber line modem, home
networking router, multiple connection ports and network monitoring software.
Our customers can conveniently install the gateway themselves simply by plugging
it into their personal computers and telephone jacks, which allows them to
connect directly to our network and the Internet. This simple, self-installable
plug-and-play solution allows us to connect large numbers of residential
consumers to our network. Once connected to our network, our customers do not
need to dial-up and wait to establish a connection each time they want to gain
access to the Internet or any of the other services we offer; instead, their
connections are always active and at speeds up to 50 times faster than
traditional dial-up Internet access. For a further description of speeds of
various forms of broadband access, please see page 13.
We have designed our service deployment platform to be flexible and
expandable. Although we currently deliver our services to our customers using
DSL technology, we have the capability to configure our gateway easily to
support all major broadband local access technologies such as cable, fiber,
wireless and satellite, by replacing a limited number of components in our
gateway, including the current DSL modem, with components that support these
technologies.
In July 1999, we began offering services commercially in Chicago. As of
December 31, 2000, we were also offering services in more than 150 metropolitan
statistical areas with coverage in such major U.S. cities as Atlanta, Boston,
Chicago, Dallas, Denver, Detroit, Los Angeles, Miami, New York, Philadelphia,
Salt Lake City, San Francisco, Seattle, and Washington, D.D. At the end of
calendar 2000, we had over 61,500 customers, of which approximately 48,000 were
receiving services and approximately 13,500 prequalified customers had placed
orders for our services. Based on our limited historical experience, we estimate
that approximately 80% of those placing orders will actually be converted into
customers receiving our services depending on the local access provider on which
we rely. We estimate that our national coverage allows us to make our services
available to at least 20% of all U.S. households. Our maximum potential market
is limited by the number of homes that are DSL-capable, meaning homes that are
within approximately 2 1/2 and 3 miles from a local telephone office that has
equipment necessary to support DSL service and have voice-grade copper telephone
lines that are in good condition.
Our senior management team has extensive experience in consumer,
telecommunications and technology businesses. Our President and Chief Executive
Officer, Patti Hart, was previously the President and Chief Operating Officer of
Sprint Corporation's Long Distance Division. Peter Olson, our Executive Vice
President and Chief Technical Officer, co-founded and was Chief Technical
Officer of Octel Communications. Edward Hayes, our Executive Vice President and
Chief Financial Officer, was previously the Chief Financial Officer of Lucent
Technologies, Inc.'s Global Service Provider Business. Dave Finley, Telocity's
Chief Operating Officer, was President of Harwood Technologies, a Dallas,
Texas-based information technology services firm and previously, he was with
Sprint for over 9 years. Jim Morrissey,
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our Executive Vice President and Chief Marketing Officer, was an Executive
Creative Director and Executive Vice President for Grey Advertising.
THE TELOCITY SOLUTION
We believe our current basic service package addresses many of the
residential market's unmet data communication needs. In addition, we are
currently developing additional services and content to be offered over our
service deployment platform, which we believe will offer our customers an
appealing combination of media, entertainment and electronic commerce services,
communication services and utility services.
Broadband Enabled Services and Content
We have designed our service deployment platform to provide our
customers with a growing number of broadband services and content that they
could not access with traditional slower speed Internet connections. Our current
service offering includes our basic services package consisting of high-speed
always connected Internet access, e-mail, personalized Web pages and remote
Internet access and our first value-added package that enables broadband
networking to multiple computers within a residence and enhanced data protection
and filtering applications. As part of our future offerings, we intend to
develop additional services in the following areas: media, entertainment and
electronic commerce, communications and utility. All of these services will only
be available to our customers through our gateway. We intend to develop, augment
and refine our broadband enabled services and content continually to allow our
customers to improve their productivity and enhance their broadband experience
at home.
Simple Plug-and-Play Deployment
We developed our service deployment platform to be scalable,
cost-effective and convenient. Our broadband platform allows our customers to
sign up through either our Web page or our toll-free number. Via this automated
signup, we obtain a customer profile, verify service qualification, authenticate
credit information, schedule and track the provisioning of the network elements
and arrange for the shipment of our residential gateway and associated
installation software. At the installation stage, we typically avoid additional
cost and complexity because the gateway can be easily self-installed by the
customer. Additionally, the installation software configures a customer's
personal computer automatically, providing immediate access to the Internet and
all of our services. Furthermore, because we can configure a gateway in a
customer's home through our network operations center, new services and features
can be added to conform to an individual user's preferences, typically without
requiring new equipment or an on-site visit by a technician. The combination of
these deployment features allows us to add customers rapidly with minimal human
intervention.
Flexible, Always-Connected Broadband Internet Access
Our gateway currently supports three DSL technologies: asymmetric
digital subscriber line, or ADSL, symmetric digital subscriber line, or SDSL and
G.Lite. However, we have designed our service deployment platform to be easily
configurable to support the delivery of services and content over a variety of
high-speed local access technologies such as wireless, fixed wireless, cable
modem, fiber and satellite by replacing a limited number of components in our
gateway, including the current DSL modem, with components that support these
technologies.
Scalable Nationwide Network with Enhanced Content Delivery
We have deployed, and will continue to expand, a managed nationwide
Internet protocol-based network. Our managed network includes communications
lines and facilities, which we lease through network agreements, as well as our
network operations center and operational support system, which we own and
operate. Our network is designed to be reliable, responsive and redundant to
ensure effective deployment and to provide superior service. Through our
operational support system and network operations center, we are able to monitor
our service throughout the network to ensure a high level of
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support. We intend to implement a differentiated-services protocol throughout
this network which will allow either us or our customers to prioritize the use
of available bandwidth among the services we provide. For example, a customer
will be able to prioritize the viewing of video streams over the downloading of
less time-sensitive data. Additionally, we reduce redundant data traffic on the
network and speed data delivery to our customers, by duplicating and storing
frequently accessed content locally at network hubs via satellite
communications. This system distributes content rapidly and cost-effectively
throughout our nationwide network.
Service Flexibility and Ease-of-Use
We designed our service deployment platform to be adaptable and
responsive to the needs of our customers. For example, the deployment,
configuration and management of each customer feature and application is fully
automated, allowing for ease of installation and use. This ease-of-use, along
with our remote configuration capabilities, enhances our ability to provide
flexible service and high quality customer care. Additionally, because the
residential gateway remains connected to our network at all times, we can
directly monitor and address service needs in a timely fashion. Finally, we have
implemented comprehensive customer care and support systems to address
customers' needs that cannot be resolved remotely.
BUSINESS STRATEGY
Our goal is to exploit our advantage as both one of the first companies
to provide residential broadband services and in our proprietary technology in
order to become a provider of choice for broadband enabled services and content
both to and throughout the home. Our ability to achieve these goals and execute
upon the strategies described below is dependent upon our ability to either
close the tender offer and merger with the HUGHES subsidiary or immediately
obtain a substantial amount of additional financing. If we are able to close the
tender offer and merger or obtain that financing, we intend to implement the
following strategies to achieve our goal:
Capture Our Early Market Entrant and Proprietary Technology Advantage
Currently, most consumers who have Internet connections experience slow
dial-up access, non-customized narrowband content and limited customer service.
The deployment of broadband access technology and content addresses those
limitations. However, most broadband providers must invest significant time and
capital to extend or upgrade their network in order to provide this access
technology and content to consumers. We believe that we have a significant
time-to-market advantage over those broadband providers because our service
deployment platform is designed to be easily configurable to support any
currently available broadband access technology. We designed our proprietary
gateway device to be self-installable, interoperable with multiple technologies
and easily upgradeable. In addition, because our customers can easily install
our residential gateway and because our service deployment platform is flexible,
we can add new customers rapidly on a nationwide basis.
Deliver Quality Broadband Services Both to and throughout the Home
We have designed our service deployment platform to deliver high-speed,
always-connected Internet access along with associated broadband services and
content such as online gaming, streaming audio and video, interactive shopping,
chat facilities and enhanced voice messaging services. In addition, we intend to
extend our services and content to devices throughout the home. For example, we
designed the next-generation residential gateway to provide home networking
capabilities by allowing a customer's personal computer and other home
appliances to connect with the gateway through wireless technology or through
the existing home phone wiring. This functionality allows us to provide our
customers with additional services, including home monitoring and data security
features, and allows our customers to access services from multiple computers
within the home.
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Deliver High-Quality Customer Service and Support
We have established a network operations center and a customer support
system in order to provide our customers with high quality service, support and
care. From our network operations center, we are able to install or upgrade
remotely a customer's desired service and to address any performance inquiries.
Our customer support system provides technical support through an automated
interactive voice response system, a live telephone support line, direct chat
system, online instructions for our product features and e-mail. These systems
enable 24-hour-a-day, 7-day-a-week proactive monitoring and management of our
entire network as well as customer service and technical support. All of these
systems have been designed with significant flexibility and scalability. We
believe that by providing high quality customer service and support, we will
enhance the overall customer experience and foster customer loyalty.
SERVICES
Our service deployment platform is capable of delivering a comprehensive
suite of broadband services, including high-speed Internet connections and
additional related services to residential customers through a variety of local
access technologies.
We seek to price our services competitively in each of our markets. We
typically enter into a customer service agreement and charge a monthly fee for
our basic service package with no additional per-minute charges. The customer
service agreement also provides information on commencement of the service,
billing, payments, pricing, system requirements and service termination. As our
business has developed, and we have begun to offer additional services for
incremental recurring fees, we expect to become less dependent on revenues from
our basic service package and we expect our operating margins to increase as we
believe these additional services and content can be added at a lower cost than
our current basic services.
Our service currently provides data transfer speeds ranging from 144
kilobits per second to 1.5 megabits per second; however, we are capable of
providing service at data transfer speeds up to 7.5 megabits per second. The
speeds we offer in any given market are based upon the speed of connectivity we
purchase from our local access provider. Additionally, our platform allows our
ADSL customers to use a single phone line for multiple purposes at once, so that
a customer may have a voice conversation, browse the Internet and download
information simultaneously, thereby eliminating the need for a second phone
line.
A customer who subscribes to our service receives our residential
gateway device that, in addition to providing high-speed Internet access, allows
us to provide our basic service package, which consists of:
- Always Connected Broadband Access. This feature eliminates many
disadvantages of dial-up connections, including busy signals and the
slow dial-up process. Always connected broadband access to the home
significantly enhance various customer-configured information services,
such as instant messaging, e-mail and content related services featuring
information such as stock quotes, real time news, sports and weather.
- Unlimited Access. We provide our customers unlimited access to the
Internet and our services with no per-minute usage charges.
- E-Mail Accounts. We provide our customers three e-mail accounts as part
of our service. If our customers require additional e-mail accounts, we
can provide them for a minimal additional charge.
- Personalized Web Pages. Our service provides up to 10 megabytes of
storage space for each customer to store e-mails or design and host
individual Web pages.
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- Remote Access. Our service allows our customers to access the Internet,
their e-mail accounts and other services remotely by using a toll-free
dial-up connection. We provide this service to our customers at no
additional charge for the first 60 minutes of use each month and charge
an incremental fee for each additional minute. This remote access
feature ensures that our customers will be able to connect to the
Internet away from home.
- The flexible architecture of our platform enables us to add new
functions and features. Some of these new functions and features will be
offered through upgrades or the addition of new technology to our
networks. During the fourth quarter of 2000, we began marketing our
first value-added service package, Connect & Protect(TM). This
value-added service allows subscribers to network up to five PCs thereby
enabling different members of the same family to browse the internet
simultaneously at different personal computers in their home. We also
have embedded data access intrusion detection and prevention technology
that enables us to configure and monitor a customer's firewall through
our operational support system. This process can be accomplished without
any intervention required on the part of a customer. As a result, a
customer without technical expertise is able to request protection
through our advanced security and firewall services.
THE TELOCITY/NBCI PORTAL
Through our agreements with NBC Internet, Inc.(NBCi), we provide dynamic
multimedia broadband content for our customers. Customers are able to access
this content through the Website we have developed with NBCi, the Telocity/NBCi
portal. The Telocity/NBCi portal, located at http://telocity.snap.com, is the
first Web page a customer views when accessing our services. From this page, a
customer can access the Internet as well as some of the services provided by us
and NBCi. The Web portal currently offers media, entertainment and electronic
commerce services provided exclusively by NBCi, such as interactive shopping, a
limited selection of streaming audio and video, financial information, sports,
news and weather. Through the Telocity/NBCi portal, our customers have been able
to access the full suite of NBCi's entertainment offerings, which included live
streaming video of the 2000 Olympics in Sydney, Australia.
On December 21, 2000, we entered into an Amendment Agreement (the
"Amendment") with NBCi pursuant to which it was mutually agreed to terminate the
NBCi/Telocity Operating Agreement dated December 10, 1999 and concurrently
amended our Advertising Agreement dated December 14, 1999 with NBCi (the
"Advertising Agreement"). The Amendment provided, among other things, that upon
the consummation of our merger with HUGHES, the Operating Agreement will
terminate, provided that, however, certain provisions of the Operating Agreement
will survive. The Advertising Agreement was amended to include an additional
$3.6 million in online, television, and radio advertising through December 31,
2002. The Amendment also requires that we conduct good faith discussions with
NBCi regarding the possibility of an ongoing commercial relationship.
OUR BROADBAND SERVICE DEPLOYMENT PLATFORM
We designed our broadband service deployment platform to provide
reliable, high-performance Internet access and to alleviate Internet bottlenecks
through an easily deployed scalable architecture with end-to-end network
management capabilities. Through our platform, we will continue to offer a
growing number of services and content offering that we can remotely configure
to each customer's needs. Our broadband service deployment platform consists of
the proprietary residential gateway device, our managed network, our user
interface software, our customer care and support services, and our automated
billing and provisioning systems.
Our Residential Gateway
We believe that customers find our broadband service easy to use
primarily because of the proprietary device we refer to as our residential
gateway. The gateway combines a DSL modem, a home networking router, multiple
connection ports, and network monitoring software in a device that simplifies
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installation, customer support, and service upgrades. The residential gateway is
a standalone unit that operates independently of the computer's operating system
and does not require a network interface card to be installed in the computer.
Our Managed Network
Our managed network includes communications lines and facilities, which
we lease through network agreements, as well as our network operations center
and operational support system, which we own and operate. We have based our
network architecture on the operational goals of responsiveness, reliability and
redundancy. Our network begins with the connection of a customer's personal
computer, or home network of computers, to our residential gateway. In our
current markets, the connection to the customer is routed to DSL equipment owned
either by the local telephone company or by a competitive local exchange carrier
and located in the local central office which we lease through network
agreements. In the future, we expect our local access connectivity to utilize a
variety of local access technologies in addition to DSL, including satellite,
wireless and cable solutions. We aggregate our customer traffic through
dedicated circuits into our leased local metropolitan hubs currently located in:
Atlanta, Miami, Orlando, Los Angeles, Dallas, McLean (Virginia), New York City,
Chicago, Denver, Philadelphia, Boston and Cupertino. These dedicated circuits
are located in secure data-centers where we lease facilities. Between
metropolitan hubs, our customer traffic travels on a leased high-capacity fiber
network which is interconnected to the Internet and to other network providers
at Internet exchange points via private and public peering arrangements. Network
peering is the process of connecting to other networks at the closest point,
thereby ensuring the least number of connection points in the delivery of data.
Our managed network has been designed to be secure and reliable. We
provide network monitoring and management 24-hours-a-day, 7-days-a-week from our
network operations center in Cupertino, California. We have engineered our
network to minimize the likelihood of service interruptions via our redundant
leased optical carrier 3 network. This secure, high-capacity fiber link has the
capacity to transmit 145 megabits of data per second in two directions
throughout the network. We have upgraded and will continue to upgrade the
transmission capacity of this backbone as dictated by our customers'
requirements to ensure that we continue to provide best-in-class service. If a
failure occurs in either of these fiber links, the other link will transmit the
data with no service loss to our customers. In addition, we have configured our
network to have two domain name system servers and two e-mail servers in each
metropolitan hub. If any of these servers are down, our network will
automatically deliver data to the closest server that is functioning.
Furthermore, we place the Internet protocol addresses for domain name system
servers and e-mail servers on switches that redirect traffic to the nearest
available server.
In order to improve network performance and minimize both delays and
bandwidth availability problems, we move data closer to our customers. We have
implemented this strategy by developing a network architecture that uses Inktomi
technology and CacheFlow caching servers customized for use with our network.
These caching servers are connected not only via the Internet but also via our
satellite content feeds. Additionally, our network directs each customer's data
request to the closest available server containing the requested content,
service or application. This close proximity enhances the delivery of data to
our customers.
We sometimes use satellite content feeds to supply data to our caching
servers because transmission of data by satellite is often more cost effective
and efficient than transmission of data over our leased land-based network. We
lease satellite dishes located on the roofs of buildings that are connected to
our leased land-based network, from which we receive content from a satellite
owned by Cidera, Inc., a satellite caching company. Cidera transmits web-based
content that our customers frequently access to this satellite throughout the
day. Once transmitted to the satellite, this content is periodically
retransmitted to our satellite dishes to help prevent data traffic congestion on
our leased land-based network.
Our network design anticipates that not all data is equally important to
a customer or requires the same urgency for delivery. In most cases, data is
transmitted across the Internet on a first in, first out basis. However, to
prioritize time-sensitive or other high priority data traffic our managed
network will implement a differentiated services protocol from the customer's
gateway across our nationwide network.
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This differentiated services protocol will allow either us or our
customers to prioritize the use of available bandwidth among the services we
provide. For example, our managed network will identify less time-sensitive
traffic, such as file transfer protocol, and then prioritize this data delivery
based upon a customer's, or content provider's, preference.
Our Customer Care and Support Services
A high level of continuing service and support is critical to our
objective of developing long-term customer relationships. We emphasize customer
service and technical support to provide our customers with the knowledge and
resources to utilize our online services and content successfully.
We offer customer support 24-hours-a-day, 7-days-a-week. We believe it
is critical to our success to have available the resources necessary to support
our customers through the entire enrollment and fulfillment process, a vital
formative period in each customer's relationship with us. We focus on pre-sales,
loop qualification, technical assistance, phone company provisioning, gateway
shipment and billing to address our customers' needs. Our objective in serving
our customers is to have enough customer service consultants to ensure that our
customers are not placed on hold when they need assistance.
We employ Sutherland, a technical customer support organization, to
respond to and assist our customers with technical issues. Sutherland's call
center processes, technical expertise and scalability help us to provide our
customers with real-time assistance.
In addition to supporting our customers, Sutherland also assists us in
actively monitoring and reviewing customer calls. We combine this feedback with
comments we receive directly, including through our Website, to address and
prevent the recurrence of problems experienced by our customers. We have our own
in-house customer care staff that helps to service the more complex needs of our
customers. We also have a customer recovery unit to address critical complaints
that cannot be solved by Sutherland. We believe these initiatives will help
reduce customer turnover and help increase customer satisfaction. We actively
monitor comments by customers and respond by incorporating their suggestions
into our customer care policies.
Our Automated Billing and Provisioning Systems
We have built our service deployment platform to perform metering and
billing tasks in the gateway. This functionality allows us to automate, monitor
and conveniently bill for each customer's services and products with minimal
human intervention. This functionality and minimal human intervention also
provides us with scalability for a number of services. We intend to expand the
metering and billing functionality.
We developed our billing and provisioning system as a customer focused,
Web-enabled process that ties together all of our customer-related processes,
including sales, customer service, marketing, billing, accounting, loop
qualification and order fulfillment. Using our automated back office process,
customers can subscribe to a service without the intervention of a service
representative. Once an order has been placed, the customer information is
disseminated in real-time to all of our key information technology systems. This
reduces costs and helps eliminate service errors. In addition, this real-time
information system provides us with a significant competitive advantage because
it helps us offer new services quickly and respond to changes in our market.
SALES AND MARKETING
Our key sales and marketing objective is to be a leading provider of
broadband services and content to residential customers.
We are leveraging our platform to capitalize on multiple methods to
attract customers. We continue to undertake targeted direct marketing efforts,
and in September 2000 we launched a nationwide television and radio campaign,
financed by the utilization of advertising credits received from NBC and
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NBCi in exchange for Series C Mandatorily Redeemable Preferred Stock, coincident
with our nationwide network deployment. We established and are now expanding our
channel programs, wherein companies market and sell our services. We also
continue to enter into agreements with channel partners to establish affinity
marketing programs, through which companies market and sell our services through
their own sales or distribution channels to their own existing or prospective
customers with special promotional or bundled offers. In addition, we have
entered into agreements with other channel partners to establish employee and
telecommuter programs, through which companies may provide our services to their
workers who have a business need for high-speed Internet access at home.
Our targeted direct marketing and branding effort uses a mix of print,
direct mail, radio, television and online advertising media specifically
tailored for each local market. We do not employ a sales force in this marketing
effort.
SUPPLIERS AND VENDORS
Our engineers are responsible for prototype development of our
residential gateway. However, we outsource the manufacturing of the gateway. Our
manufacturing partner provides materials planning and procurement, final
assembly, testing and quality control under our supervision. Our manufacturing
process enables us to configure our products to meet a wide variety of customer
requirements and respond to future technological and industry developments. We
currently employ Wellex Corporation as the sole contract manufacturer of our
gateway.
COMPETITION
The business of broadband and Internet services is highly competitive
with frequent new market entrants, many of whom may be rivals. The principal
bases of competition in our markets include:
- price;
- performance, including breadth of service availability, reliability
of service;
- ease of access and use;
- network security;
- availability and desirability of content;
- customer support;
- brand recognition and market penetration; and
- capital resources.
We anticipate that over the next few years the high-speed broadband
market will become increasingly commoditized, thereby standardizing the price of
broadband access. We believe that those providers who will differentiate
themselves will do so on the basis of value-added services.
We believe America Online/TimeWarner, At Home Corporation, Earthlink,
and AT&T Broadband represent our most direct source of competition and that we
will face direct and indirect competition from:
- providers of online services;
- Internet service providers;
- cable modem service providers;
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- interactive television providers;
- Internet portal or content sites;
- telecommunications service providers;
- wireless and satellite service providers; and
- consumer electronics and appliance manufacturers.
Although many companies offer broadband access and content, we believe that
we are currently the only company that combines all of the following features
into a unified service offering tailored for the residential market:
- we manage data traffic over the network, lease and utilize
telecommunications lines and facilities and operate our own network
operations center;
- we have designed and supply our own proprietary gateway device, which we
have customized to provide our current services and which will enable us
to provide our future services;
- we provide content and services to our subscribers, many of which we
have customized for high-speed Internet access; and
- our service delivery system, or platform, allows us to provision
customers quickly and cost-effectively, as does our simple plug-and-play
residential gateway device.
The unique combination of all of these features provides us with flexibility
and scalability. The most significant feature unique to our service offering is
our plug-and-play residential gateway device. Our proprietary gateway combines a
DSL modem, a home networking router, multiple connection ports and network
monitoring software. Because our gateway simplifies installation, customer
support and service upgrades, we can deploy our services to customers nationwide
more rapidly at a lower cost than competitors who do not have a similar device.
For a more complete discussion of our gateway, please refer to "-- Our Broadband
Service Deployment Platform -- Our Residential Gateway." And, unlike some of our
competitors, we are not dependent upon a single local access technology to
deliver our services, but have designed our platform to be configured to support
technologies other than DSL.
Online Service Providers
Online service providers include companies such as AOL, At Home Corporation,
and MSN. These companies provide services and content over the Internet and on
proprietary online services ranging from news and sports to video conferencing.
In addition, these companies provide Internet connectivity, ease-of-use and
consistency of environment, especially through the development of their own
access networks. After its merger with Time Warner, AOL will have access to
content for its broadband access customers similar to the services we will
provide.
Internet Service Providers
Internet service providers include both national and regional providers,
independent Internet service providers and Internet service providers affiliated
with a telecommunications carrier or a data-centric competitive carrier.
Internet service providers such as Earthlink Networks provides Internet access
to residential customers, generally using the existing telephone network. Many
Internet service providers have begun offering DSL-based services.
hese competitors have traditionally distinguished themselves from the online
service companies because they provide only Internet access rather than a
collection of proprietary content and services. This
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distinction has diminished because major online services companies also offer
access while many portal sites actively compete for the chance to provide
proprietary content services to the subscribers of major Internet service
providers. Of the thousands of Internet service providers in the United States,
the majority are relatively small, localized providers.
Cable Modem Service Providers
Providers such as At Home Corporation, AOL/Time Warner, AT&T Broadband, High
Speed Access, SoftNet and RoadRunner and their respective cable partners are
deploying high-speed Internet access services over hybrid fiber coaxial cable
networks. Where deployed, these networks provide similar speed, and when
handling a limited amount of traffic, provide higher-speed Internet access than
we provide through DSL. A number of cable modem service providers have existing
local and regional monopolies in their service markets. In addition, cable modem
service providers and their partners have more direct ties to desirable
traditional media and entertainment content, as well as the size and financial
resources to execute exclusive deals for content.
Interactive Television Providers
Several companies are developing technologies relevant to interactive
television. For example, Wink and Liberate are software developers that are
working to create interactive television solutions. Microsoft has been active in
many areas of interactive television. Microsoft's wholly-owned subsidiary,
WebTV, offers set-top boxes with Internet access, interactive program listings,
and simultaneous television and Internet usage. EchoStar offers WebTV to its
subscribers. Microsoft has also acquired equity interests in several network
operators. These investments give Microsoft influence in the network operator's
choice of interactive software. With its financial, technical and marketing
resources, Microsoft will be a strong competitor in the market for interactive
television operating systems.
Internet Portal Sites
Internet portal sites such as Yahoo! and Lycos are specialized Websites that
offer an aggregation of content and services either directly or through
hyperlinks to other sites. Internet portal sites typically offer search engines,
navigational aids, directories, chat facilities, classified ads, message boards,
e-mail and other customized content and services. Many sites derive a majority
of their revenues from the display of advertising on the site, but may also
generate revenue from product promotions or redirection of Internet traffic from
the portal to specific sites.
Wireline Telecommunications Service Providers
Telecommunications service providers, including new competitive
telecommunications companies, traditional telephone companies, and traditional
and new long-distance carriers all pose competition to us because many currently
offer DSL services.
- Traditional Telephone Companies. All of the largest traditional
telephone companies in our target markets have begun offering DSL
services or have announced their intention to provide DSL services in
the near term. The traditional telephone companies have an established
brand name in their service areas, possess sufficient capital to deploy
DSL equipment rapidly, own the local lines themselves and can bundle
digital data services with their existing voice services to achieve
economies of scale in serving their customers. Certain of the
traditional telephone companies have aggressively priced their consumer
DSL services as low as $30-$40 per month, placing pricing pressure on
our service.
- New Competitive Telecommunications Companies. Many competitive carriers
such as Covad, Rhythms NetConnections and NorthPoint Communications
offer high-speed DSL-based services. Companies such as RCN, McLeodUSA,
and some subsidiaries of utility companies currently offer or are
beginning to offer voice and data service to the residential market.
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- National Long Distance Carriers. Interexchange carriers, such as AT&T,
Sprint, MCI WorldCom, GTE, and Qwest sell connectivity to businesses and
residential customers, and they have brand recognition. They also have
interconnection agreements with many of the traditional telephone
companies and a number of spaces in central offices from which they are
currently offering or could begin to offer competitive DSL services.
Wireless and Satellite Telecommunications Service Providers
Wireless and satellite telecommunications service providers utilize
wireless and satellite-based networks to provide Internet connectivity. We may
face increasing competition from terrestrial wireless services, including 2
Gigahertz (Ghz) and 28 Ghz wireless cable systems (multi-channel multipoint
distribution system and local multipoint distribution system), and 24 Ghz and 38
Ghz point-to-point microwave systems. For example, the FCC has adopted new rules
to permit multi-channel multipoint distribution system licensees to use their
systems to offer two-way services, including high-speed data, rather than solely
to provide one-way video services. The FCC also recently auctioned spectrum for
local multipoint distribution system services in all markets. This spectrum is
expected to be used for wireless cable and telephony services, including
high-speed digital services. The FCC has announced that it plans to auction off
additional spectrum from time to time for other wireless services. In addition,
companies such as Teligent Inc., Advanced Radio Telecom Corp. and WinStar
Communications, Inc., which are targeted to the business market, hold
point-to-point microwave licenses to provide fixed wireless services such as
voice, data and videoconferencing. We also may face increasing competition from
satellite-based systems. Motorola Satellite Systems, Inc., Teledesic and others
have filed applications with the FCC for global satellite networks which can be
used to provide broadband voice and data services, and the FCC has authorized
several of these applicants to operate their proposed networks.
Consumer Electronics and Appliance Manufacturers
Our service deployment platform will support a number of consumer
electronic devices and appliances, including cellular phones, flat panel
displays and personal digital assistants. Consumer electronics companies and
manufacturers of appliances may, in the future, decide to compete with us by
bundling their own software with their hardware products, or by entering into
exclusive alliances with a competitor. In both instances, they might create
products that are incompatible with our systems.
COMPARISON OF DIAL-UP AND BROADBAND TECHNOLOGIES
For our local access connections, the speed and effectiveness of the DSL
connection we utilize varies based on a number of factors. In the future, we
intend to examine utilizing a variety of high-speed local access technologies as
they gain popularity. The chart below together with the footnotes compares the
performance and range for traditional dial-up service with those of broadband
technologies.
Dial-up ADSL SDSL IDSL Cable Satellite
------------- ----------------- ----------------- ------------- ------------- -------------------
Speed to
End Users 28-56Kbps 144Kpbs-8Mpbs(2) 128Kbps-2Mbps(3) 144Kbps(4) 4Mbps-10Mpbs 384Kpbs-400Kbsp(6)
Speed from
End Users 14-33Kbps 64Kbps-1Mbps 64Kbps-1.5Mbps 144Kbps 1Mbps-4Mbps(5) 14Kbps-33Kbps(7)
Distance
Limitations None(1) 17,500 ft 29,000 ft 30,000 ft None None
- ---------------
Key: Kbps = kilobits per second
Mbps = megabits per second (1000 Kbps = 1 Mbps)
(1) Speed is limited by line condition.
(2) The following table sets forth estimated distance limitations and speeds for
ADSL:
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NUMBER SPEED TO SPEED FROM
OF FEET END USER END USER
------- -------- ----------
15,000 384 Kbps 384 Kbps
14,000 512 Kbps 512 Kbps
12,000 768 Kbps 768 Kbps
12,000 1 Mbps 1 Mbps
10,700 3 Mbps 1 Mbps
9,000 5 Mbps 1 Mbps
7,800 7.1 Mbps 1 Mbps
These numbers vary by the telecommunications service provider of the
ADSL connection. ADSL speed is also affected by the distance of the end
user from the local telephone office and the condition of the copper
telephone line that connects the end user to the local telephone office.
(3) The following table sets forth estimated distance limitations and speeds for
SDSL:
NUMBER SPEED TO SPEED FROM
OF FEET END USER END USER
------- -------- ----------
18,000 256 Kbps 256 Kbps
8,000 1.5 Mbps 1.5 Mbps
These numbers vary by the telecommunications service provider of the
SDSL connection. SDSL technology allows end users to achieve up to 1.5
Mbps speeds both to and from the end user. Depending on the quality of
the copper telephone line, 1.5 Mbps can typically be achieved if the end
user is within 8,000 feet, or approximately 1.5 miles, from the local
telephone office.
(4) The following table sets forth the estimated distance limitation and speed
for IDSL:
NUMBER SPEED TO SPEED FROM
OF FEET END USER END USER
------- -------- ----------
Unlimited 144 Kbps 144 Kbps
These numbers vary by the telecommunications service provider of the
IDSL connection. IDSL technology may reach all end users within a
telephone office serving area irrespective of the end user's distance
from the telephone office. IDSL service operates at up to 144 Kbps in
each direction and can use existing integrated services digital network
equipment at the end user site. IDSL may be offered to end users that
have lines that do not consist of continuous copper, such as digital
line carrier equipped lines that are partially copper and partially
fiber. Speeds are 128 Kbps under certain circumstances.
(5) Bandwidth is generally shared between individuals in a particular
neighborhood so that service may be degraded if a number of users attempt to
utilize the service over shared bandwidth at the same time. The connection from
the end user may be analog for some cable system providers limiting speed from
the end user to 33Kbps.
(6) Requires a line of sight view to receive the satellite signal.
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(7) Speeds from the end user are limited by a analog connection to 33Kbps.
NATIONWIDE NETWORK ROLLOUT
At the end of 2000, we offered services in more than 150 of the nation's
349 metropolitan statistical areas. We identified markets in which to offer our
services based upon a number of criteria, including the following:
- The total number of potential customers and the anticipated consumer
response to our service offering in a market;
- the technical compatibility of our equipment with the equipment of
traditional telephone companies and competitive telephone companies in a
market;
- our ability to negotiate agreements with and receive cooperation from
traditional telephone companies and competitive telephone companies in
specific regions of the nation as well as within a single market for
network connections and other infrastructure needs;
- the number of households of potential customers that are DSL-capable in
a market;
- the existence of competitors as well as the services and prices offered
by those competitors in a market; and
- our anticipated return on investment from expanding our network to a
market.
Once we have determined that we would like to begin offering our services in
a market, we put in place the components of our managed network necessary to
deliver our services. In particular, we lease additional communication lines to
ensure that we have sufficient capacity on our managed network and an adequate
number of dedicated circuits to meet the projected demand for our services in a
market. We also lease communications facilities, and, as necessary, facilities
space for new metropolitan hubs, which are data distribution centers in
metropolitan areas. Once we have configured and tested our network and
equipment, we are ready to begin provisioning services to new customers in the
market.
NETWORK AGREEMENTS
The gateway used by our customers is connected to a telephone line and
from there to DSL equipment. This equipment is owned by the traditional
telephone company or the new competitive carrier and is located in the local
central office. We currently have agreements for DSL connectivity with Rhythms
Links Inc., a subsidiary of Rhythms NetConnections, Inc., NorthPoint, Inc.,
BellSouth, Bell Atlantic Network Services, Southwestern Bell, Pacific Bell, and
Nevada Bell.
In September and October 1999, we entered into a number of non-exclusive
agreements with BellSouth. We entered into a market development agreement with
BellSouth Business Systems, Inc. in which we agreed to market asymmetrical
digital subscriber line service in areas in which BellSouth has asymmetrical
digital subscriber line service available. We also entered into a series of
agreements with BellSouth Telecommunications, Inc. in which we agreed to
purchase asymmetrical digital subscriber line and related telecommunications
services from BellSouth pursuant to its FCC tariffs. The commitments and terms
of our agreements for telecommunications services are for 36 months.
In September 1999, we entered into a five-year agreement with Bell
Atlantic Network Services, Inc. to purchase asymmetrical digital subscriber line
services pursuant to Bell Atlantic's FCC tariffs. In October 1999, we entered
into a 54-month agreement to purchase asymmetrical digital subscriber line
services from Southwestern Bell, Pacific Bell and Nevada Bell pursuant to
applicable FCC tariffs.
In March 2000, we entered into an amended one-year provisioning
agreement with Rhythms Links Inc. for DSL lines and connections between our
points of presence and Rhythms Links Inc. This
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agreement is non-exclusive and gives us the right to purchase services or
products from other providers. The agreement provides that we may purchase up to
10,000 lines at costs fixed in the agreement.
In April 2000, we entered into a two-year provisioning agreement with
NorthPoint Communications Inc. for DSL lines and connections between our points
of presence and NorthPoint Communications Inc. This agreement is non-exclusive
and gives us the right to purchase services or products from other providers.
The agreement provides that we may purchase up to 20,000 lines at costs fixed in
the agreement.
In each of the metropolitan hubs of our networks, we aggregate our
customer traffic through dedicated circuits. We have agreements for dedicated
circuits, collocation, backbone and peering agreements with Level 3
Communications, LLC and MCI WorldCom. In October 1999, we entered into
agreements with Level 3 terminating in September 2002 that provide us with
optical carrier 3, digital signal, level 1, digital signal, level 3 and other
circuits, collocation throughout the country at Level 3's facilities, roof
rights for the location of our caching satellite dishes, remote hands services
and peering arrangements. Through Level 3, we currently have collocation space
in Atlanta, Miami, Orlando, Los Angeles, Dallas, McLean (Virginia), New York
City, Chicago, Denver, Philadelphia, Boston and Cupertino. In October 1999, we
entered into agreements with MCI WorldCom terminating in September 2002 that
provide us with optical carrier 3, digital signal, level 1, digital signal,
level 3 and other circuits as well as collocation space and peering
arrangements. In 2000, we added collocation space through both Level 3 and MCI
WorldCom.
GOVERNMENT REGULATION
Many of the services and content that we offer are subject to varying
degrees of federal, state and local regulation. Future regulations and
legislation may be less favorable to us than current regulation and legislation.
In addition, we may expend significant financial and managerial
resources to participate in proceedings setting rules at either the federal or
state level, without achieving a favorable result.
Communications Regulation
The Telecommunications Act of 1996 substantially departs from prior
legislation in the telecommunications industry by establishing local
telecommunications competition as a national policy. The Telecommunications Act
removes state regulatory barriers to competition and overrules state and local
laws restricting competition for telecommunications services. In general, by
accelerating competitive entry into the telecommunications market, including new
DSL services offered by competitive carriers, the Telecommunications Act
establishes a market structure in which the network infrastructure and services
we purchase are now available from a variety of providers in addition to
traditional telephone companies. As a result, our business options and choice of
vendors, along with the quality and price of facilities and services we buy from
telecommunications carriers, should become more favorable over time.
Nevertheless, our business is substantially dependent on successful
implementation of the Telecommunications Act by the FCC and other regulatory
agencies and it impact on competition among our vendors.
Recently, the viability of several Competitive Local Exchange Carriers
(CLECs) has been brought into question because, among other things, of the
significant capital requirements for their businesses and market conditions that
suggest they will have difficulty in raising sufficient capital to meet their
needs. Several of these CLECs provide last-mile DSL connectivity to companies
like ours in competition with the former Bell Companies. Their viability
maintains competition among our suppliers. If one or more of the CLECs with whom
we do business, or with whom we may do business in the future, were to leave the
marketplace, it may adversely impact our business and financial prospects.
Although some of the Telecommunications Act is self-executing, the FCC
has issued a variety of regulations upon which we and other broadband
competitors rely. We believe that the FCC's regulations and decisions have
generally favored competition and the wide availability of DSL connectivity
which we
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purchase in order to provide broadband services to our customers. However, these
regulations and decisions have been and may continue to be appealed by one or
more traditional telephone companies or other parties, which may lead to
uncertainty and delays in implementation of regulations favorable to us, or
which may adversely affect our business and financial prospects.
Broadband issues are also the subject of a number of proposed bills
introduced in the U.S. Congress. To varying degrees, proposed legislation could
either reduce or increase open access to the traditional Bell carrier networks
as well as to the cable networks which have yet to be opened to the type of
competition that exists in the telephone network. Many of the largest providers
of broadband and Internet services, including AOL/TimeWarner, AT&T and the Bell
companies, have been significantly involved in lobbying for and against this
sort of legislation, which, if enacted, may affect our business and financial
prospects.
For several years, traditional telecommunications carriers have argued
that the FCC should repeal rules treating Internet service providers as
unregulated providers of enhanced information services. Under this regulatory
paradigm, Internet service providers have been subject to a lesser degree of
regulation and taxation than traditional telephone service providers which is
favorable to us. The FCC has to date resisted all efforts to modify the
unregulated treatment of Internet service providers. However, there may be
increased legal and political pressure on the FCC to modify these policies.
While there is no indication that a major change in the FCC's policies is
imminent, the imposition of access charges, universal service fees and other
elements of traditional telecommunications regulation on Internet service
providers would require us to review and possibly change our financial and
business models.
Internet Content Regulation
Government regulation of communications and commerce on the Internet
varies greatly from country to country. The United States has not adopted many
laws and regulations applicable to online communications and commerce. However,
it is possible that a number of laws and regulations may be adopted covering
issues such as user privacy, freedom of expression, pricing, content and quality
of products and services, taxation, advertising, gaming, intellectual property
rights, enforceability of contracts and information security.
While sections of the Communications Decency Act of 1996, or the CDA,
that proposed criminal penalties for distributing indecent material to minors
over the Internet were held to be unconstitutional, other provisions of the CDA
remain in effect. Congress has since passed the Child Online Protection Act, or
COPA, in an effort to remedy the deficiencies the Supreme Court identified in
the CDA. It is unclear whether COPA will survive constitutional challenges that
have been raised. However, indecency legislation and other government efforts to
regulate Internet content could subject us or our customers to potential
liability, which in turn could affect our business. The adoption of these laws
or regulations might also decrease the rate of growth of Internet use, which in
turn could decrease the demand for our services or increase the cost of doing
business or otherwise harm, results of operations, and financial condition.
Likewise, the applicability to the Internet of traditional property ownership,
copyright, taxation, libel and obscenity law is uncertain.
Likewise, the impact of ongoing discussions of privacy issues and the
Internet remains uncertain. Several U.S. states have proposed, and the European
Union has adopted, limitations on the use of personal information gathered
online. Pursuant to negotiations with the European Union and the United States,
the United States may decide to adopt restrictive laws on the subject of
privacy. The Federal Trade Commission, or FTC, has initiated action and obtained
a consent decree against at least one online service provider regarding the
manner in which personal information is collected from users and provided to
third parties. In 1998, Congress enacted the Child Online Privacy Protection Act
(COPPA) protecting the privacy of children on the Internet and limiting the
information that can be collected from and disseminated to children over the
Internet without parental consent. The FTC promulgated broad new rules
implementing COPPA in late 1999. Changes to existing laws or the passage of new
laws intended to address online privacy and related issues may create
uncertainty in the marketplace or could affect the manner in which we do
business.
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We may also be subject to claims for defamation, negligence, copyright
or trademark infringement (including contributory infringement) based upon
information available through our Internet sites, including content created by
third parties. Although recent federal legislation protects online services from
some claims, the law in this area remains in flux and varies by jurisdiction. It
is not possible to develop a business plan that can definitively protect us
against liability for our Internet content, including content on our sites that
we have not written or created. This uncertainty is likely to prevail for some
time, as the laws continue to develop.
RISK FACTORS
You should carefully consider the risks described below before making an
investment decision. The risks and uncertainties described below are not the
only one that we face. Any of the following risks could harm our business,
financial condition or results of operations. In such case, the trading price of
our common stock could decline, and you may lose all or part of your investment.
This Form 10-K also contains forward-looking statements that involve risks and
uncertainties. Our actual results could differ materially from those anticipated
in the forward-looking statements as a result of factors that are described
below and elsewhere in this Form 10-K.
IF WE FAIL TO COMPLETE THE MERGER WITH HUGHES AND DIRECTV BROADBAND INC., OUR
STOCK PRICE AND FUTURE BUSINESS OPERATIONS COULD BE HARMED.
On December 21, 2000, we signed a merger agreement with HUGHES
Electronics Corporation and its wholly owned subsidiary, DIRECTV Broadband Inc.
Under the terms of the merger agreement, DIRECTV Broadband Inc. has commenced a
cash tender offer to purchase all of the outstanding shares of our common stock
at a price per share of $2.15; if the tender offer is closed, the agreement
provides for a follow-on merger with a subsidiary of HUGHES with our remaining
stockholders receiving $2.15 per share in cash. There can be no assurance that
the tender offer will be consummated; the closing of the tender offer is subject
to customary conditions. If the tender offer is not completed for any reason, we
may be forced to discontinue operations, as we only have enough cash on hand to
continue operations until April 15, 2001, and we would have substantial
additional expenses arising from the termination of the merger with HUGHES.
Further, the current price of our common stock could decline,
particularly to the extent that it reflects a market assumption that the tender
offer will not be completed. In addition, we are required to pay substantial
fees related to the negotiation of the merger agreement, including legal and
accounting fees, and the expenses and fairness opinion fee of our financial
advisor; these must be paid even if the tender offer or the follow-on merger is
not completed. We may be required to pay HUGHES a termination fee up to $8.1
million if the merger agreement is terminated under some circumstances as
outlined in the merger agreement. The payment of these substantial fees would
have a material and adverse effect on our cash position, which could harm our
business and results of operations.
In addition, our customers may, in response to the announcement of the
tender offer, delay or defer decisions concerning purchasing our products. Any
delay or deferral in those decisions by our customers or suppliers could have a
material adverse effect on our business, regardless of whether the merger is
ultimately completed. Similarly, current and prospective employees may
experience uncertainty about their future roles with HUGHES until HUGHES'
strategies with regard to Telocity are announced or executed. This may adversely
affect our ability to attract and retain key management, sales, marketing and
technical personnel.
Furthermore, if the merger is terminated and our board of directors
determines to seek another merger or business combination or other financing
options, there can be no assurance that it will be able to find a partner
willing to pay an equivalent or more attractive price than the price to be paid
in the merger.
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AT PRESENT, WE CANNOT PROVIDE OUR SERVICES UNLESS DSL ACCESS PROVIDERS SUPPLY US
WITH DSL CONNECTIONS AND COOPERATE WITH US FOR THE TIMELY PROVISION OF DSL
CONNECTIONS FOR OUR CUSTOMERS.
We must obtain DSL connections from traditional telephone companies and
new competitive carriers and have their continuing cooperation for the timely
provision of DSL connections for our customers in order for us to provide our
services. DSL operates over local telephone lines, which are under the control
of traditional telephone companies and new competitive carriers and requires a
special connection from our network to the telephone lines. We rely on them to
provide us with these DSL connections, and if we were unable to use these
connections, we would not be able to provide our services. In addition, we
depend on traditional telephone companies and new competitive carriers to test
and maintain the quality of the DSL connections that we use. An inability to
obtain adequate and timely access to DSL connections on acceptable terms and
conditions from traditional telephone companies and competitive carriers and to
gain their cooperation in the timely provision of DSL connections for our
customers could harm our business, as could their failure to properly maintain
the DSL connection we use.
MANY OF OUR VENDORS OR SUPPLIERS MAY NOT HAVE THE RESOURCES TO SUSTAIN THEIR
BUSINESSES AND MAY NOT BE ABLE TO PROVIDE COMPONENT PARTS FOR OUR INFRASTRUCTURE
OR DSL CONNECTIONS FOR OUR CUSTOMERS
Many of our vendors or suppliers, including our DSL access providers,
are facing serious financial difficulty. With the recent economic slow down and
the down turn in the DSL market, many of these vendors or suppliers are
forecasting that their revenue for the foreseeable future will be lower than
anticipated, and some of these vendors and suppliers are experiencing, or are
likely to experience, serious cash flow problems, and even bankruptcy. If some
of these vendors or suppliers are not successful in generating sufficient
revenue or securing alternate financing arrangements in order to sustain their
operations, they may not be able to supply us with components for our
infrastructure or DSL connections for our customers. If any of these failures
occur, we may not be able to provide continued service to existing customers or
install our service for new customers and further, we may be exposed to
technical obsolescence for certain types of our gateway. For example, Northpoint
Communications, Inc., one of our DSL access providers, recently filed for
bankruptcy and is shutting down most of its DSL network. Telocity will likely be
forced to interrupt service to approximately 19,700 customers delivered service
through Northpoint. We are diligently seeking to reprovision the affected
customers, however, it is likely that a substantial number of these customers
may choose to terminate their relationship with Telocity. The failure of our
vendors or suppliers to provide us with component parts for our infrastructure
or DSL connections for our customers will harm our business and will adversely
affect our operating results.
WE WILL COMPETE WITH OUR DSL ACCESS PROVIDERS IN PROVIDING BROADBAND INTERNET
ACCESS, WHICH MAY CAUSE DELAYS, INCREASE EXPENSES, OR ADVERSELY IMPACT OUR
MARGINS.
Because in some instance our DSL access providers will also provide
broadband Internet access and other services, we compete with them. Although our
DSL access providers are required to provide DSL connections to us on a
non-discriminatory basis under the Telecommunications Act of 1996, they may
nevertheless be reluctant to cooperate with us. Compelling these DSL access
providers to meet the regulatory requirements may be expensive and
time-consuming and could result in delays and increased expenses associated with
providing our services and content on a wider scale, which in turn could harm
our business. In view of the comparative size of the traditional telephone
companies, we may also be vulnerable to predatory pricing which could force us
to either forgo orders because we operate at a comparative price disadvantage,
or reduce our prices, thereby adversely impacting our margins and our long-term
profitability.
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OUR FAILURE TO MANAGE OUR GROWTH COULD HARM OUR ABILITY TO RETAIN AND GROW OUR
CUSTOMER BASE AND EXPAND OUR SERVICE OFFERINGS.
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. Failure to manage our future growth effectively could harm our
ability to retain and grow our customer base and expand our service offerings
which would materially and adversely affect our business, prospects, operating
results and financial condition.
CUSTOMERS MAY NOT ACCEPT THE VALUE ADDED SERVICES WE ARE CURRENTLY DEVELOPING.
IF THESE SERVICES DO NOT GAIN BROAD MARKET ACCEPTANCE, WE WILL NOT BE ABLE TO
INCREASE OUR REVENUES AND BUILD OUR BUSINESS AS ANTICIPATED.
We are currently developing a range of value-added services which
include firewall and other internet safety features; multiple computer support;
unified messaging; and consumer related content and voice services. Broadband
services are a new and emerging business, and we cannot guarantee that these
services will attract widespread demand or market acceptance. If this market
fails to develop or develops more slowly than anticipated, we will not be able
to increase our revenues, build our business, or improve our margins as
anticipated.
BECAUSE OUR CUSTOMER ACQUISITION COSTS ARE HIGH, IF WE FAIL TO RETAIN CUSTOMERS
LONG ENOUGH TO PAY BACK OUR UP FRONT INVESTMENT, WE MAY NOT ACHIEVE
PROFITABILITY.
Our customer acquisition costs comprise a significant portion of our
operating costs, including advertising, order fulfillment, installation,
customer care, and the cost of our residential gateway. Because of our
significant up-front investment in each customer, if our customers terminate
their relationships with us before we recover our up front costs, we may fail to
generate a profit. In addition, if we fail to reduce our customer acquisition
costs, including by increasing the efficiency of our customer care organization
and reducing the costs associated with the development and production of our
gateways, our operating results will suffer.
OUR ABILITY TO REDUCE THE COST OF RESIDENTIAL GATEWAY IS DEPENDENT UPON
ACHIEVING A SUFFICIENT VOLUME OF PRODUCTION. IF WE FAIL TO ACHIEVE THE REQUIRED
LEVEL OF PRODUCTION THEN WE MAY BE UNABLE TO REALIZE THE COST REDUCTIONS THAT WE
ARE ANTICIPATING, THEREBY REDUCING OUR FUTURE PROFITABILITY.
Anticipated reductions in the cost of our residential gateway are
largely dependent upon our ability to continue to grow our subscriber base at
current rates. If we are unable to grow our subscriber base at current rates
then we will be unable to secure the forecast cost reductions in our gateway,
thereby adversely impacting our future anticipated operating results.
OUR GROWTH DEPENDS ON OUR ABILITY TO HIRE AND RETAIN HIGHLY QUALIFIED EMPLOYEES
AND SENIOR EXECUTIVES.
The loss of the services of any of our senior management team, all but one
of whom are at-will employees, the failure to attract and retain additional key
employees, or the ability to maintain the morale and enthusiasm of our employees
could harm the continued deployment of our services and content, the marketing
of our services and the development of new services, our brand and our strategy.
Our future growth and ability to sustain this growth depend upon the continued
service, morale and enthusiasm of our executive officers and other key
engineering, sales, operations, marketing and support personnel.
OUR OPERATING RESULTS ARE LIKELY TO FLUCTUATE SIGNIFICANTLY FROM PERIOD TO
PERIOD, WHICH MAY CAUSE OUR STOCK PRICE TO BE EXTREMELY VOLATILE. WE MAY
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ALSO FAIL TO MEET OR EXCEED THE EXPECTATIONS OF SECURITIES ANALYSTS OR
INVESTORS, CAUSING OUR STOCK PRICE TO DECLINE.
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. If we experience such fluctuation, we may fail to
meet or exceed the expectations of securities analysts or investors, causing our
stock price to decline or be extremely volatile.
THE SCALABILITY, RELIABILITY AND SPEED OF OUR NETWORK REMAIN LARGELY UNPROVEN
AND MAY NOT SATISFY CUSTOMER DEMAND.
We may not be able to scale our network and operational support system
to meet our projected customer numbers while achieving and maintaining superior
performance. This risk will continue to exist as long as we expand our services
geographically to increasing numbers of customers. Our failure to achieve or
maintain high-speed digital transmissions, for a number of reasons including the
reliability and inter-operability of our network equipment, would significantly
reduce customer demand for our services, resulting in decreased revenues and the
inability to build our business as planned.
FACTORS OUTSIDE OF OUR CONTROL MAY ADVERSELY AFFECT OUR TRANSMISSION SPEED.
LOWER SPEEDS MAY RESULT IN CUSTOMER DISSATISFACTION AND ULTIMATELY A LOSS OF
CUSTOMERS.
Peak digital data transmission speeds currently offered across our
networks when utilizing DSL are 1.5 megabits per second. However, the actual
data transmission speeds over our networks can be significantly slower. These
slower speeds may result in customer dissatisfaction and ultimately in the loss
of customers and revenues. The speeds over our networks depend on a variety of
factors, many of which are out of our control, including:
- the distance an end-user is located from a central office;
- the configuration of the telecommunications line being used;
- the quality of the telephone lines provisioned by traditional
telephone companies;
- the inside wiring of our customers' homes; and
- the limitations of our customers' computers.
WE AND MANUFACTURERS OF OUR PRODUCTS RELY ON A CONTINUOUS POWER SUPPLY TO
CONDUCT OPERATIONS, AND CALIFORNIA'S CURRENT ENERGY CRISIS COULD DISRUPT OUR
BUSINESS AND INCREASE OUR EXPENSES
California is in the midst of an energy crisis that could disrupt our
operations and increase our expenses. In the event of an acute power shortage,
that is, when power reserves for California fall below 1.5%, California has on
some occasions implemented, and may in the future continue to implement, rolling
blackouts. Virtually all of our operations are located in California and our
backup power supplies can only work for a finite period of time. If blackouts
are prolonged, we would be temporarily unable to continue operations at our
facilities. Any such interruption in our ability to continue operations at our
facilities could damage our reputation, harm our ability to retain existing
customers and to obtain new customers, and could result in lost revenue, any of
which could substantially harm our business and results of operation.
The manufacturer of our residential gateway, Wellex, and the providers
of our DSL connections, NorthPoint and PacBell, are located in California. As a
result of this crisis, Wellex may be unable to manufacture sufficient quantities
of our gateway to meet our needs, or they may increase the fees they charge us
for their services. In addition, NorthPoint and PacBell would no longer be able
to install DSL
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connections for our customers, or they may increase the fees they charge us for
providing us with DSL connections. We do not have a long-term contracts with
Wellex, NorthPoint or PacBell. The inability of our contract manufacturer to
provide us with adequate supplies of our gateway and the inability of our
service providers to install DSL connections for new customers would cause a
delay in our ability to fulfill our customers' orders, which would hurt our
business, and any increase in their fees could adversely affect our financial
condition.
A SYSTEM FAILURE OR BREACH OF NETWORK SECURITY COULD CAUSE DELAYS OR
INTERRUPTIONS OF SERVICE TO OUR CUSTOMERS, WHICH COULD HURT OUR BRAND IMAGE,
LEAD TO A LOSS OF CUSTOMERS, AND RESULT IN A SIGNIFICANT DECREASE OF REVENUES.
Although we have not experienced any system failures or breaches of
network security that materially affected us, if we experience one or more of
the problems described below in the future, our financial performance and
results of operations could be materially affected at that time.
Our operations depend on our ability to avoid damages from fires,
earthquakes, floods, power losses, excessive sustained or peak user demand,
telecommunications failures, network software flaws, transmission cable cuts,
and similar events. The occurrence of a natural disaster or other unanticipated
problem at our network operations center, our operational support system, our
managed network of leased communication lines or any metropolitan hubs or
collocation facilities could cause interruptions in the services provided by us
and these interruptions could result in the loss of customers and the attendant
reduction of revenue. Additionally, if a traditional telephone company, new
competitive carrier or other service provider fails to provide the
communications capacity we require, as a result of a natural disaster,
operational disruption or any other reason, then this failure could interrupt
our services.
WE ARE VULNERABLE TO CLAIMS THAT ANY ELEMENT OF OUR SERVICE DEPLOYMENT PLATFORM
INFRINGES THIRD-PARTY INTELLECTUAL PROPERTY RIGHTS, AND ANY RESULTING CLAIMS
AGAINST US COULD BE COSTLY TO DEFEND OR SUBJECT US TO SIGNIFICANT DAMAGES.
Infringement claims could materially harm our business. From time to
time, we may receive notice of claims of infringement of third parties'
proprietary rights. The fields of telecommunications and Internet communications
are filled with patents, both pending and issued. We may unknowingly infringe
such a patent. We may be exposed to future litigation based on claims that our
platform infringes the intellectual property rights of others, especially patent
rights. Someone, including a competitor, might file a suit with little merit, in
order to harm us commercially, to force us to re-allocate resources to defending
such a claim, or extract a large settlement. In addition, our employees might
utilize proprietary and trade secret information from their former employers
without our knowledge, even though we prohibit these practices.
IF SALES FORECASTED FOR A PARTICULAR PERIOD ARE NOT REALIZED IN THAT PERIOD DUE
TO THE LENGTHY DEVELOPMENT AND TESTING CYCLES OF OUR TECHNOLOGIES AND SERVICES,
OUR OPERATING RESULTS FOR THAT PERIOD WOULD BE ADVERSELY AFFECTED.
We cannot forecast with any degree of accuracy our revenues in future
periods or how quickly customers will select our services, if at all. In view of
these factors, we may not be able to achieve or sustain profitability which
could cause our stock price to decline. Our ability to achieve profitable
operations on a continuing basis will depend on a number of factors, many of
which are beyond our control.
OUR FAILURE TO MEET CHANGING CUSTOMER REQUIREMENTS AND EMERGING INDUSTRY
STANDARDS WOULD LIMIT OUR ABILITY TO ATTRACT AND RETAIN CUSTOMERS.
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The market for high-speed broadband access is characterized by rapidly
changing customer demands and short life cycles for services and content. If
enhancements to our existing services, such as broadband Internet access, e-mail
and storage for web pages, or development of new services, including electronic
commerce, communications and utility services, take longer than planned,
customer requirements and industry standards may have changed, which would
adversely affect our ability to sell our services and cause our results of
operations and financial condition to suffer.
WE DEPEND ON SINGLE AND LIMITED SOURCE SUPPLIERS FOR KEY COMPONENTS OF OUR
GATEWAY WHICH MAKES US SUSCEPTIBLE TO SUPPLY SHORTAGES OR PRICE FLUCTUATIONS
THAT COULD ADVERSELY AFFECT OUR OPERATING RESULTS.
We rely on Wellex Corporation to produce our proprietary residential
gateway device and we will not have another supplier for at least three months.
In the event of any significant delay, disruption, capacity constraint or
quality control problem in its manufacturing operations, gateway shipments to
our customers could be delayed, which would negatively affect our net revenues,
competitive position and reputation. Should Wellex cease to be our contract
supplier for any reason, we would then need to qualify a new gateway supplier
and we may be unable to find a gateway supplier that meets our needs or that can
source components as cost-effectively as Wellex. Qualifying a new gateway
supplier and commencing volume production is expensive and time consuming.
Transferring production operations can significantly disrupt gateway supply. If
we are required or choose to change gateway suppliers, we may lose sales and may
experience increased production or component costs, and our customer
relationships may suffer.
If any of our sole-source manufacturers delays or halts production of
any of the components or equipment that we use in our residential gateway we
would be unable to manufacture and ship our gateway, and, as a result, our
revenues and operating results would decline and our customer relationships may
suffer. Furthermore, we expect to incorporate additional sole-source components
into our next-generation gateways planned for release during 2000, thereby
increasing our sole-source supplier risks. We currently depend on single source
suppliers for a number of key components, such as chipsets, processors and
unique tooled plastics. For example, there is only one supplier available for
our processor and our chip set is a specific model which we have designed and is
built by a single manufacturer. Should either of these suppliers become
unavailable, we will be required to undertake a redesign of our gateways such as
the layout of the board or the pin connections.
There are a number of other risks associated with our dependence on a
single third party supplier, including the following:
- reduced control over delivery schedules and quality assurance;
- manufacturing yields and costs;
- the potential lack of adequate capacity during periods of excess demand;
- limited warranties on products supplied to us;
- increases in prices; and
- the potential misappropriation of our intellectual property.
IF WE FAIL TO PREDICT ACCURATELY OUR SUPPLY REQUIREMENTS, WE COULD INCUR
ADDITIONAL COSTS OR EXPERIENCE DELAYS WHICH COULD RESULT IN A SIGNIFICANT
DECREASE IN OUR REVENUES AND GROSS MARGINS.
We provide Wellex with rolling forecasts of our gateway requirements
based on anticipated orders. Wellex uses these forecasts to purchase components
for our gateway. Our component requirement forecasts may not be accurate. If we
overestimate our component requirements, Wellex may have excess inventory, which
would increase our costs. Also, because lead times for materials and components
that we
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require vary significantly and depend on a variety of factors, if we
underestimate our requirements, Wellex may have inadequate inventory, which
could interrupt their manufacturing of our gateways and result in delays in
system shipments. Any of these events could harm our business and results of
operations.
OUR SERVICES MAY NOT BE DELIVERED EFFECTIVELY, OR AT ALL, BECAUSE OF DISTANCE
SENSITIVITY OF DSL TECHNOLOGY, THE PHYSICAL LIMITATIONS OF OUR CUSTOMERS'
TELEPHONE LINES, OR BECAUSE THE TELEPHONE LINES WE RELY UPON MAY BE UNAVAILABLE
OR IN POOR CONDITION.
Because DSL technology is distance sensitive and operates over local
telephone lines, we will not be able to provide services to customers whose
homes are outside a maximum distance.
Our ability to provide services to potential customers using DSL
connections through the telephone network over which DSL must operate depends on
the length of our customers' local telephone lines. It also depends on the
quality, physical condition, availability and maintenance of those telephone
lines, all of which are within the control of traditional telephone companies.
DSL technology is distance sensitive and, in many cases, the homes of our
potential customers may be located outside the maximum distance from the
telephone company central switching office for the proper function of the DSL
technologies we currently use. Our existing customers are all within this
maximum distance, as we cannot provide our services to customers beyond this
maximum distance. Currently, 70% of U.S. homes are not DSL-capable, meaning they
are more than approximately 2 1/2 to 3 miles from a local telephone office that
has equipment necessary to support DSL service or do not have voice-grade copper
telephone lines that are in good condition. Many traditional telephone companies
are rapidly deploying additional equipment in central offices and we work with
our DSL access providers to identify new locations in which we would like to
offer our services. Nevertheless, our DSL access providers may fail to expand
their equipment. If the homes of a significant number of customers that desire
our service continue to be located beyond this maximum distance, it could
materially inhibit our ability to deploy our broadband services to those homes,
which would harm our business.
If we receive inaccurate information regarding the distances of
customers from the central telephone office, we will incur additional expenses
that will harm our operating results.
Although we work with our DSL access providers to identify in advance of
accepting orders those customers who are close enough to a central office, we
sometimes find that the information given to us is inaccurate. In the past, our
historical experiences of finding inaccurate information have caused us to incur
expenses such as costs associated with sending a technician to enable a
potential customer's telephone line that cannot be DSL enabled. Although to date
these expenses have not materially harmed our operating results, if we cannot
reduce the number of these false positive customer identifications as we expand
our operations on a larger scale, we will continue to incur significant expenses
that will harm our operating results.
If the telephone lines of our customers are in poor condition, we may
not be able to provide our services to those customers.
The current condition of local telephone lines may be inadequate to
permit us to provide our services to all of our customers utilizing current DSL
technologies. Because the copper telephone lines are owned by other companies
and because the number of copper lines is so large and often inside a potential
customer's house, the condition of the lines can only be determined on a
case-by-case basis. The copper telephone lines that we rely upon to provide
service to our customers' homes may not be of sufficient quality or they may not
be adequately maintained by the traditional telephone company for proper DSL
functionality, which could significantly inhibit our ability to deploy our
broadband services to those homes, which would harm our business.
Our ability to provide DSL-based services to customers whose homes are
connected to telephone networks that do not use copper lines will be limited
because DSL-based services are not be available to those customers.
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Some telephone companies use technologies other than copper lines to
provide telephone services between the traditional telephone company central
switching office and the customer's residence and DSL-based services will not be
available to those customers. If a significant number of the homes of customers
that desire our service are connected to the telephone network with non-copper
local access connection, it could materially inhibit our ability to deploy our
DSL-based services to those homes and would harm our business.
ALWAYS CONNECTED INTERNET SERVICES, SUCH AS OURS, MAY BE SUBJECT TO ADDITIONAL
SECURITY RISKS WHICH COULD CAUSE US TO LOSE EXISTING CUSTOMERS, DETER POTENTIAL
CUSTOMERS AND HARM OUR REPUTATION.
Since our services allow customers to be connected to the Internet at
all times, unauthorized users may have a greater ability to access information
stored in our customers' computer systems. Always connected Internet services
may give unauthorized users, or hackers, more and longer opportunities to break
into a customer's computer or access, misappropriate, destroy or otherwise alter
data through the Internet. We are currently developing data security systems
that protect a customer's computer from unauthorized access through the
Internet, but we cannot ensure that the security risks will be eliminated.
A GENERAL ECONOMIC DOWNTURN COULD RESULT IN CUSTOMERS CANCELING OUR SERVICES AND
CONTENT OR THE DECISION BY PROSPECTIVE CUSTOMERS NOT TO USE OUR SERVICE.
To the extent the general economic health of the United States or of
certain regions in which many of our customers reside declines from recent
historically high levels, or to the extent customers fear a decline is imminent,
these customers may reduce expenditures for services such as ours. Any decline
or concern about an imminent decline could also delay decisions among certain of
our customers to renew our services or to add new services or could delay
decisions by prospective customers to make initial evaluations of our services.
Since many consumers may perceive our services as unnecessary or as a "luxury"
item, we could be particularly hard hit by an economic downturn. Any reduction
of or delays in expenditures would harm our business.
OUR BUSINESS IS SIGNIFICANTLY AFFECTED BY THE LEGISLATIVE, REGULATORY AND
JUDICIAL RULES APPLICABLE TO TELECOMMUNICATIONS SERVICES AND THE BROADBAND
MARKETPLACE.
Changes in existing laws and regulations applicable to our business may
not be favorable to us and may require us to direct time and money toward legal
and regulatory matters. Since 1996, telecommunications laws have been in a state
of particularly rapid change. We rely on our ability to purchase DSL access from
both traditional telephone companies and new competitive carriers, vendor
channels that may not remain open to use, or for which prices may rise, if the
regulatory status of these service providers changes in the future. In order to
protect our market options and business flexibility, we may also be required to
participate in legislative, regulatory and judicial proceedings, or proceedings
may be instituted against us by competitors seeking to harm our business, all of
which could entail the diversion of substantial funds and management attention.
We may be prevented from or delayed in providing asymmetric digital
subscriber line, or ADSL, access to our customers if the FCC does not grant our
application for a waiver from compliance with the requirements for connecting
ADSL equipment to the public telephone network.
We currently provide ADSL access to some of our customers. On February
28, 2000, the FCC set forth guidelines streamlining the process for obtaining
waivers from compliance with the requirements for connecting ADSL equipment to
the public telephone network. We have submitted our application for a waiver and
expect to receive this waiver in the near future because we believe we have met
the requirements for receiving the waiver. However, we cannot assure you that we
will obtain this waiver. If
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we do not obtain this waiver, the FCC may enjoin us from providing ADSL service.
If this occurs, we would be prevented from or delayed in providing ADSL access
to our customers.
Our services might be determined to be subject to price regulation at
the federal or state level and may affect our pricing structure and decrease our
profits.
If the current laws and regulations governing our business change, we
may become subject to price regulation at the state or federal level. Such price
regulation could adversely impact our profitability.
Federal, state, local or foreign governments may impose taxation on the
Internet and the services we offer, which would decrease our revenues and harm
our operating results.
Future legislation affecting our business could subject us to taxation
due to the services we provide. This taxation may decrease our revenues and harm
our operating results.
The competition among our DSL providers could be adversely affected by
changes in existing laws and regulations and that could increase our costs and
lower our profit margin.
If existing laws and regulations change, the competition among our DSL
providers that we rely on to maintain efficiently priced and high quality DSL
connections, could be adversely affected. In addition, if the Telecommunications
Act of 1996 and recent decisions by the Federal Communications Commission
implementing portions of the Act that have opened the existing telephone network
to competition are stayed, reversed or modified by appellate courts, if the laws
and decisions requiring traditional telephone companies and competitive carriers
to sell DSL connections to companies like our are changed or vacated, or if new
regulatory mandates degrade competition, our costs will increase and we will
have lower profit margins.
AS A PROVIDER OF CONTENT-BASED INTERNET SERVICES, WE MAY FACE POTENTIAL LEGAL
EXPOSURE BECAUSE OF THE NATURE OF SOME OF THE CONTENT WE PROVIDE.
We may be subject to claims for defamation, negligence, copyright or
trademark infringement, including contributory infringement, or other claims
relating to the information contained on our Internet sites, whether written by
us or third parties which could cause us to make unexpected legal expenditures
and significantly increase our costs. These types of claims have been brought
against providers of online services in the past and can be costly to defend
regardless of the merit of the lawsuit. Although recent federal legislation
protects online services from some claims when the material is written by third
parties, this protection is limited. Furthermore, the law in this area remains
in flux and varies from state to state, and from country to country.
We may also face potential legal exposure associated with the provision
of content-based Internet services in such areas as obscenity and indecency,
advertising, gaming, privacy, child Internet privacy, the use of personal
information gathered online and trademark or copyright infringement. Many of the
rules in these areas are ambiguous and rapidly evolving, making definitive
assessment of legal risks difficult. For a discussion of the regulatory
environment in which we operate, please see the section entitled "Business --
Government Regulation."
OUR HEADQUARTERS AND SUPPLIERS ARE ALL LOCATED IN NORTHERN CALIFORNIA WHERE
NATURAL DISASTERS MAY OCCUR WHICH COULD DAMAGE OUR FACILITIES AND RENDER US
UNABLE TO PROVIDE SERVICES TO OUR CUSTOMERS.
Currently, our corporate headquarters, network operations center and the
only manufacturer of our residential gateway are all located in Northern
California. Northern California historically has been vulnerable to natural
disasters and other risks, such as earthquakes, fires and floods, which at times
have disrupted the local economy and posed physical risks to our property and
the property of the manufacturer of our residential gateway. In the event of
such disaster, our business would suffer. We presently do not have redundant,
multiple site capacity in the event of a natural disaster.
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ITEM 2. PROPERTIES
Our corporate headquarters facility of approximately 60,000 square feet
is located in Cupertino, California. We occupy our corporate headquarters
facility pursuant to a lease that expires in June 2005. In March 2000, we
expanded into a second facility of approximately 66,000 square feet located in
San Jose, California and with a lease that will expire in November 2004. In June
2000, we expanded into a third facility of approximately 52,000 square feet in
Chicago, Illinois with a lease that will expire in December 2010. In addition,
we continue to lease our prior facility in San Jose, California under a lease
that expires in October 2002. We intend to continue subleasing this 13,200
square foot facility through the expiration of the lease term.
ITEM 3. LEGAL PROCEEDINGS
From time to time, we may be involved in litigation that arises in the
normal course of our business operations. As of the date of this Form 10-K
filing, we are not a party to any litigation that we believe could adversely
affect our business relationships and our financial results.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted during the fourth quarter of the year ended
December 31, 2000.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Our common stock is traded on the NASDAQ National Market under the
symbol "TLCT." We began trading on NASDAQ on March 29, 2000, the date of our
initial public offering. The following table sets forth the range of high and
low closing sales prices, as reported on the NASDAQ National Market for our
common stock for the periods indicated.
HIGH LOW
-------- --------
Calendar Year 2000
First Quarter (from March 29, 2000)................. $ 13.25 $ 12.375
Second Quarter...................................... $ 15.875 $ 4.563
Third Quarter....................................... $ 5.438 $ 2.563
Fourth Quarter...................................... $ 3.125 $ 1.25
As of January 11, 2001, there were 7,653 round-lot shareholders and
9,589 beneficial owners of our common stock.
DIVIDEND INFORMATION
We have never paid any cash dividends on our stock, and we anticipate
that for the foreseeable future, we will continue to retain any earnings for use
in the operation of our business.
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ITEM 6. SELECTED CONSOLIDATED FINANCIAL INFORMATION
The following selected consolidated financial data should be read in
conjunction with our consolidated financial statements and related notes and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" included elsewhere in this Form 10-K
FOR THE PERIOD
FROM AUGUST 18, 1997 YEAR ENDED
(INCORPORATION) DECEMBER 31,
TO DECEMBER 31, ------------------------------------------------
1997 1998 1999 2000
--------------------- ------------ ------------ ------------
(In Thousands, except share and per share data)
CONSOLIDATED STATEMENT OF OPERATIONS DATA:
Revenues ........................................... $ -- $ -- $ 187 $ 9,352
Operating expenses:
Network and product costs ....................... -- -- 2,080 29,090
Sales and marketing ............................. 5 240 13,081 45,784
General and administrative ...................... 335 1,906 5,903 43,954
Research and development ........................ 327 4,723 15,900 18,336
Amortization of stock-based compensation ........ -- 145 3,095 32,779
Depreciation and amortization ................... 11 424 2,253 15,592
---------- ------------ ------------ ------------
Total operating expenses ................... 678 7,438 42,312 185,535
---------- ------------ ------------ ------------
Loss from operations ............................ (678) (7,438) (42,125) (176,183)
Interest expense ................................ -- (187) (1,448) (2,934)
Interest income ................................. -- 35 379 5,728
Other income / (expense), net ................... -- -- (225) --
---------- ------------ ------------ ------------
Net loss ........................................ (678) (7,590) (43,419) (173,389)
Deemed dividend and accretion on mandatorily
redeemable convertible preferred stock ........ -- -- (16,750) (341)
---------- ------------ ------------ ------------
Net loss attributable to common stockholders .... $ (678) $ (7,590) $ (60,169) $ (173,730)
========== ============= ============ ============
Net loss per share, basic and diluted ........... $ (0.56) $ (1.39) $ (7.32) $ (2.89)
========== ============= ============ ============
Shares used in computing net loss per share,
basic and diluted ............................. 1,219,538 5,471,617 8,219,183 60,079,659
========== ============= ============ ============
OTHER CONSOLIDATED FINANCIAL DATA:
Net cash flows provided by (used in):
Operating activities .......................... $ (677) $ (5,356) $ (29,524) $ (99,473)
Investing activities .......................... (303) (1,026) (9,104) (34,800)
Financing activities .......................... 1,001 7,763 104,204 105,717
EBITDA(1) .......................................... (667) (6,869) (37,002) (127,812)
Capital expenditures(2) ............................ 303 2,830 22,196 38,530
AS OF DECEMBER 31
-----------------------------------------------------
1997 1998 1999 2000
--------- --------- --------- ---------
CONSOLIDATED BALANCE SHEET DATA:
Cash and cash equivalents ........................... $ 21 $ 1,402 $ 66,978 $ 38,422
Working capital (deficit) ........................... 31 (1,204) 53,729 (1,442)
Total assets ........................................ 423 4,697 140,071 132,343
Long-term obligations, less current portion ......... 1,000 3,490 12,058 7,124
Mandatorily redeemable convertible preferred stock .. -- 6,671 156,020 --
Total stockholders' equity (deficit) ................ (677) (8,107) (48,282) 73,013
- ----------
(1) EBITDA is the acronym for earnings before interest, taxes, depreciation
and amortization. EBITDA consists of the net loss excluding net
interest, depreciation and amortization of capital assets and
stock-based compensation. EBITDA is presented to enhance an
understanding of our operating results and is not intended to represent
cash flow or results of operations in accordance with generally accepted
accounting principles for the period indicated and may be calculated
differently than EBITDA for other companies.
(2) Total of property and equipment acquired for cash and under capital
lease.
For an explanation of the determination of the weighted average common
and common equivalent shares used to compute net loss per share, refer to Note 2
of Notes to Consolidated Financial Statements.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
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The following discussion and analysis should be read in conjunction with
Selected Financial Information and our 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 could differ materially from those anticipated in the forward-looking
statements as a result of certain factors including the risks discussed in "Risk
Factors" and elsewhere in this Form 10-K.
OVERVIEW
We develop, market and deliver to the residential market interactive
online services and content designed for use over high-speed, or broadband,
connections. These broadband connections allow our customers to enjoy services
and content that they could not access with traditional slower speed Internet
connections. Although we currently deliver our services to customers using
digital subscriber line, or DSL, technology, in the future we intend to utilize
the technology we have developed to deliver these services and content over a
variety of broadband technologies from a managed nationwide network to and
throughout the home. Our goal is to become a leading provider of broadband
access services, content and home networking services to the residential market.
In July 1999, we began offering services commercially in Chicago. As of
December 31, 2000, we were offering services in more than 150 metropolitan
statistical areas nationwide. At December 31, 2000, we had approximately 48,000
active subscribers and almost 13,500 prequalified customers who have placed
orders for our services. Based on our limited historical experience, we estimate
that approximately 75% of those placing orders will actually be converted into
customers receiving our services depending on the local access provider on which
we rely. Our maximum potential market is limited by the number of homes that are
DSL-capable, meaning homes that are within approximately 2 1/2 and 3 miles from
a local telephone office that has equipment necessary to support DSL service and
have voice grade copper telephone lines that are in good condition.
On December 21, 2000, we announced an agreement in which HUGHES, through
a recently formed subsidiary, DIRECTV Broadband Inc., would acquire all our
outstanding shares of common stock at a purchase price of $2.15 per share, or
approximately $178 million, subject to the satisfaction of certain conditions.
Also, to ensure we have sufficient access to funding during the period prior to
the consummation of our merger with HUGHES, HUGHES agreed to provide unsecured
interim financing of $20 million in the form of a convertible subordinated note.
The cash tender offer for those shares commenced February 1, 2001 and is
scheduled to expire on April 2, 2001, unless extended. The consummation of the
tender offer remains subject to customary closing conditions. During February
and March 2001, we accessed the $20 million interim financing.
If the tender offer is not completed for any reason, we may be forced to
discontinue operations, as we only have enough cash on hand to continue
operations until April 15, 2001.
Since our incorporation in August 1997, our primary activities have
consisted of:
- developing our residential broadband gateway technology;
- obtaining space and locations for our network equipment;
- deploying and installing our network;
- developing and integrating our operational support system and other back
office systems;
- negotiating and executing network agreements with traditional telephone
companies and new competitive carriers;
- launching service in target markets;
- developing a marketing and branding strategy;
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- building our customer service organization;
- negotiating agreements for broadband content;
- hiring management and other personnel; and
- raising capital.
We have incurred operating losses, net losses and negative earnings
before interest, taxes, amortization of stock-based compensation, depreciation
and amortization, or EBITDA, for each month since our formation. We had annual
revenues of $9.4 million for 2000 and as of December 31, 2000, an accumulated
deficit of $242.2 million. We intend to increase substantially our capital
expenditures and will incur higher operating expenses in an effort to build our
customer base and our brand rapidly, as well as expand our infrastructure and
network services. We expect to incur substantial operating losses, net losses
and negative EBITDA as we expand our operations.
We incur network and product costs, sales and marketing expenses and
capital expenditures when we enter a new market. Once we have developed our
network in a market, we incur incremental expenditures as we connect new
customers. These incremental expenditures primarily include local access costs
and gateway device costs. In addition to the capital expenditures, we will be
required to fund our operating and cash flow and working capital deficits as we
build our customer base.
RESULTS OF OPERATIONS
Revenues. Initially, we expect to derive substantially all of our
revenues from our basic service package, which we offer directly to our
customers. Our current basic service package consists of always connected
Internet access, e-mail accounts, storage space and hosting for Web pages and 60
minutes of remote access to the Internet each month when the customer is away
from home. We bill our customers a monthly rate for these services. In addition
to monthly service fees, our customers are billed for nonrecurring service
activation, gateway and installation charges. To encourage potential customers
to adopt our services, we may in some instances offer reduced monthly prices for
an initial period of time or reduced service activation, gateway, or
installation charges. To date we have not received any revenue from the content
provided through our website, nor do we expect to receive any substantial
revenue from this content in the near future. In the future we expect to bill
our customers for monthly recurring charges based on the services and content
selected by the customer.
As our business develops and we offer additional services and content
for incremental recurring fees, we expect to become less dependent on revenues
from our basic service package. By providing additional services and content, we
expect to enhance our overall operating margins as we believe these additional
services and content can be added at a lower cost than our current basic
services. We also believe that these additional services and content will enable
us to build customer loyalty and minimize customer turnover.
We seek to price our services competitively in each market. In 2000 we
offered our basic services package for either $39.95 or $49.95 per month,
depending on the geographic location, with no additional per-minute usage
charges. During 2001, there has been considerable consolidation among DSL
providers and a general upward shift in the price for DSL access service. In
response to these developments, we implemented a uniform national price for all
new subscriber orders of $49.95 from March 1, 2001. Although we believe that we
will be able to successfully implement a price increase in 2001, during the past
several years, market prices for many telecommunications services have been
declining and we expect that, as a result of competition, prices for broadband
access will decline over time. However, we intend to provide additional
value-added services and content to our customers so as to maintain and
potentially increase our price levels. In November 2000,we began marketing our
first additional service "Connect & Protect (TM)" which provides home networking
and enhanced internet security features for $9.95 per month; we did not
recognize any additional service revenue during the year ended December 31,
2000.
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Our future financial performance and our ability to achieve positive
operating cash flow will depend on a number of factors, some of which we cannot
control. We believe that improvements in our financial performance depend
largely on our ability to:
- obtain sufficient additional financing to continue our operations and to
fund our growth;
- deploy our network rapidly and cost-effectively;
- provide high quality services at competitive prices;
- offer additional value-added services and applications;
- acquire customers in a cost-effective manner;
- reduce the costs associated with the production of our gateway;
- attract qualified personnel;
- minimize customer turnover;
- manage increased sales and marketing and general and administrative
expenses; and
- identify and integrate the necessary administrative and operations
support systems to manage our growth effectively.
Network and Product Costs. Our network expenses consist of nonrecurring
and monthly recurring charges for the transport elements we choose to lease
rather than own. We have entered into agreements that include commitments for
the lease of the communications lines that comprise our high-speed managed
network with MCI WorldCom Communications, Inc. in the amount of $13.5 million,
payable over the 27 months commencing January 2001, and with Level 3
Communications, LLC in the amount of $8.5 million, payable over the 17 months
commencing January 2001. As we expand our network and our revenue base, we
expect that these costs will increase significantly in the future. Nonrecurring
network expenses include installation fees related to transport and local loop
circuits. We expect these costs will continue to be largely related to the
activation of new customers. Monthly recurring network expenses include
transport and backbone fees, facility rent, power and other fees charged by
traditional telephone companies and new competitive carriers and other
providers. As our customer base grows, we expect the largest element of network
expenses to be carrier charges for local access, which are approximately $30 per
customer per month, depending on the provider, location and type of local access
connectivity. Product costs will be incurred as our business develops and we
begin to offer additional value added services and content.
Sales and marketing expenses. Our sales and marketing expenses consist
primarily of expenses related to the acquisition of customers and the
development of promotional materials, advertising and branding. We expect that
our marketing expenses will grow significantly as we enter new markets and offer
our services on a nationwide basis.
General and administrative expenses. Our general and administrative
expenses consist primarily of costs related to personnel, customer service,
finance, administrative services, recruiting and legal services. We expect that
our general and administrative costs will grow significantly as we expand our
operations. However, we expect these expenses to decline as a percentage of our
revenue as we build our customer base and the number of customers connected to
our network increases.
Research and development expenses. Research and development expenses
consist primarily of costs related to engineering personnel engaged in research
and development activities, and, to a lesser extent, costs of materials relating
to these activities. We expense research and development costs as we incur them.
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Depreciation and amortization expenses. Depreciation and amortization
expenses include: depreciation of network and computer equipment, depreciation
of furniture and fixtures, and the amortization of completed technology and
leasehold improvements. We expect depreciation and amortization expense to
increase significantly as more of our network becomes operational and as we
increase capital expenditures to expand our operations. Depreciation and
amortization is computed on a straight-line basis over estimated useful lives
ranging from two to seven years.
Interest expense. Interest expense arose as a result of our capital
lease lines, notes payable and bridge loan financing.
Stock-based compensation expenses. Stock-based compensation arose as a
result of the rescission of exercise of certain out-of-the-money option grants
and granting stock awards to employees with per-share purchase or exercise
prices subsequently determined to be below the fair values at the purchase or
grant dates and stock, stock option, and warrant grants to non-employees in
return for services and financing arrangements. Stock grants to non-employees
include advertising credits with a fair value of $38.8 million that were
provided by NBC and NBCi in exchange for Series C mandatorily redeemable
preferred stock. The employee stock-based compensation is being amortized over
the applicable option vesting period (generally four years). The fair value of
non-employee options and warrant grants are amortized over the service period or
expensed as services are provided and advertising credits are utilized.
Taxation. We have not generated any taxable income to date and therefore
have not paid any federal income taxes since inception. We expect to generate
significant operating loss carryforwards. Use of our net operating loss
carryforwards may be subject to limitations under Section 382 of the Internal
Revenue Code of 1986, as amended. We have recorded a full valuation allowance on
our deferred tax asset, consisting primarily of net operating loss
carryforwards, because of uncertainty regarding its recoverability.
YEAR ENDED DECEMBER 31, 2000 COMPARED TO YEAR ENDED DECEMBER 31, 1999
Revenues. During the year ended December 31, 2000, we continued the
development of our business operations, with the expansion of our national
broadband footprint to over 150 metropolitan statistical areas from
approximately 30 metropolitan statistical areas as of December 31, 1999. The
initiation of last-mile coverage with SBC, Verizon, and NorthPoint, together
with an expansion of our geographical coverage with Rhythms, contributed to the
increase. Subscriber revenues, net of certain deferred revenues, for the year
ended December 31, 2000, were $9.4 million compared to $187,000 for the year
ended December 31, 1999. As 1999's revenues were limited to a trial launch of
service in the Chicago area in July of that year, and our commercial launch in
Chicago, Detroit, and 29 of the 40 most populous metropolitan statistical areas
in the Southeast in November 1999, the increase in revenues over the prior
periods is consistent with the growth of our subscriber base, which increased
from approximately 1,500 to 48,000 during 2000.
Network and product costs. For the year ended December 31, 2000, we
recorded network and product costs of $29.1 million compared to $2.1 million for
the year ended December 31, 1999. As 1999's network and operation costs were
limited to a limited launch of service in the Chicago area in July and our
commercial roll-out to approximately 30 metropolitan statistical areas in
November of that year, the increase in the expenses over the prior period is
consistent with the development of our commercial operations. We expect network
and product costs to increase significantly in future periods as our subscriber
base grows. We believe that these costs will exceed revenue for at least the
next twelve months.
Sales and marketing expenses. Sales and marketing expenses increased
from $13.1 million for the year ended December 31, 1999 to $45.8 million for the
year ended December 31, 2000. The overall increase in expenditure is consistent
with the development of our business. Following the commercial trial of our
service deployment platform in Chicago in July 1999, we have rapidly expanded
our geographical service areas with commercial launches in the Southeast and
Midwest in November 1999; the Northeast in March 2000; Northern and Southern
California in April 2000; the mountain states in July 2000; Texas in August
2000; and Connecticut, Rhode Island, Arizona, and Western Florida in October
2000. We now
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offer service in more than 1,500 cities in 35 states nationwide. The table below
sets out the primary areas of increased expenditure for the year ended December
31, 2000 compared to the prior year (in thousands):
Incremental advertising and promotional costs $22,748
Incremental employee costs $ 9,204
Sales and marketing expenses for the year ended December 31, 2000,
excludes $15.3 million of our NBC and NBCi advertising credits which were used
from September 2000 to launch a nationwide television and radio advertising
campaign, coincident with our nationwide network deployment. There are $23.5
million in remaining credits, which we expect to utilize by the end of calendar
year 2002.
General and administrative expenses. General and administrative expenses
increased from $5.9 million for the year ended December 31, 1999 to $44.0
million for the year ended December 31, 2000. The increased level of
expenditures reflects the growth in the volume and complexity of our underlying
business as we have evolved from an enterprise primarily focused on research and
development to a commercial operating company following our commercial trial of
service in Chicago in July 1999 and the ongoing expansion of commercial
operations resulting in an increase in our installed subscriber base from
approximately 1,500 at December 31, 1999 to 48,000 at December 31, 2000. The
table below sets out the primary areas of increased expenditure for the year
ended December 31, 2000 compared to the prior year (in thousands):
Incremental customer service expenditure $15,831
Incremental executive and general corporate expenditure $15,986
Incremental facilities expenditure $ 4,049
We expect general and administrative expenses to increase as we add
personnel and incur additional expenses related to the planned growth of our
business.
Research and development expenses. Research and development expenses
increased from $15.9 million for the year ended December 31, 1999 to $18.3
million for the year ended December 31, 2000. This increase is primarily due to
incremental charges, over the prior year, for facilities and the hiring of
additional engineers and consultants involved in increased research and
development activities associated with our service development platform and
associated services. In future periods, we expect to continue to make
investments in research and development at current rates.
Stock-based compensation. Stock-based compensation increased from $3.1
million for the year ended December 31, 1999, to $32.8 million for the year
ended December 31, 2000. The increase in stock-based compensation expense is
primarily attributable to the utilization of $15.3 million of prepaid
advertising received from NBC and NBCi as part of our Series C round of
financing; and incremental employee stock-based compensation of $6.1 million
arising from the issuance of option grants prior to our initial public offering
at exercise prices less than fair market value and $8.7 million arising from the
rescission of the exercise of certain employee stock options with recourse
notes.
Depreciation and amortization expenses. Depreciation and amortization
expenses increased from $2.3 million for the year ended December 31, 1999 to
$15.6 million for the year ended December 31, 2000. This increase was primarily
due to additional capital expenditures arising both from the build out of our
managed network and the increase in our subscriber base.
Interest income and expense. Our interest income increased from $379,000
in 1999 to $5.7 million in 2000 due primarily to the interest earned on the
proceeds received from our Series C round of financing and our initial public
offering, which were completed in December 1999 and March 2000, respectively.
Our interest expense increased from $1.4 million to $2.9 million primarily due
to higher interest expense charges resulting from higher average lease
obligations in 2000.
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YEAR ENDED DECEMBER 31, 1999 COMPARED TO YEAR ENDED DECEMBER 31, 1998
Revenues. During the year ended December 31, 1999, we continued the
development of our business operations, commencing commercial service in the
Chicago market in July. We recorded revenues of $187,000 during this period,
which was from service and installation charges net of discounts given to
customers. We did not offer commercial services in 1998 and, as a result, did
not record any revenues in 1998.
Network and product costs. For the year ended December 31, 1999, we
recorded network and product costs of $2.1 million. Since we did not offer
commercial services in 1998, we did not record any network and product costs in
1998.
Sales and marketing expenses. Sales and marketing expenses increased
from $240,000 for the year ended December 31, 1998 to $13.1 million for the year
ended December 31, 1999. This increase was primarily due to a $9.3 million
increase in advertising and promotion costs related to the launch of our service
deployment platform in July 1999 and a $2.2 million increase in employee costs.
General and administrative expenses. General and administrative expenses
increased from $1.9 million for the year ended December 31, 1998 to $5.9 million
for the year ended December 31, 1999. This increase was primarily due an
incremental charge of $1.3 million for the addition of personnel performing
general corporate and customer service and a $2.5 million increase in rent and
associated overhead expense.
Research and development expenses. Research and development expenses
increased from $4.7 million for the year ended December 31, 1998 to $15.9
million for the year ended December 31, 1999. This increase was primarily due to
an incremental charge of $9.3 million for the hiring of additional engineers and
consultants involved in increased research and development activities associated
with the development of our service development platform and associated
services. We expect to continue to make substantial investments in research and
development and anticipate that these expenses will continue to increase.
Stock-based compensation. Stock-based compensation increased from
$145,000 for the year ended December 31, 1998 to $3.1 million for the year ended
December 31, 1999. This increase is primarily attributable to employee stock-
based compensation arising from our increased hiring efforts during 1999
resulting in a greater number of stock options issued that were subsequently
deemed to be below fair market value on the date of grant.
Depreciation and amortization expenses. Depreciation and amortization
expenses increased from $424,000 for the year ended December 31, 1998 to $2.3
million for the year ended December 31, 1999. This increase was primarily due to
additional capital expenditures arising from the build out of our managed
network.
Interest expense. Interest expense increased from $187,000 for the year
ended December 31, 1998 to $1.4 million for the year ended December 31, 1999
inclusive of noncash interest expenses of $12,000 and $492,000, respectively.
This increase was due to increased borrowings.
LIQUIDITY AND CAPITAL RESOURCES
From inception through December 31, 2000, we financed our operations
primarily through the proceeds of our initial public offering, net of
underwriting commissions and other issuance costs, of $120.7 million; private
placements of equity of approximately $149.0 million in cash and promotional
services; the use of operating equipment leases totaling $18.3 million; and
borrowings under notes payable of $11.9 million. As of December 31, 2000, we had
an accumulated deficit of $242.2 million, cash and cash equivalents of $38.4
million and restricted cash of $6.0 million.
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During the year ended December 31, 2000, the year ended December 31,
1999 and the year ended December 31, 1998 the net cash used in our operating
activities was $99.5 million, $29.5 million and $5.4 million, respectively. This
cash was used for a variety of operating purposes, including salaries;
consulting and legal expenses; network operations; marketing; customer care; and
overhead expense
Our net cash used for investing activities for the year ended December
31, 2000, the year ended December 31, 1999 and the year ended December 31, 1998
was $34.8 million, $9.1 million and $1 million, respectively and was used for
purchases of property and equipment coincident with the build out of our
network, subscriber base and corporate capabilities.
Net cash provided by financing activities for the year ended December
31, 2000, the year ended December 31, 1999 and the year ended December 31, 1998
was $105.7 million, $104.2 million and $7.8 million, respectively. The financing
in 2000 came from initial public offering proceeds, net of underwriting
commissions, legal, accounting and sundry other expenses, of $120.7 million and
$650,000 from the exercise of warrants, partially offset by $6.0 million in the
prepayment and repayment of notes, $4.5 million of principal payments under
capital lease obligations and a $5.7 million increase in restricted cash related
to letters of credit and other commitments. Notes were prepaid in May 2000 in
order to remove restrictive liens over the Company's assets. The financing in
1999 and 1998 was primarily from the issuance of preferred stock and notes
payable.
Upon the closing of our initial public offering on March 29, 2000,
mandatorily redeemable preferred stock with a liquidation value of approximately
$148.6 million was converted to common stock.
While we believe that our existing cash balances will be sufficient to
fund our operating losses, capital expenditures, lease payments and working
capital requirements through April 15, 2001, we may make appropriate mid-course
actions to stretch our cash position beyond this point. We expect our operating
losses and capital expenditures to increase substantially as our customer base
ramps, and we expect to record substantial losses for the foreseeable future. As
a result, additional financing will be required for us to maintain operations.
On December 21, 2000 we entered into an agreement with HUGHES, whereby HUGHES
will acquire us for $2.15 per share, or a total purchase price of approximately
$178.0 million. Failure to complete the transaction with Hughes or, in the event
the transaction does not close, failure to secure sufficient additional capital
would likely force us to discontinue operations, as we only have enough cash on
hand to continue operations until April 15, 2001.
In order to ensure we have sufficient access to funding during the
period prior to the consummation of our merger with HUGHES, HUGHES has agreed to
provide unsecured interim financing of $20.0 million, pursuant to a convertible
subordinated note; we drew down this balance, in full, during February and March
2001.
Our capital requirements will vary based upon the timing and success of
implementation of our business plan and as a result of competitive,
technological and regulatory developments, or if:
- demand for our services or our cash flow from operations varies from
projections;
- our development plans or projections change or prove to be inaccurate;
- we make any acquisitions; or
- we accelerate deployment of our network or otherwise alter the schedule
or targets of our business plan implementation.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities" (FAS 133). The new standard requires companies to record
derivatives on the balance sheet as assets or liabilities, measured at fair
value. Under FAS 133, gains or losses resulting from changes in the values of
derivatives are to be reported in the statement of operations or as a deferred
item, depending on the use of the derivatives and whether they qualify for hedge
accounting. The key criterion for hedge accounting is that the derivative must
be highly effective in achieving offsetting changes in fair value or cash flows
of the hedged items
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during the term of the hedge. The Company is required to adopt FAS 133 in the
first quarter of 2001. To date, the Company has not engaged in any foreign
currency or interest hedging activities and does not expect adoption of this new
standard to have a significant impact on the Company.
In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 101 or SAB 101, Revenue Recognition in Financial
Statements, which provides guidance on the recognition, presentation, and
disclosure of revenue in financial statements filed with the Commission. SAB 101
outlines the basic criteria that must be met to recognize revenue and provides
guidance for disclosures related to revenue recognition policies. The
implementation of SAB 101 did not have a material effect on our financial
position or results of operations.
In March 2000, the Financial Accounting Standards Board issued
Interpretation No. 44, "Accounting for Certain Transactions Involving Stock
Compensation" an interpretation of APB Opinion No. 25 ("FIN 44"). This
Interpretation clarifies the definition of employee for purposes of applying
Accounting Practice Board Opinion No. 25, Accounting for Stock Issued to
Employees (`APB 25'), the criteria for determining whether a plan qualifies as a
non-compensatory plan, the accounting consequence of various modifications to
the terms of a previously fixed stock option or award, and the accounting for an
exchange of stock compensation awards in a business combination. This
Interpretation was effective July 1, 2000, and did not have a material effect on
the financial position or results of operations of the Company.
In January 2001 the SEC issued Staff Announcement Topic No. D-93
"Accounting for the Rescission of the Exercise of Employee Stock Options". This
announcement clarifies how the rescission of a previous exercise of a stock
option by an employee is treated under APB25. One of the conditions of closing
the transaction with HUGHES was that a minimum of 80% of the out-of-the-money
early stock option exercises, financed by the Company under full recourse notes,
were rescinded by December 31, 2000. Under Topic No. D-93, these rescissions
resulted in $8.7 million of stock-based compensation expense for the year ended
December 31, 2000.
ITEM 7.A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK INTEREST
RATE SENSITIVITY
The primary objective of our investment activities is to preserve
principal while at the same time maximizing the income we receive from our
investments without significantly increasing risk. Some of the securities that
we may invest in may be subject to market risk. This means that a change in
prevailing interest rates may cause the principal amount of the investment to
fluctuate. For example, if we hold a security that was issued with a fixed
interest rate at the then-prevailing rate and the prevailing interest rate later
rises, the principal amount of our investment will probably decline. To minimize
this risk in the future, we maintain our cash in money market funds. In general,
money market funds are not subject to market risk because the interest paid on
such funds fluctuates with the prevailing interest rate. As of December 31,
2000, all of our cash and cash equivalents were in money market and checking
funds.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Company's financial statements at December 31, 2000 and 1999, and
for each of the three years in the period ended December 31, 2000, and the
Report of PricewaterhouseCoopers LLP, Independent Accountants, are included in
this Report on pages F-1 through F-21.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF REGISTRANT
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EXECUTIVE OFFICERS AND DIRECTORS
The following table sets forth certain information with respect to our
directors, executive officers and other key employees as of December 31, 2000.
NAME AGE POSITION
- ---- --- --------
Patti Hart................. 44 President, Chief Executive Officer and Director
Peter Olson................ 58 Executive Vice President, Chief Technical Officer and Director
David Finley............... 35 Chief Operating Officer
Edward Hayes............... 45 Executive Vice President and Chief Financial Officer
Scott Martin............... 44 Executive Vice President, Chief Administrative Officer and
Corporate Secretary
Jim Morrissey.............. 51 Executive Vice President and Chief Marketing Officer
Kevin Grundy............... 43 Senior Vice President, Engineering
Thomas Obenhuber........... 45 Senior Vice President, Corporate Development
Regina Wiedemann........... 39 Senior Vice President, Business Development
Vicki Foshee............... 43 Senior Vice President, Service Delivery & Support
Robert Sandor.............. 47 Senior Vice President, Operations
David Wilson............... 33 Vice President, Financial Services
David Cowan................ 34 Director
Christie Hefner............ 48 Director
Andrew Rappaport........... 43 Director
Elisabeth Sami............. 32 Director
James Scheinman............ 34 Director
Michael Solomon............ 48 Director
Randall Strahan............ 48 Director
Patti Hart has served as President, Chief Executive Officer and as a
member of the Company's Board of Directors since June 1999. From February 1994
through April 1999, Ms. Hart was at Sprint Corporation, where she most recently
served as President and Chief Operating Officer of Sprint Corporation's Long
Distance Division. At Sprint, Ms. Hart also served as President of Sprint
Business, President of Sales and Marketing, and President of the Business
Services Group. Ms. Hart is a member of the board of directors of Vantive Corp.,
which was acquired by PeopleSoft, and Premisys Corp.
Peter Olson, one of our founders, has served as our Executive Vice
President and Chief Technical Officer since July 1998. Previously, Mr. Olson
served as our President and Chief Executive Officer from our incorporation in
August 1997 until July 1998. Mr. Olson has served on our Board of Directors
since August 1997. From June 1982 through December 1994, Mr. Olson served as
Chief Technical Officer of Octel Communications Corporation, a company he
co-founded. Mr. Olson is a member of the board of directors of Flycast
Communications Corp., IMP, Inc. and Netpulse Communications, Inc.
Edward Hayes has served as our Executive Vice President and Chief
Financial Officer since January 2000. From July 1996 through December 1999, Mr.
Hayes worked at Lucent Technologies Inc., where from July 1997 he served as
Financial Vice President and Chief Financial Officer of Lucent's Global Service
Provider Business. From July 1995 through July 1996, Mr. Hayes worked at Unisys
Corporation, where from November 1995 he served as Vice President, Chief
Financial Officer and Chief Information Officer of Unisys' Global Professional
Services Division. From April 1990 through July 1995, Mr. Hayes worked at ASEA
Brown Boveri (ABB), Inc. the U.S. subsidiary of the joint venture between ASEA
and BBC Brown Boveri, where from September 1993 he served at Vice President,
Chief Financial Officer and Chief Information Officer of ABB Nuclear Operations.
Scott Martin has served as our Executive Vice President, Chief
Administrative Officer and Corporate Secretary since December 1999. From October
1982 through August 1999, Mr. Martin held various positions at Van Kampen
Investments Inc., including Senior Vice President and Deputy General Counsel
from January 1995.
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Jim Morrissey has served as our Executive Vice President and Chief
Marketing Officer since September 1999. From January 1980 through September
1999, Mr. Morrissey held various positions at Grey Advertising, including
Executive Creative Director and Executive Vice President from December 1995.
Kevin Grundy, one of our founders, has served as our Senior Vice
President, Engineering since December 1997. From February 1997 through November
1997, Mr. Grundy served as President and CEO of Aspen Internet Systems, Inc., a
DSL modem company. From June 1995 through August 1997, Mr. Grundy served as Vice
President of Engineering and Operations at Minerva Systems, an MPEG encoder
company. From June 1994 through June 1995, Mr. Grundy was Director of
Engineering at Auspex Systems, Inc., a high reliability network data storage
company. Previously, Mr. Grundy worked at NeXT, Incorporated as Executive
Director, Manufacturing Engineering and Production, where he was responsible for
all hardware engineering, manufacturing and support.
Thomas Obenhuber, one of ours founders, has served as our Senior Vice
President, Corporate Development since February 2000. From August 1997 to
February 2000, Mr. Obenhuber served as Senior Vice President, Business and
Product Planning. From January 1995 through July 1997, Mr. Obenhuber served as
Vice President, Operations and Engineering at Genuity, a national backbone
Internet service provider that he co-started. From July 1990 through January
1995, Mr. Obenhuber worked at Sun Microsystems where he most recently served as
Director, System Architecture.
Vicki Foshee has served as our Senior Vice President, Service Delivery
and Support since January 2000. From February 1999 to January 2000, Ms. Foshee
served as General Manager, Vice President Service Delivery at NorthPoint
Communications, a provider of digital subscriber line technology. From February
1998 through February 1999, Ms. Foshee was the Senior Director of Southwestern
Bell Corp for SBC Telecom, Inc., a provider of telecommunications services. From
January 1995 through February 1998, Ms. Foshee was the Director of AT&T ICSC
centers for SBC Telecom, Inc.
David Wilson has served as our Vice President, Financial Services since
April 2000. From September 1990 to January 2000, Mr. Wilson was an auditor for
PricewaterhouseCoopers, where he last held the position of Senior Manager.
David Finley has served as our Chief Operating Officer since July 2000.
From May 1999 to July 2000, Mr. Finley served as President of Hardwood
Technologies, an Information Technology consulting company. From August 1997 to
May 1999, Mr. Finley served as Chief Operating Officer and Assistant to the
President at Sprint Corporation's Long Distance Division. From May 1994 to
August 1997, Mr. Finley served as National Account Manager for Sprint Long
Distance.
Robert Sandor has served as our Senior Vice President, Operations since
September 2000. From September 1999 to September 2000, Mr. Sandor was Vice
President of Operations with Engage, Inc., an Internet advertising company. From
August 1998 to September 1999, Mr. Sandor was Vice President of Network
Operations and Customer Service with General Magic, Inc., an Internet services
company. From October 1997 to March 1998, Mr. Sandor was Vice President of
Operations with Internex, an Internet services company. From April 1993 to
October 1997, Mr. Sandor was Director of Network Operations and Information
Technology with Gemstar, an interactive television company.
Regina Wiedemann has served as our Senior Vice President, Business
Development since October 1999. From June 1999 through September 1999 Ms.
Wiedemann served as Vice President of Business Development for Notify Technology
Corp., a consumer telephony and Internet notification device company. From
August 1997 through October 1998, Ms. Wiedemann was Vice President of Commercial
Services for Infonet, a global data communications company. From January 1996
through July 1997, Ms. Wiedemann served as Vice President of Sales and Channel
Management at Pacific Bell Internet. From February 1988 through December 1995,
Ms. Wiedemann worked at Sprint, where she last held the position was Executive
Assistant to the President of Multimedia.
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40
David Cowan has served on our Board of Directors since July 1998. Mr.
Cowan is the Managing General Partner of Bessemer Venture Partners, which he
joined in August 1992. From August 1996 through May 1997, he served as Chief
Executive Officer of Visto Corporation, an Internet-based personal information
company. From March 1995 through December 1996, he served as Chairman and Chief
Financial Officer of VeriSign, Inc. Mr. Cowan is a member of the boards of
directors of Flycast Communications Corp., Keynote Systems, Inc., VeriSign,
Inc., Worldtalk Communications Corp., and several private companies.
Christie Hefner has served on our Board of Directors since May 2000. Ms.
Hefner is the Chairman and Chief Executive Officer of Playboy Enterprises, a
multimedia company, a position which she has held since November 1988. Ms.
Hefner is a member of the board of directors of Playboy Enterprises, Inc.
Andrew Rappaport has served on our Board of Directors since October
1997. Mr. Rappaport has been a general partner at August Capital since August
1996. From August 1984 through July 1996, Mr. Rappaport was President of The
Technology Research, Inc. Mr. Rappaport is a member of the board of directors of
Silicon Image, Inc. as well as several private corporations.
Elisabeth Sami has served on our Board of Directors since December 2000.
Ms. Sami has been the Vice President of Business Development at NBC, Inc. since
March 1997. From May 1993 to March 1997, Ms. Sami was Vice President of Business
Development at Discovery Communications, Inc.
James Scheinman has served on our Board of Directors since December
2000. Mr. Scheinman has been the Senior Vice President of Business Development
at NBC Internet, Inc. since October 1998. From October 1995 to October 1998, Mr.
Scheinman was an associate with the law firm Gray Cary Ware & Freidenrich LLP.
Michael Solomon, one of the Company's founders, has served on our Board
of Directors since the Company's incorporation in August 1997 and served as our
Interim CEO from June 1998 through July 1999. Mr. Solomon has been at Mohr,
Davidow Ventures since March 1996. From July 1994 through September 1999, Mr.
Solomon also worked as an advisor and consultant. Mr. Solomon is a member of the
board of directors of Flycast Communications Corp. and several private
corporations.
Randall Strahan has served on our Board of Directors since December
1998. From January 1999 through December 1999, Mr. Strahan served as President
and Chief Executive Officer of Telmax Communications Corporation, a DSL
equipment company, and is currently chairman of its board of directors. Since
November 1999, Mr. Strahan has served as a Venture Partner at Mohr, Davidow
Ventures. From November 1978 through January 1998, Mr. Strahan was at Pacific
Bell, where he most recently held the position of President, Service Operations.
COMPLIANCE WITH SECTION 16(a) OF THE SECURITIES AND EXCHANGE ACT
Section 16(a) of the Exchange Act requires the Company's directors and
executive officers, and persons who own more than ten percent of a registered
class of the Company's equity securities, to file with the SEC initial reports
of ownership and reports of changes in ownership of Shares and other equity
securities of the Company. Officers, directors, and greater than ten-percent
stockholders are required to furnish the Company with copies of all Section
16(a) forms they file.
To our knowledge, based solely upon a review of the copies of such
reports furnished to us and written representations that no other reports were
required, during the last fiscal year ended December 31, 2000, all Section 16(a)
filing requirements applicable to our officers, directors and
greater-than-ten-percent beneficial owners were complied with by such persons.
MEETINGS OF THE BOARD AND COMMITTEES
During 2000, the Company Board held 19 meetings. All directors attended
at least 75% of the aggregate number of meetings held by the Company Board and
meetings held by all committees on which each such director served during his or
her term of office. The Company Board has an Audit Committee and a Compensation
Committee, but does not have a Nominating Committee.
The Audit Committee currently consists of Andrew Rappaport, Randall
Strahan and Michael Solomon. Mr. Rappaport serves as Chairman of the Audit
Committee. The functions of the Audit Committee include recommending the
independent auditors to the Company Board, reviewing and approving the planned
scope of the annual audit, proposed fee arrangements and the results of the
annual audit, reviewing the adequacy of accounting and financial controls,
reviewing the independence of the independent auditors, approving all
assignments to be performed by the independent auditors, reviewing transactions
between the Company and its officers and directors and instructing the
independent auditors, as deemed appropriate, to undertake special assignments.
During the year 2000, the Audit Committee held five formal meetings. The Company
Board has adopted a written charter for the Audit Committee (the "Audit
Committee Charter"). The audit committee has reviewed and discussed audited
financial statements of the Company for the fiscal year ended December 31, 2000
with management. In addition, the audit committee has discussed with
PricewaterhouseCoopers, LLP, the Company's independent auditors, the matters
required to be discussed by Statement on Auditing Standards 61. The audit
committee also has received the written disclosures and the letter from
PricewaterhouseCoopers, LLP as required by Independence Standards Board Standard
No. 1 and the audit committee has discussed the independence of
PricewaterhouseCoopers, LLP with that firm.
Based on the audit committee's review of the matters noted above and its
discussions with the Company's independent auditors and the Company's
management, the audit committee recommended to the Board of Directors that the
financial statements be included in the Company's Annual Report on Form 10-K.
ITEM 11. EXECUTIVE COMPENSATION
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The following table provides certain summary information concerning the
compensation paid to or accrued by Telocity for the fiscal years ended December
31, 1998, and 1999, and 2000 for our Chief Executive Officer and our four other
most highly compensated officers whose compensation exceeded $100,000 for the
period (hereinafter referred to as the "Named Executive Officers"):
SUMMARY COMPENSATION TABLE
ANNUAL COMPENSATION LONG-TERM COMPENSATION
--------------------------------------------------- ---------------------------
OTHER
ANNUAL SECURITIES
NAME AND PRINCIPAL COMPENSATION UNDERLYING ALL OTHER
POSITION YEAR SALARY BONUS (1) OPTIONS COMPENSATION
- ---------------------------------- ---- --------- --------- ------------ ----------- ------------
Patti Hart(2) .................... 2000 $ 350,000 $ 65,962 0 200,000 0
President and Chief 1999 $ 140,000 0 $ 3,097 3,226,274 $ 150,000(3)
Executive Officer 1998 -- -- -- -- --
Peter Olson ...................... 2000 $ 280,000 $ 61,565 0 0 0
Executive Vice President 1999 $ 223,333 0 $ 9,961 7,714 0
and Chief Technical Officer 1998 $ 135,000 0 $ 7,485 82,286 0
Edward Hayes(4) .................. 2000 $ 284,114 $ 39,343 0 335,000 325,000(5)
Executive Vice President 1999 -- -- -- 370,000 --
and Chief Financial Officer 1998 -- -- -- -- --
Scott Martin(6) .................. 2000 $ 211,020 $ 32,517 0 25,000 150,000(7)
Executive Vice President 1999 $ 12,279 0 0 245,000 0
Chief Administrative 1998 -- -- -- -- --
Officer and
Corporate Secretary
Jim Morrissey(8) ................. 2000 $ 275,000 $ 60,465 0 0 $1,222,735(9)
Executive Vice President 1999 $ 77,211 0 $ 80,939(10) 800,000 $ 357,992(11)
and Chief Marketing Officer 1998 -- -- -- -- --
- ----------
(1) Includes only health insurance premiums paid by the Company unless
otherwise noted.
(2) Ms. Hart became an executive officer of the Company in June 1999.
(3) The Company paid Ms. Hart a $150,000 signing bonus pursuant to her
employment agreement.
(4) Mr. Hayes became an executive officer of the Company in January 2000.
(5) The Company paid Mr. Hayes a $325,000 signing bonus pursuant to his
employment agreement.
(6) Mr. Martin became an executive officer of the Company in December 1999.
(7) The Company paid Mr. Martin a $150,000 signing bonus pursuant to his
employment agreement.
(8) Mr. Morrissey became an executive officer of the Company in September
1999.
(9) Includes $666,667 in debt forgiveness and $16,068 for costs related to
housing and moving. Also includes $240,000 in contingent compensation
that Mr. Morrissey is required to repay to the Company if the Company's
stock is publicly traded at $20 or more per share on October 1, 2001, a
$150,000 bonus paid on January 1, 2000 pursuant to his offer letter and
a $150,000 bonus paid upon the consummation of the Company's initial
public offering pursuant to his offer letter.
(10) Includes $1,422 in health insurance premiums paid by the Company and
$79,517 in debt forgiveness pursuant to Mr. Morrissey's employment
agreement.
(11) Includes $147,992 payment for closing costs related to the sale of Mr.
Morrissey's house (which includes a $66,918 gross up component to cover
Mr. Morrissey's additional taxes) and $60,000 in contingent compensation
that Mr. Morrissey is required to repay to the Company in the event the
Company's stock is publicly traded at $20 or more per share on October
1, 2001. Also includes a $150,000 signing bonus paid to Mr. Morrissey
pursuant to his employment agreement.
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OPTION GRANTS IN 2000
The following table sets forth information concerning grants of stock
options to the Named Executive Officers who received stock options during 2000.
All options granted to the Named Executive Officers in the last fiscal year were
granted under the Telocity Delaware, Inc. 2000 Equity Incentive Plan (the
"Plan"). The percent of the total options set forth below is based on an
aggregate of 6,016,365 options granted to employees during the year ended
December 31, 2000.
STOCK OPTION GRANTS IN LAST FISCAL YEAR
% OF
TOTAL POTENTIAL REALIZABLE
OPTIONS VALUE AT ASSUMED ANNUAL
NUMBER OF GRANTED RATES OF STOCK PRICE
SECURITIES TO EXERCISE APPRECIATION FOR OPTION
UNDERLYING EMPLOYEES PRICE TERMS(3)
OPTIONS DURING PER EXPIRATION --------------------------
NAME GRANTED(1) PERIOD SHARE(2) DATE 5% 10%
- ----------------------- ---------- ---------- ---------- ------------ ---------- ----------
Patti Hart ............ 200,000 3.32% $ 5.56 6/21/10 $ 699,326 $1,772,194
Jim Morrissey ......... 0 -- -- -- -- --
Peter Olson ........... 0 -- -- -- -- --
Edward Hayes .......... 25,000 0.42% $ 12.00 3/28/10 $ 188,667 $ 478,110
160,000 2.66% $ 5.56 6/21/10 $ 559,461 $1,417,756
150,000 2.49% $ 3.28 9/29/10 $ 309,414 $ 784,100
Scott Martin .......... 25,000 0.42% $ 5.56 6/21/10 $ 87,471 $ 221,524
- ----------
(1) Generally, initial grants of options granted in 2000 under the Plan vest
according to the following schedule: 1/4 of the options vest on the first
anniversary of the date of grant and 1/48 of the options vest monthly
thereafter.
(2) All options were granted at an exercise price equal to the fair market
value of the common stock on the date of grant.
(3) Potential realizable value represents hypothetical gains that could be
achieved for the options if exercised at the end of the option term
assuming that the fair market value of the Company's common stock
appreciates at 5% and 10% over the option term of ten years based on
per-share market price at the time of grant and that the option is
exercised and sold on the last day of its option term for the appreciated
stock price. The assumed 5% and 10% rates of stock price appreciation are
provided in accordance with rules of the SEC and do not represent the
Company's estimate or projection of the Company's future common stock
price.
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AGGREGATE OPTION EXERCISES IN LAST FISCAL
YEAR AND FISCAL YEAR-END OPTION VALUES
OPTION EXERCISES IN 2000 AND VALUES AT DECEMBER 31, 2000
The following table provides information with respect to the Named
Executive Officers concerning the exercise of options during the last fiscal
year and unexercised options held as of the end of the fiscal year:
NUMBER OF SECURITIES
UNDERLYING UNEXERCISED
OPTIONS AT DECEMBER 31,
SHARES 2000
ACQUIRED ON VALUE -------------------------------
NAME EXERCISE REALIZED EXERCISABLE UNEXERCISABLE
- ---- ------------ -------- ----------- -------------
Patti Hart .............. 0 $ 0 200,000 0
Jim Morrissey ........... 0 0 0 0
Peter Olson ............. 0 0 0 0
Edward Hayes ............ 370,000(1) 0 705,000(1) 0
Scott Martin ............ 245,000(2) 0 270,000(2) 0
- ----------
(1) Mr. Hayes had exercised 370,000 options on January 5, 2000, however,
this exercise was rescinded on December 22, 2000 and the Shares are now
deemed exercisable options. See "Rescission Agreements."
(2) Mr. Martin had exercised 245,000 options on December 16, 1999, however,
this exercise was rescinded on December 22, 2000 and the Shares are now
deemed exercisable options. See "Rescission Agreements."
DIRECTOR COMPENSATION
All non-employee directors who commence service following the initial
public offering are granted an option to purchase 40,000 Shares on the date on
which they commence their board service. These Shares will vest and become
exercisable in four equal annual installments. The exercise price shall be the
closing price of the stock on the date of grant.
All non-employee directors who have served for at least six (6) months
prior to the Company's annual stockholder meeting will be granted an additional
option to purchase 10,000 Shares on the date of the annual meeting. These Shares
will vest and become exercisable in full on the day immediately preceding the
date of the next annual meeting. The exercise price shall be the closing price
of the stock on the date of grant.
Non-employee, non-affiliate directors shall receive an annual cash
retainer of $18,000 paid quarterly ($4,500 per quarter) at the end of each
quarter and an additional $5,000 paid quarterly ($1,250 per quarter) at the end
of each quarter for each committee on which such director serves. In lieu of a
quarterly cash payment, a director may elect to take such payment in the form of
stock or stock options. If a director elects to receive stock, the number of
Shares to be issued will be determined by dividing the payment to be received by
the closing price of the stock on the date of payment. If a director elects to
receive a stock option, the number of Shares subject to the option will be
determined by dividing the payment to be received by 50% of the closing price
and the exercise price of the option shall be 50% of the closing price.
Page 42
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REPORT OF THE COMPENSATION COMMITTEE ON EXECUTIVE COMPENSATION
The Compensation Committee currently consists of David Cowan and Michael
Solomon. Mr. Cowan serves as Chairman of the Compensation Committee. The
Compensation Committee reviews and recommends salaries, bonuses and other
compensation for the President and Chief Executive Officer Patti Hart, corporate
executive officers and other members of senior management. During the year 2000,
the Compensation Committee held three meetings.
Our Board established the Compensation Committee in December 1999. Prior
to establishing the Compensation Committee, the Board of Directors as a whole
performed the functions delegated to the Compensation Committee. No member of
the Compensation Committee has served as a member of the board of directors or
compensation committee of any entity that has one or more executive officers
serving as a member of our Board of Directors or Compensation Committee. Since
the formation of the Compensation Committee, none of its members has been an
officer or employee of Telocity.
SALARY
In particular, Ms. Hart's compensation as President and Chief Executive
Officer is based on compensation levels of President and Chief Executive
Officers of companies of comparable size. In addition, our compensation
committee considers certain incentive objectives based on Telocity's performance
as it relates to revenue levels and earnings per share levels.
In determining executive officers salaries, our compensation committee
reviews recommendations from Ms. Hart that include information from salary
surveys, performance evaluations, and the financial condition of Telocity. The
compensation committee also establishes both financial- and operational-based
objectives and goals in determining executive officer salaries. These goals and
objectives include sales and spending forecasts for the upcoming year and
published executive compensation literature for companies of comparable size.
For more information regarding the compensation and employment
arrangements of Ms. Hart and other executive officers, see "EXECUTIVE
COMPENSATION."
BONUSES
Our compensation committee administered a bonus plan for executives in
2000. Awards under this bonus plan were contingent upon Telocity's attainment of
EBITDA and subscriber targets, set by the compensation committee in consultation
with our Chief Executive Officer. Additionally, awards may be weighted so that
executives would receive proportionately higher awards when our performance
reaches maximum targets, proportionately smaller awards when our performance
reaches minimum targets, and no awards when we do not meet minimum performance
targets.
STOCK OPTIONS
The compensation committee believes that employee equity ownership
provides significant motivation to executive officers to maximize value for our
stockholders and, therefore, periodically grants stock options under our stock
option plan. Stock options are granted at the current market price and will only
have value if our stock price increases over the exercise price.
The compensation committee determines the size and frequency of option
grants for executive officers, after consideration of recommendations from the
Chief Executive Officer. Recommendations for options are based upon the relative
position and responsibilities of each executive officer, previous and expected
contributions of each officer to Telocity, and previous option grants to such
executive officers. Generally, option grants vest 25% twelve months after
commencement of employment or after the date of grant and continue to vest
thereafter in equal monthly installments over three years, conditioned upon
continued employment.
/s/ DAVID COWAN
-----------------------------
/s/ MICHAEL SOLOMON
-----------------------------
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45
Comparison of Five - Year Cumulative Total Returns
Performance Graph for
TELOCITY, INC.
Produced on 02/23/2001 including data to 12/29/2000
[PERFORMANCE GRAPH]
03/2000 06/2000 12/2000
------- ------- -------
TELOCITY, INC. 100.0 34.4 15.1
Nasdaq Stock Market (US Companies) 100.0 85.7 52.8
Nasdaq Stocks (SIC 4810-4819 US companies) 100.0 82.1 34.0
Telephone Communications
NOTES:
A. The lines represent monthly index levels derived from compounded daily
returns that include all dividends.
B. The indexes are reweighted daily, using the market capitalization on the
previous trading day.
C. If the monthly interval, based on the fiscal year-end, is not a trading
day, the preceding trading day is used.
D. The index level for all series was set to $100.00 on 03/29/2000.
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ITEM 12: SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
BENEFICIAL OWNERSHIP
The following table sets forth information known to us with respect to
the beneficial ownership of our common stock as of December 31, 2000, by the
following:
- each stockholder known by us to own beneficially more than 5% of our
common stock;
- each of our executive officers named in the compensation table in
the section entitled "Executive Compensation;"
- each of our directors; and
- all directors and executive officers as a group.
The address for those individuals for which an address is not otherwise
indicated is 10355 North De Anza Boulevard, Cupertino, California 95014.
The number of Shares beneficially owned and the percent of shares
outstanding are based on (a) 81,623,140 shares outstanding as of December 31,
2000. Beneficial ownership is determined in accordance with the rules of the SEC
and generally includes voting or investment power with respect to securities.
All Shares subject to options exercisable within 60 days following December 31,
2000 are deemed to be outstanding and beneficially owned by the person holding
those options for the purpose of computing the number of Shares beneficially
owned and the percent of ownership of that person. They are not, however, deemed
to be outstanding and beneficially owned for the purpose of computing the
percent ownership of any other person. Except as indicated in the other
footnotes to the table and subject to applicable community property laws, based
on information provided by the persons named in the table, these persons have
sole voting and investment power with respect to all Shares shown as
beneficially owned by them.
SHARES
SUBJECT TO
SHARES PERCENT OF RIGHT OF
BENEFICIALLY SHARES REPURCHASE AS
NAME OR GROUP OF BENEFICIAL OWNERS OWNED OUTSTANDING OF 12/31/00
- ----------------------------------------------- ------------ ----------- -------------
DIRECTORS AND EXECUTIVE OFFICERS
David Cowan ................................... 9,050,088(1) 11.12% --
Bessemer Ventures Partners
535 Middlefield Road, Suite 245
Menlo Park, California 94025
Patti Hart .................................... 3,577,137 4.40% 2,016,421
Christie Hefner ............................... 0 * --
Peter Olson ................................... 2,500,065 3.07% --
Andrew Rappaport .............................. 15,026,102(2) 18.50% --
August Capital
2480 Sand Hill Road, Suite 101
Menlo Park, California 94025
James Scheinman ............................... 6,382,632(3) 7.75% --
NBC Internet, Inc.
225 Bush Street
San Francisco, California 94104
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47
SHARES
SUBJECT TO
SHARES PERCENT OF RIGHT OF
BENEFICIALLY SHARES REPURCHASE AS
NAME OR GROUP OF BENEFICIAL OWNERS OWNED OUTSTANDING OF 12/31/00
- ----------------------------------------------- ------------ ----------- -------------
Elisabeth Sami .................................. 8,779,198(4) 10.65% --
National Broadcasting Company, Inc.
30 Rockefeller Plaza
New York, NY 10112
Michael Solomon ................................. 8,538,355(5) 10.49% 72,844
Mohr, Davidow Ventures
2775 Sand Hill Road
Menlo Park, California 94025
Randall Strahan ................................. 311,500(6) * --
Mohr, Davidow Ventures
2775 Sand Hill Road
Menlo Park, California 94025
Scott Martin .................................... 246,167(7) * --
Edward Hayes .................................... 371,167(8) * --
Jim Morrissey ................................... 800,000 * 533,334
All directors and officers as a group
(Twelve persons)(12) ........................ 55,582,411(9) 68.10% 2,622,599
5% STOCKHOLDERS:
Entities affiliated with August Capital, L.P. ... 15,026,102(2) 17.76% --
2480 Sand Hill Road, Suite 101
Menlo Park, California 94025
NBC Internet, Inc. .............................. 6,382,632(3) 7.75% --
225 Bush Street
San Francisco, California 94104
Entities affiliated with National Broadcasting
Company, Inc. ............................... 8,779,198(4) 10.65% --
30 Rockefeller Plaza
New York, NY 10112
Entities affiliated with Bessemer Venture
Partners .................................... 9,050,088(1) 11.12% --
1400 Old Country Road, Suite 407
Westbury, New York 11590
Entities affiliated with Mohr, Davidow Ventures.. 8,849,855(10) 10.87% 72,844
2775 Sand Hill Road
Menlo Park, California 94025
- ----------
* Represents less than 1%
(1) Includes:
- 5,043,123 shares held by Bessemer Venture Partners IV L.P.;
- 3,246,997 shares held by Bessec Ventures IV L.P.; and
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48
- 759,968 shares held by Bessemer Venture Investors L.P.
The general partner of Bessemer Venture Partners IV L.P. is David Cowan.
In this capacity, Mr. Cowan, through an executive committee, exercises sole
voting and investment power with respect to all shares held of record by the
named investment partnerships; individually, no stockholder, director or officer
of Bessemer Venture Partners IV L.P. has or shares such voting or investment
power. Mr. Cowan disclaims beneficial ownership of shares held by these entities
except to the extent of his pecuniary interest in these entities.
(2) Includes:
- 12,130,253 shares held by August Capital, L.P.;
- 399,980 shares held by August Capital Strategic Partners, L.P.;
- 587,472 shares held by August Capital Associates, L.P.; and
- 1,908,397 shares held by August Capital II, L.P.
The general partner of August Capital L.P. is Andrew Rappaport. In this
capacity, Mr. Rappaport, through an executive committee, exercises sole voting
and investment power with respect to all shares held of record by the named
investment partnerships; individually, no stockholder, director or officer of
August Capital L.P. has or shares such voting or investment power. Mr. Rappaport
disclaims beneficial ownership of shares held by these entities except to the
extent of his pecuniary interest in these entities.
(3) Includes 5,343,510 shares held by NBC Internet, Inc. Also includes warrants
to purchase 1,039,122 shares subject to a warrant exercisable within 60
days of December 31, 2000. James Scheinman disclaims beneficial ownership
of these shares except to the extent of his pecuniary interest in NBC
Internet, Inc.
(4) Includes:
- 6,679,389 shares held by NBC-TLCT Holding, Inc. and
- 1,049,618 shares held by GE Capital Equity Investments, Inc.
Also includes warrants to purchase 850,191 Shares held by NBC-TLCT
Holding, Inc., all of which are exercisable at $5.24 per share and warrants to
purchase 200,000 Shares held by General Electric Company, all of which are
exercisable at $12.00 per share. Elisabeth Sami disclaims beneficial ownership
of these shares except to the extent of her pecuniary interest in National
Broadcasting Company, Inc.
(5) Includes 4,582,235 shares held by Mohr, Davidow Ventures V, L.P., 344,900
Shares held by Mohr, Davidow Ventures V, L.P. as nominee for MDV
Entrepreneurs' Network Fund II (A), L.P. and MDV Entrepreneurs' Network
Fund II (B), L.P. and 1,717,558 Shares held by Mohr, Davidow Ventures V-L,
L.P.
Mr. Solomon is a member of Fifth MDV Partners, the General Partner of
Mohr, Davidow Ventures V, L.P. In this capacity, Mr. Solomon, through an
executive committee, exercises sole voting and investment power with respect to
all shares held of record by the named investment partnerships; individually, no
stockholder, director or officer of Mohr Davidow Ventures V, L.P. has or shares
such voting or investment power. Mr. Solomon disclaims beneficial ownership of
shares held by these entities except to the extent of his pecuniary interest
therein. In addition to the 6,644,693 Shares held by the entities affiliated
with Mohr, Davidow Ventures, Mr. Solomon owns 1,893,662 shares in his own name
which includes 72,844 shares subject to the Company's right of repurchase as of
January 3, 2001, which lapses over time so long as Mr. Solomon continues to
serve as an advisor to us.
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49
(6) Includes 50,000 shares subject to options exercisable within 60 days of
December 31, 2000. These options had been exercised on March 14, 2000,
however, this exercise was rescinded on December 22, 2000, and the shares
are now deemed exercisable options (see section entitled "Rescission
Agreements").
(7) Represents 245,000 shares subject to options exercisable within 60 days of
December 31, 2000. These options had been exercised on December 16, 1999,
however, this exercise was rescinded on December 22, 2000, and the shares
are now deemed exercisable options.
(8) Includes 370,000 shares subject to options exercisable within 60 days of
December 31, 2000. These options had been exercised on January 5, 2000,
however, this exercise was rescinded on December 22, 2000, and the shares
are now considered exercisable options.
(9) Includes the shares beneficially owned by the all directors and named
executive officers.
(10) Includes:
- 4,582,235 shares held by Mohr, Davidow Ventures V, L.P.;
- 344,900 shares held by Mohr, Davidow Ventures V, L.P. as nominee for
MDV Entrepreneurs' Network Fund II (A), L.P. and MDV Entrepreneurs'
Network Fund II (B), L.P.; and
- 1,717,558 Shares held by Mohr, Davidow Ventures V-L, L.P.
Also includes 1,893,662 shares beneficially owned by Mr. Solomon
personally and 311,500 shares beneficially owned by Mr. Strahan personally.
AGREEMENTS CONCERNING CHANGE OF CONTROL
MERGER AGREEMENT
On December 21, 2000, we entered into a Merger Agreement with Hughes
Electronics Corporation and its wholly-owned subsidiary DIRECTV Broadband, Inc.
(the "Merger Agreement") pursuant to which: (i) Hughes shall commence an offer
to purchase all outstanding Shares, of the Company at a price of $2.15 per
Share, net to the seller in cash (the "Offer") without interest; and (ii)
following the successful completion of the offer, upon approval by a stockholder
vote, if required, and subject to certain other conditions, Hughes will be
merged with and into the Company, with the Company continuing as the surviving
corporation and a wholly owned subsidiary of Hughes.
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50
TENDER AGREEMENTS WITH CERTAIN OFFICERS, DIRECTORS AND OTHER STOCKHOLDERS
In connection with the Merger Agreement, Hughes, DIRECTV Broadband, Inc.
and the stockholders identified in the chart below have entered into a Tender
and Stockholder Support Agreement (the "Tender Agreement"), dated December 21,
2000, pursuant to which the stockholders identified below have (i) agreed to
tender and sell their Shares to the Purchaser pursuant to the Offer, (ii) agreed
not to withdraw any shares tendered in the Offer, (iii) agreed to vote such
Shares in favor of the Merger and the Merger Agreement and against any
acquisition proposal other than the Merger and (iv) granted to Hughes and
certain officers of Hughes an irrevocable proxy to vote such Shares in favor of
the transactions contemplated by the Merger Agreement.
SHARES OF
NAME AND ADDRESS COMMON STOCK
- ---------------- ------------
Entities affiliated with August Capital........................ 15,026,102
Entities affiliated with Bessemer Ventures Partners............ 9,050,088
Entities affiliated with Mohr, Davidow Ventures................ 8,799,855
NBC Internet, Inc. ............................................ 5,343,511
NBC-TLCT Holding, Inc. ........................................ 6,679,389
Kevin Grundy................................................... 1,619,075
Edward Hayes................................................... 1,167
Patti Hart..................................................... 3,577,137
Christie Hefner................................................ 0
Scott Martin................................................... 1,167
Thomas Obenhuber............................................... 1,505,467
Peter Olson.................................................... 2,500,065
Matthew Stepovich.............................................. 1,056,184
See also "Employment Agreements" as described in Item 11 above.
EMPLOYMENT AGREEMENTS WITH CHANGE OF CONTROL PROVISIONS
Unless otherwise specified below, for purposes of the our employment
agreements with our executive officers, a "change of control" or "ownership
change event" is defined as and shall be deemed to have occurred if any of the
following occur: (i) the direct or indirect sale or exchange in a single or
series of related transactions by the stockholders of Telocity of more than
fifty percent of the voting stock of the Company; (ii) a merger or consolidation
in which Telocity is a party; (iii) the sale, exchange, or transfer of all or
substantially all of the assets of the Company; or (iv) a liquidation or
dissolution of the Company.
Whenever the term "for cause" or "good reason" is used below, it means
"for cause" or "good reason," respectively as defined in that individual's
employment agreement.
On May 5, 1999, we entered into an at will employment agreement with
Patti Hart, President and Chief Executive Officer of Telocity, pursuant to
which Ms. Hart received a salary of $300,000 per year. Ms. Hart's salary as of
December 31, 2000 was $400,000 per year. Ms. Hart also received a signing bonus
of $150,000 and a bonus of $100,000 at the end of her first year of service as
our Chief Executive Officer. After two years of service as our Chief Executive
Officer and for each year of employment after that, Ms. Hart is eligible under
her agreement to earn a performance bonus in accordance with a performance bonus
plan. The agreement also provides for a stock option grant for the purchase of
up to 3,226,274 shares of our common stock. Ms. Hart exercised this option in
full on June 22, 1999, at an exercise price of $0.35 per share. The shares
obtained upon exercise of the option are subject to the Company's right of
repurchase, which lapses as the shares vest at a rate of 1/48 per month of
employment. If Ms. Hart is terminated other than for cause or she resigns for
good reason sixty days prior to or within twelve months following an ownership
change event, Ms. Hart is entitled to (i) a lump sum payment of twelve months
salary, (ii) a lump sum payment of her target annual performance bonus for the
term in which her employment is terminated, (iii) continued benefits for twelve
months, and (iv) vesting of one half of any unvested shares. If we terminate Ms.
Hart's employment without cause absent a change of control, Ms. Hart is entitled
to (i) continued payment of her
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salary for twelve months following her termination, (ii) a pro rata portion of
her target performance bonus for the year, and (iii) twelve months vesting of
any unvested shares.
Effective January 1, 1998, we entered into at will employment agreements
with Peter Olson and Thomas Obenhuber under which they were to receive salaries
of $180,000 and $120,000 per year, respectively; their salaries as of December
31, 2000 were $280,000 and $225,000 per year, respectively. In addition, under
their agreements, Messrs. Olson and Obenhuber are each eligible for a
performance bonus for each year of employment based upon the achievement of
performance objectives. The amount of these bonuses is to be negotiated
annually. If Messrs. Olson or Obenhuber are terminated without cause or if any
of them resign for good reason, the individual so terminated will receive his
compensation, including pro-rated bonuses, and benefits for three months
following termination, plus continued vesting of shares for six months.
Effective February 25, 1998, we entered into an employment agreement with Kevin
Grundy containing the same material terms, except that Mr. Grundy was to receive
a salary of $120,000 per year. Mr. Grundy's current salary is $225,000.
On December 3, 1999, we entered into an at will employment agreement
with Edward Hayes, Executive Vice President and Chief Financial Officer of
Telocity, which was subsequently amended on November 29, 2000 and December 17,
2000. Pursuant to the agreement as amended, Mr. Hayes receives a salary of
$250,000 per year. Mr. Hayes also received a signing bonus of $325,000 and he is
eligible to participate in our bonus program. The agreement also provides for a
stock option grant for the purchase of up to 370,000 shares of our common stock.
Mr. Hayes exercised this option in full on January 5, 2000, at an exercise price
of $3.00 per share. On December 22, 2000, Mr. Hayes rescinded the exercise of
these options pursuant to an Option Exercise and Note Rescission Agreement with
the Company. The shares subject to the option grant vest 1/4 after 12 months of
employment, and an additional 1/48 per month of employment thereafter. If Mr.
Hayes is terminated without cause or he resigns for good reason, we will pay him
a lump sum severance payment equal to 12 months of salary and target incentive
bonus, remove any vesting cliff and immediately vest the greater of 75% of his
unvested stock options or an amount equivalent to an additional six months of
vesting. Mr. Hayes' agreement also provides that in consideration for devoting
his full energies to the Company and foregoing the consideration of other market
opportunities, provided he is not terminated for cause, resigns other than for
good reason, or seeks alternate employment prior to such date, he will be
entitled to a retention bonus of $750,000 on the earlier of (i) the date he is
terminated by the Company without cause, (ii) the date he resigns for good
reason, or (iii) April 1, 2001.
On September 14, 1999, we entered into an at will employment agreement
with Jim Morrissey, Executive Vice President and Chief Marketing Officer of
Telocity, under which Mr. Morrissey receives a salary of $275,000 per year. Mr.
Morrissey also received a signing bonus of $150,000. On January 4, 2000, Mr.
Morrissey received an additional bonus of $150,000 as required by his employment
agreement for meeting certain objectives mutually agreed upon by Mr. Morrissey
and Telocity. Upon our initial public offering, Mr. Morrissey received a bonus
of $150,000 based upon certain objectives. In the event of certain payments
under his agreement, Mr. Morrissey is entitled to receive gross up payments. The
agreement also provides for a stock option grant for the purchase of up to
800,000 shares of the Company's common stock, which Mr. Morrissey exercised in
full on September 14, 1999, at a an exercise price of $0.75 per share. The
shares obtained upon exercise of the option are subject to the Company's right
of repurchase, which lapses at a rate of 1/4 after one year of employment, and
an additional 1/48 per month of employment thereafter. In order to leave his
previous employment, Mr. Morrissey was required to make payments to his former
employer. To facilitate his departure, we loaned Mr. Morrissey $2 million as
follows: on December 6, 1999, we provided Mr. Morrissey with a $900,000 loan;
and on January 5, 2000, we provided Mr. Morrissey with a $1,100,000 loan, the
principal and interest on both loans will be forgiven by Telocity at a rate of
1/36 per month over three years beginning on September 20, 1999 and January 1,
2000, respectively. Upon Mr. Morrissey's termination for cause or his voluntary
resignation other than for good reason, the loans become due within 90 days.
Pursuant to Mr. Morrissey's agreement, the Company provides Mr. Morrissey with a
monthly housing allowance of $20,000 for 24 months beginning on October 1, 1999.
If the Company's stock trades at $20 or more per share on October 1, 2001, then
Mr. Morrissey will be required to repay the allowance; otherwise, the Company
will forgive the entire housing allowance. If Mr. Morrissey is terminated
without cause or he resigns with good reason, he will receive his base salary
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for one year, continued payment of his housing allowance for one year, discharge
of any of his obligations to repay loans or his housing allowance to us, and
removal of any vesting cliff plus six months acceleration of his option vesting.
Upon a change of control, Mr. Morrissey will vest the greater of one half of his
unvested shares subject to the stock option or an amount equivalent to an
additional six months vesting.
On December 8, 1999, we entered into an at will employment agreement
with Scott Martin, Executive Vice President, Chief Administrative Officer and
Corporate Secretary of the Company, pursuant to which Mr. Martin received a
salary of $190,000 per year. Mr. Martin's salary as of December 31, 2000 was
$200,000 per year. Mr. Martin also received a signing bonus of $150,000. The
agreement also provides for a stock option grant for the purchase of up to
245,000 shares of the Company's common stock. Mr. Martin exercised the option in
full on December 16, 1999, at a price of $3.00 per share. Mr. Martin
subsequently rescinded the exercise of these options pursuant to an Option
Exercise and Note Rescission Agreement with the Company. The shares subject to
the option grant vest 1/8 after six months of employment, and an additional 1/48
per month of employment thereafter. If Mr. Martin is terminated without cause,
or he resigns for good reason, one month prior to or within one year after a
change of control, the Company will continue to pay Mr. Martin his base salary
for six months, remove any vesting cliff and immediately vest one half of his
unvested stock options. If Mr. Martin is terminated without cause or he resigns
for good reason absent a change in control, the Company will remove any vesting
cliff, pay Mr. Martin a lump sum of $150,000 and make continued medical and
dental benefits to Mr. Martin for six months.
On September 13, 1999, we entered into an at will employment agreement
with Regina Wiedemann, Senior Vice President, Business Development of the
Company, pursuant to which Ms. Wiedemann received a salary of $140,000 per year.
Ms. Wiedemann's salary as of December 31, 2000 was $220,000. The agreement also
provides for a stock option grant for the purchase of up to 240,000 shares of
the Company's common stock. Ms. Wiedemann exercised the option in full on
October 26, 1999 at a price of $1.50 per share. The shares obtained upon
exercise of the option are subject to the Company's right of repurchase which
lapses 1/8 after six months of employment, and an additional 1/48 per month of
employment thereafter. If, following a change of control, Ms. Wiedemann is
terminated or she resigns for good cause, Ms. Wiedemann shall receive an
additional six months of salary, benefits and vesting.
On July 14, 2000, we entered into an at will employment agreement with
David Finley, Chief Operating Officer of Telocity, which was subsequently
amended on November 29, 2000 and December 17, 2000. Pursuant to the agreement as
amended, Mr. Finley receives a salary of $280,000 per year. Mr. Finley also
received a signing bonus of $150,000. If Mr. Finley voluntarily resigns his
employment without good reason before the first anniversary of his commencement
of employment, he shall repay a pro rata share of the signing bonus based on the
time remaining in his first year of service. The agreement also provides for a
stock option grant for the purchase of up to 500,000 shares of the Company's
common stock at a price of $3.28 per share. The shares subject to the option
grant vest 1/4 after 12 months of employment, and an additional 1/48 per month
of employment thereafter. Under Mr. Finley's agreement, we extended to Mr.
Finley a full recourse promissory note in an amount not to exceed $400,000 in
connection with his purchase of a home. The promissory note is secured by a
second lien on Mr. Finley's home and accrues interest at a rate of 8% per annum.
Interest accrues quarterly to principal, and principal plus all accrued interest
on the note is due and payable upon the first to occur of (i) 60 months from the
commencement of his employment with the Company, (ii) 12 months following
termination of Mr. Finley's employment with the Company and (iii) upon Mr.
Finley's sale or transfer of 100,000 shares of the Company's stock. Mr. Finley's
agreement provides that if he is terminated without cause or resigns for good
reason absent a change of control, he will receive (i) a lump sum payment equal
to 50% of his annual salary, (ii) 12 equal payments thereafter of the remaining
50% of his annual salary, (iii) a lump sum payment of his then current annual
target bonus, (iv) reimbursement for the cost of continuing his medical coverage
for himself and any eligible dependents under COBRA for one year following the
date of his termination or resignation, and (v) vesting of 50% of any remaining
unvested shares. Mr. Finley's agreement also provides that if Mr. Finley is
terminated without cause or resigns for good reason within one year of a change
of control, he will receive (i) a lump sum payment equal to 50% of his annual
salary, (ii) 12 equal payments thereafter of the remaining 50% of his annual
salary, (iii) a lump sum payment of his then current annual target bonus, (iv)
reimbursement for the cost of continuing his medical coverage for himself and
any eligible dependents under COBRA for one year following the date of his
termination or
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resignation, and (v) the equivalent of vesting of 36 months of any unvested
stock options if his termination or resignation occurs prior to the one year
anniversary of his commencement of employment with the Company or, if he is
terminated or resigns after the one year anniversary of his commencement of
employment with the Company, vesting of 75% of any unvested stock options. Mr.
Finley's agreement also provides that in consideration for devoting his full
energies to the Company and foregoing the consideration of other marketing
opportunities, provided he is not terminated for cause, resigns other than for
good reason, or seeks alternate employment prior to such date, he will be
entitled to a retention bonus of $750,000 on the earlier of (i) the date he is
terminated by the Company without cause, (ii) the date he resigns for good
reason or (iii) April 1, 2001.
On December 10, 1999, we entered into an employment agreement with Vicki
Foshee, Senior Vice President, Service Delivery and Support of Telocity,
pursuant to which she was to receive an annual salary of $150,000. Ms. Foshee's
salary as of December 31, 2000 was $190,000. Ms. Foshee also received a signing
bonus of $20,000. The agreement also provides for a stock option grant on
December 15, 1999, for the purchase up to 85,000 shares of the Company's common
stock. Ms. Foshee exercised the option in full on January 18, 2000. On December
26, 2000 Ms. Foshee rescinded the exercise of these options pursuant to an
Option Exercise and Note Rescission Agreement with the Company. The agreement
also provides for a stock option grant on May 24, 2000, for the purchase of up
to an additional 100,000 shares of the Company's common stock at an exercise
price of $5.50 per share. The shares subject to the option grants vest 1/8 after
six months of employment, and an additional 1/42 per month of employment
thereafter. On October 10, 2000, the Company entered into an amendment to Ms.
Foshee's employment agreement which provides that in the event Ms. Foshee is
terminated without cause or resigns for good reason within one year after a
change of control, she is entitled to (i) a waiver of the 6 month vesting cliff
applicable to each of the option grants, (ii) six months acceleration per option
grant, or an amount of acceleration that would bring her to 50% vesting in each
of her option grants, which ever is greater, and (iii) six months continued
salary and benefits.
On January 24, 2000, we entered an employment agreement with David
Wilson, Vice President, Financial Services of Telocity, pursuant to which Mr.
Wilson receives an annual salary of $150,000. The agreement also provides for a
stock option grant for the purchase of up to 100,000 shares of the Company's
common stock, Mr. Wilson exercised the option in full on February 24, 2000 at an
exercise price of $9.00 per share. On December 27, 2000, Mr. Wilson subsequently
rescinded the exercise of these options pursuant to an Option Exercise and Note
Rescission Agreement with the Company. The shares subject to the option grant
vest 1/4 after twelve months of employment, and an additional 1/30 per month
thereafter. Mr. Wilson's agreement provides that if Mr. Wilson is terminated
without cause or resigns for good reason, he is entitled to a lump sum cash
payment equal to three months of his then-existing salary.
On August 16, 2000, we entered into an employment agreement with Robert
Sandor, Senior Vice President, Operations of Telocity, pursuant to which Mr.
Sandor receives an annual salary of $200,012.04. The agreement also provides for
a performance bonus of $33,000 upon the completion of certain objectives. The
agreement provides for a stock option grant for the purchase of up to 130,000
shares of the Company's common stock, and an additional 25,000 shares upon
successful completion of the bonus objectives. The shares subject to the option
grants vest 1/4 after one year of employment, and an additional 1/36 per month
of employment thereafter. Mr. Sandor's agreement also provides that if he is
terminated without cause or resigns for good reason within one year after a
change of control, he is entitled to (i) a waiver of the one year vesting cliff,
(ii) six months acceleration per grant, or an amount of acceleration that would
bring him to 50% vesting, which ever is greater, and (iii) six months continued
salary and benefits.
FOUNDER STOCK PURCHASE AND REPURCHASE AGREEMENTS
On December 23, 1997, we entered into Founder Stock Purchase Agreements
with Peter Olson, Michael Solomon and Thomas Obenhuber (the "December 23, 1997
Agreements"), pursuant to which Mr. Olson, Mr. Solomon and Mr. Obenhuber
purchased 4,662,000, 1,554,000 and 480,000 shares, respectively at a price of
$0.0005 per share. The shares are subject to the Company's right of repurchase
which lapsed 11/32 on October 3, 1997 for Messrs. Olson and Solomon, and 1/8 on
February 3, 1998 for Mr. Obenhuber.
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The remaining shares vest at a rate of 1/42 per month. The Company's option to
repurchase the unvested shares terminates upon a change of control, as defined
and set forth in the December 23, 1997 Agreements. The December 23, 1997
Agreements give us a right of first refusal before a founder may transfer or
sell any of their shares. The December 23, 1997 Agreements also provide each
founder piggyback registration rights as set forth in the agreements.
In order to reallocate its founders' stock, we entered into agreements
to repurchase certain founder's shares. On June 1, 1998, the Company entered
into Founder Stock Repurchase Agreements with Mr. Olson and Mr. Solomon to
repurchase 2,662,000 shares of the Company's common stock from Mr. Olson at a
price of $0.0005 per share, and 154,000 shares of the Company's common stock
from Mr. Solomon at a price of $0.0005 per share. On June 10, 1998, the Company
entered into supplemental Founder Stock Purchase Agreements (the "June 10, 1998
Agreements") with Mr. Obenhuber and Kevin Grundy pursuant to which Mr. Obenhuber
and Mr. Grundy purchased 1,120,000 and 1,600,000 shares, respectively at a price
of $0.005 per share. The shares purchased pursuant to the June 10, 1998
Agreements are subject to our right of repurchase which lapsed 7/48 on December
3, 1997 and 1/42 per month thereafter. Our option to repurchase the unvested
shares terminates upon the occurrence of certain events within one year of a
change of control, as defined in the June 10, 1998 Agreements. The June 10, 1998
Agreements give the Company a right of first refusal before a founder may
transfer or sell any of his shares.
With respect to the June 10, 1998 Agreements, our right to repurchase
unvested options terminates if within one year of the change of control (as
defined in the December 23, 1997 Agreements): (i) there is a decrease in the
employee's base salary, benefits and/or bonus compensation, (ii) there is a
material breach by us of the June 10, 1998 Agreement or the applicable founder's
employment agreement or (iii) we fail to obtain the assumption of the June 10,
1998 Agreement or the applicable founder's employment agreement by our successor
or assign.
With respect to the December 23, 1997 Agreements, a change of control
shall be deemed to have occurred and our right to repurchase unvested options
terminates, upon any of the following events: (i) the direct or indirect sale or
exchange by our stockholders of all or substantially all of the stock of the
Company where the stockholders of the Company before such sale or exchange do
not retain, directly or indirectly, at least a majority of the beneficial
interest in our voting stock; (ii) a merger in which our stockholders before the
merger do not retain, directly or indirectly, at least a majority of the
beneficial interest in our voting stock of; or (iii) the sale, exchange, or
transfer of all or substantially all of our assets (other than a sale, exchange,
or transfer to one or more corporations where our stockholders before such sale,
exchange, or transfer retain, directly or indirectly, at least a majority of the
beneficial interest in the voting stock of the corporation(s) to which the
assets were transferred).
AMENDMENT AGREEMENT WITH NBCI
On December 21, 2000, we entered into an Amendment Agreement (the
"Amendment") with NBC Internet, Inc. ("NBCi") pursuant to which the parties
agreed to terminate the NBCi/Telocity Operating Agreement dated December 10,
1999 (the "Operating Agreement") and concurrently amended the Advertising
Agreement dated December 14, 1999 by and between us and NBCi (the "Advertising
Agreement"). The Amendment provides, among other things, that upon the
consummation of the Merger, the Operating Agreement will terminate, provided
that, however, certain provisions of the Operating Agreement will survive. The
Advertising Agreement was amended to include an additional $3.6 million in
online, television and radio advertising through December 31, 2002. The
Amendment also requires that we conduct good faith discussions with NBCi
regarding the possibility of an ongoing commercial relationship.
WAIVER BY NBCI OF RIGHT OF FIRST NEGOTIATION
On December 14, 2000, we entered into a letter agreement whereby NBCi
agreed to waive its right of first negotiation as set forth in the Second
Amended and Restated Investor Rights Agreement dated December 13, 1999 by and
among us and certain of our stockholders (the "Rights Agreement"). The
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waiver is conditioned upon the execution of the Merger Agreement and the closing
of the Merger on or before June 1, 2001 at a per share price of not less than
$2.00 per share.
NBC AMENDMENT AND WAIVER
On December 20, 2000, we, together with National Broadcasting Company
("NBC"), entered into an amendment to the Advertising Agreement dated December
13, 1999 by and among us and certain of its stockholders including NBC (the "NBC
Amendment"). The NBC Amendment amends the Advertising Agreement to include an
additional advertising expenditure of $3.0 million by Telocity through July
2002. The NBC Amendment further provides that the advertising spots provided by
NBC between the fourth quarter of 2000 and June 14, 2002 will be broadcast
according to a certain schedule. The NBC Amendment is executed by DIRECTV, Inc.,
a subsidiary of HUGHES, as a third-party beneficiary. In addition, the NBC
Amendment also waives NBC's right of first negotiation as set forth in the
Rights Agreement.
ITEM 13: CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
RESCISSION AGREEMENTS
Prior to our initial public offering, our stock option plans permitted
employees to exercise their stock options by issuing a full recourse promissory
note to us, secured by the stock obtained upon exercise of the option. This
provision in our stock option plans was designed to allow employees to obtain
shares when the exercise price equaled the then-current fair market value. From
adoption of our first stock option plan until the date of the our initial public
offering, most of our employees who received stock options exercised them
through the issuance of promissory notes. Due to the decline in our share price
in recent months, in December 2000 the principal amounts of many outstanding
promissory notes were greater than the value of the respective shares of stock
securing such notes (the "Underwater Notes"). As a result of the large number of
employees with outstanding Underwater Notes, many with significant outstanding
principal amounts, employee morale was threatened. In addition, we had received
several threats of litigation by current and former employees challenging the
Underwater Notes.
Under the Merger Agreement, it is a condition to the closing of the
Offer that prior to December 31, 2000, we enter into rescission agreements with,
and obtain releases from, holders of at least 80% of the aggregate outstanding
principal amount of all Underwater Notes issued during 2000 (the "2000
Promissory Notes"). In addition, it is a condition of the Merger that we enter
into rescission agreements and releases with all other persons holding
Underwater Notes prior to the closing of the Merger. On December 20, 2000, in
connection with, and conditioned on, the approval of the Merger Agreement, after
considering the reasons for the transaction with HUGHES, and determining that
the rescission complied with the requirements of Delaware law, our Board of
Directors approved the rescission of the option exercises and transactions in
which Underwater Notes were issued.
On December 21, 2000, the date of the Merger Agreement, the aggregate
outstanding principal amount of the 2000 Promissory Notes was $12,033,540.
Between the date the Merger Agreement was executed and December 31, 2000, the
Company entered into Option Exercise and Note Rescission Agreements (the
"Rescission Agreements") and Mutual Releases (the "Releases"), with 64 persons
representing $11,954,640 in aggregate outstanding principal amount under the
2000 Promissory Notes (or 99.3% of the total aggregate outstanding principal
amount under the 2000 Promissory Notes). Accordingly, the condition in the
Merger Agreement relating to the rescission of the Underwater Notes and
associated option exercises has been satisfied. The net result of the rescission
is that employees hold options at the original exercise price. No cash exchanged
hands in connection with the original option exercise or at the rescission.
Each Rescission Agreement provides for the rescission of the note
maker's option exercise and promissory note, the cancellation and re-conveyance
of the promissory note to such note maker and the tender of the shares issued
upon exercise of such note maker's option to us. The Release provides that we
and the note maker each release and discharge any and all claims they may have
against each other. As of
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January 31, 2001, we had entered into Rescission Agreements and Releases with 73
people representing 100% of the total $12,033,540 in outstanding principal
amount under the Underwater Notes.
The following of our director and executive officers entered into a
Rescission Agreement and Release with us providing for the rescission of his or
her option exercise and promissory note, the cancellation and re-conveyance of
his or her promissory note and the tender to us of the shares issued upon
exercise of his or her option:
PRINCIPAL
OPTION AMOUNT OF
EXERCISE SHARES NOTE
NAME & TITLE PRICE RESCINDED RESCINDED
------------ -------- ---------- ----------
Randall Strahan ............................ $12.00 50,000 $ 600,000
Director
Kevin Grundy ............................... $ 9.00 150,000 $1,350,000
Senior Vice President, Engineering
Thomas Obenhuber ........................... $ 9.00 150,000 $1,350,000
Senior Vice President, Corporate
Development
Edward Hayes ............................... $ 3.00 370,000 $1,110,000
Executive Vice President and
Chief Financial Officer
David Wilson ............................... $ 9.00 100,000 $ 900,000
Vice President, Financial Services
Scott Martin ............................... $ 3.00 245,000 $ 735,000
Executive Vice President,
Chief Administrative Officer and
Corporate Secretary
Vicki Foshee ............................... $ 3.00 85,000 $ 255,000
Senior Vice President,
Service Delivery and Support
EFFECT OF ACCELERATION ON OUTSTANDING OPTIONS
Under the terms of the Merger Agreement, HUGHES, the Purchaser and
Telocity agreed to confer and work together in good faith to agree upon mutually
acceptable employee benefit and compensation arrangements with respect to
Telocity's employees as soon as practicable after the Merger Agreement was
signed. After evaluating the terms of our stock option plans, on January 26,
2001, representatives of HUGHES and our management discussed the treatment of
our unvested stock options and the Shares of stock obtained upon the early
exercise of options. During the discussion, HUGHES advised us that it would
neither assume nor substitute our outstanding stock options and proposed that,
as a result of the effect of such termination on employee morale, all unvested
stock options and shares of stock obtained upon the early exercise of options be
accelerated under the plans. On January 28, 2001, after receiving advice from
our outside legal counsel and independent accountants, our Compensation
Committee executed a unanimous written consent authorizing the amendment of
option agreements evidencing all outstanding options and governing all
outstanding shares of stock obtained upon early exercise of options to provide
for full vesting of all unvested shares and to provide a net exercise mechanism
for all outstanding options. Such acceleration is conditioned on the
consummation of the Offer. As a result of this acceleration, shares and options
to purchase shares held by the following directors and executive officers which
otherwise would not vest upon a change of control will vest contingent on the
consummation of the Offer:
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57
NUMBER OF
UNVESTED EXERCISE VALUE
NAME SHARES(1) PRICE(2) REALIZED
- ------------------------------------------------------- ---------- --------- -------------
Patti Hart ............................................ 1,814,779 $ 0.35 $3,266,602.20
President, Chief Executive Officer and Director 200,000 $ 5.56 --
Randall Strahan ....................................... 25,000 $ 12.00 --
Director 41,667 $ 3.2812 --
20,000 $ 5.38 --
Ned Hayes ............................................. 231,459 $ 3.00 --
Executive Vice President and 18,750 $ 12.00 --
Chief Financial Officer 160,000 $ 5.5625 --
125,000 $ 3.28 --
Scott Martin .......................................... 168,437 $ 3.00 --
Executive Vice President, Chief Administrative 25,000 $ 5.5625 --
Officer and Corporate Secretary
David Finley .......................................... 500,000 $ 4.50 --
Chief Operating Officer 125,000 $ 3.2812 --
Regina Wiedemann ...................................... 150,000 $ 1.50 $ 97,500.00
Senior Vice President, Business Development 40,000 $ 5.5625 --
Jim Morrissey ......................................... 499,999 $ 0.75 $ 699,998.60
Executive Vice President and Chief Marketing
Officer
Thomas Obenhuber ...................................... 106,250 $ 9.00 --
Senior Vice President, Corporate Development
Kevin Grundy .......................................... 106,250 $ 9.00 --
Senior Vice President, Engineering
Robert Sandor ......................................... 130,000 $ 4.9375 --
Senior Vice President, Operations
Vicki Foshee .......................................... 60,379 $ 3.00 --
Senior Vice President, Service Delivery and Support 100,000 $ 5.50 --
David Wilson .......................................... 70,833 $ 9.00 --
Vice President, Financial Services 69,000 $ 5.375 --
83,333 $ 3.2812 --
- ----------
(1) Unvested share totals are as of April 2, 2001, the initial expiration date
of the Offer.
(2) Despite the acceleration of these options, we expect that options with an
exercise price above $2.15 per share (the price per share to be paid by the
Purchaser in the Offer) will not be exercised by the foregoing executive
officers and directors because the exercise price is in excess of the offer
price. If unexercised, these options will terminate and be of no further
effect upon consummation of the Offer.
Page 56
58
2000 OUTSIDE DIRECTORS STOCK PLAN
In January 2000, the our Board of Directors adopted the Company's 2000
Outside Directors Stock Plan (the "Directors Plan"). The adoption of the
Directors Plan was approved by the our stockholders in March 2000. The Directors
Plan establishes an initial automatic grant of an option to purchase 40,000
shares of the Company's common stock (the "Initial Options") to non-employee
directors. The Directors Plan also provides that upon the date of each annual
stockholders meeting, each non-employee director who has been a member of the
our Board of Directors for at least six months shall receive an automatic grant
of an option to purchase 10,000 shares of Common Stock (the "Annual Options").
The Initial Options and the Annual Options each have an exercise price equal to
the fair market value of a share of the Company's common stock on the date of
grant. The Initial Options vest and become exercisable in four equal annual
installments. The Annual Options vest and become exercisable in full on the day
immediately preceding the date of the first annual stockholders' meeting
following the date of grant. Upon a change of control, all outstanding Initial
Options and Annual Options become fully vested and exercisable. For purposes of
the Directors Plan, a "change of control" is defined as having occurred upon a
transaction or series of related transactions wherein the stockholders of the
Company do not retain immediately after the transaction direct or indirect
beneficial ownership of more than fifty percent of the total combined voting
power of the outstanding voting stock of the Company. Because the consummation
of the Offer constitutes a change of control under the Directors Plan, all of
the outstanding Initial Options will become fully vested and exercisable. As a
result, shares and options to purchase shares issued under the Directors Plan
and held by the following directors will vest upon consummation of the Offer:
NUMBER OF
UNVESTED EXERCISE VALUE
NAME SHARES(1) PRICE REALIZED
- ----------------------------------- ------------ -------- ---------
Christie Hefner ................... 40,000 5.50 --(2)
Director
Elisabeth Sami .................... 40,000 2.00 $6,000.00
Director
James Scheinman ................... 40,000 2.00 $6,000.00
Director
- ----------
(1) Unvested share totals are as of April 2, 2001, the initial expiration date
of the Offer.
(2) Despite the acceleration of these options, we expect that options with an
exercise price above $2.15 per share (the price per share to be paid by the
Purchaser in the Offer) will not be exercised by the foregoing directors
because the exercise price is in excess of the offer price. If unexercised,
these options will terminate and be of no further effect upon consummation
of the Offer.
INDEMNIFICATION; DIRECTORS AND OFFICERS' INSURANCE
The Merger Agreement provides that the surviving corporation in the
merger (the "Surviving Corporation") shall keep in effect provisions in its
bylaws for a period of not less than six years from the effective time of the
Merger (the "Effective Time") that provide for exculpation of director and
officer liability and indemnification (and advancement of expenses related
thereto) of the past and present officers and directors of the Company and its
subsidiaries to the fullest extent permitted by the Delaware General Corporation
Law (the "DGCL"). Such provisions shall not be amended except as required by
applicable law or except to make changes permitted by law that would enhance the
rights of past or present officers and directors to indemnification or
advancement of expenses, and shall observe the indemnification agreements
existing in favor of past and present officers and directors of the Company and
its subsidiaries.
Page 57
59
The Merger Agreement provides that the Surviving Corporation shall
maintain in effect the Company's and its subsidiaries' current directors' and
officers' liability insurance policies covering those persons who are currently
covered by such policies with respect to actions or omissions occurring prior to
the Effective Time for a period of six years from the Effective Time; provided,
however, that in no event shall the Surviving Corporation be required to expend
in any one year an amount in excess of 150% of the annual premiums currently
paid by the Company and its subsidiaries for such insurance coverage, and,
provided further, that if the annual premiums of such insurance coverage exceed
such amount, the Surviving Corporation shall be obligated to obtain policies
with the greatest coverage available for a cost not exceeding such amount.
The Merger Agreement also provides that the Company shall indemnify and
hold harmless, to the fullest extent permitted under applicable law, each person
who is, or has been at any time prior to the date of the Merger Agreement or who
becomes prior to the Effective Time, an officer, director or similar person of
the Company or any subsidiary of the Company, against all losses, claims,
damages, liabilities, costs or expenses (including attorneys' fees), judgments,
fines, penalties and amounts paid in settlement in connection with any claims,
actions, suits, proceedings, arbitrations, investigations or audits arising
before or after the Effective Time out of or pertaining to acts or omissions, or
alleged acts or omissions, by them in their capacities as such, which acts or
omissions occurred prior to the Effective Time. Without limiting the foregoing,
the Surviving Corporation shall periodically advance expenses as incurred with
respect to the foregoing to the fullest extent permitted under applicable law
provided that the person to whom the expenses are advanced provides an
undertaking to repay such advance if it is ultimately determined that such
person is not entitled to indemnification.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) Documents filed as part of this Report:
PAGE
----
(1) Financial Statements:
Report of Independent Accountants.................................... F-2
Consolidated Balance Sheets.......................................... F-3
Consolidated Statements of Operations................................ F-4
Consolidated Statements of Stockholders' Equity (Deficit)............ F-5
Consolidated Statements of Cash Flows................................ F-6
Notes to Consolidated Financial Statements........................... F-7
(2) Financial statement schedules have been omitted because they are
either not required, not applicable or the information is otherwise included in
the Financial Statements.
(3) Exhibits:
EXHIBIT
NUMBER DESCRIPTION
---------- -----------
3.1(1) Restated Certificate of Incorporation of Registrant
3.2(1) Bylaws of Registrant
4.1(1) Specimen of stock certificates
10.1(1) Form of Indemnification Agreement between Registrant and
each of its directors and officers
10.2(1) 2000 Equity Incentive Plan and form of agreements
thereunder
10.3(1) 2000 Employee Stock Purchase Plan
10.4(1) 2000 Outside Directors Stock Plan and form of
agreements thereunder
10.5(1) Lease between Registrant and Vidovich-Cupertino Limited
Partnership
10.6(1) Lease between Registrant and Lee Li Chun Koo
10.7(1) Lease between Registrant and The Sobrato Group
10.8(1) Second Amended and Restated Investors' Rights Agreement
10.9(1) Product Manufacturing Agreement between Registrant and
Wellex Corporation
10.10(1) Agreement for Services between Registrant and
Telamon-IMS, Inc.
10.11(1) Agreement for Services between Registrant and the
Sutherland Group, Ltd.
10.12(1) Employment Agreement between Registrant and Patti Hart
10.13(1) Employment Agreement between Registrant and Peter Olson
10.14(1) Employment Agreement between Registrant and Jim
Morrissey
10.15(1) Employment Agreement between Registrant and Thomas
Obenhuber
10.16(1) Employment Agreement between Registrant and James Rohrer
10.17(1) Employment Agreement between Registrant and Matthew
Stepovich
10.18(1) Employment Agreement between Registrant and Regina
Wiedemann
Page 58
60
EXHIBIT
NUMBER DESCRIPTION
---------- -----------
10.19(1) Employment Agreement between Registrant and Kevin Grundy
10.20(1) Employment Agreement between Registrant and Jef Raskin
10.21(1) Employment Agreement between Registrant and Andrew
Robinson
10.22(1) Employment Agreement between Registrant and Edward Hayes
10.23(1) Employment Agreement between Registrant and Scott Martin
10.24(1) Consultants Stock Option Plan and form of agreements
thereunder
10.25(1) Market Development Agreement between Registrant and
BellSouth Business Systems, Inc.
10.26(1) Private Line Service Level Agreement between Registrant
and Level 3 Communications, LLC
10.27(1) Private Line Service Agreement between Registrant and
MCI WorldCom Communications, Inc.
10.28(1) Operating Agreement between Registrant and NBC
Internet, Inc.
10.29(1) Advertising Agreement between Registrant and the
National Broadcasting Company, Inc.
10.30(1) Advertising Agreement between Registrant and NBC
Internet, Inc.
10.31(1) Founder Stock Purchase Agreement between Registrant and
Peter Olson dated December 23, 1997
10.32(1) Founder Stock Purchase Agreement between Registrant and
Michael Solomon dated December 23, 1997
10.33(1) Founder Stock Purchase Agreement between Registrant and
Thomas Obenhuber dated December 23, 1997
10.34(1) Founder Stock Purchase Agreement between Registrant and
Matthew Stepovich dated December 23, 1997
10.35(1) Founder Stock Repurchase Agreement between Registrant
and Peter Olson dated June 1, 1998
10.36(1) Founder Stock Repurchase Agreement between Registrant
and Michael Solomon dated June 1, 1998
10.37(1) Founder Stock Purchase Agreement between Registrant
and Kevin Grundy dated June 10, 1998
10.28(1) Founder Stock Purchase Agreement between Registrant
and Thomas Obenhuber dated June 10, 1998
10.39(1) Founder Stock Purchase Agreement between Registrant
and Matthew Stepovich dated June 10, 1998
10.40(1) Secured Promissory Note between Registrant and
Comdisco, Inc. dated March 27, 1998
10.41(1) Secured Promissory Note between Registrant and
Comdisco, Inc. dated November 10, 1998
10.42(1) Secured Promissory Note between Registrant and
Comdisco, Inc. dated December 24, 1998
10.43(1) Subordinated Promissory Note between Registrant and
Comdisco, Inc. dated September 3, 1999
10.44(1) Subordinated Promissory Note between Registrant and
Comdisco, Inc. dated September 9, 1999
10.45(1) Subordinated Promissory Note between Registrant and
Comdisco, Inc. dated September 24, 1999
10.46(1) Subordinated Promissory Note between Registrant and
Comdisco, Inc. dated September 24, 1999
10.47(1) Subordinated Promissory Note between Registrant and
Comdisco, Inc. dated October 19, 1999
10.48(1) Subordinated Promissory Note between Registrant and
MMC/GATX Partnership No. 1 dated September 30, 1999
10.49(1) Master Broadband Network Services Agreement and Form of
Warrant Agreement between Registrant and General
Electric Company
10.50(1) Consent of Jupiter Communications
10.51(1) Consent of Forrester Research
10.52(1) Consent of International Data Corporation
10.53(2) Letter to Telocity Stockholders
10.54(2) Employment Agreement with Vicki Foshee
10.55(2) Employment Agreement with David Finley
10.56(2) Employment Agreement with Robert Sandor
10.57(2) Form of Option Exercise and Note Recission Agreement
10.58(2) Form of Mutual Release
10.59(2) Second Amended and Restated Investor Rights Agreement
10.60(2) NBC TV Advertising Inventory Agreement
21.1(1) Subsidiaries of the Registrant
23.1 Consent of PricewaterhouseCoopers LLP, Independent
Accountants
(1) Incorporated by reference from the Exhibits with corresponding numbers
filed with the Company Registration Statement on Form S-1 (No. 333-94271)
filed on January 7, 2000, as amended by Amendment No. 1 to Form S-1 (No.
333-94271) filed February 16, 2000, Amendment No. 2 to Form S-1 (No.
333-94271) filed March 8, 2000, Amendment No. 3 to Form S-1 (No.
333-94271) filed March 20, 2000, Amendment No. 4 to Form S-1 (No.
333-94271) filed March 23, 2000, Amendment No. 5 to Form S-1 (No.
333-94271) filed March 27, 2000 and Amendment No. 6 to Form S-1 (No.
333-94271) filed March 28, 2000.
(2) Incorporated by reference from the Exhibits filed with the Company's
Initial Solicitation Statement on Form 14D9 (No. 005-60021) filed on
February 1, 2001, as amended by Amendment No. 1 to Form 14D9 (No.
005-60021) filed on February 9, 2001 and Amendment No. 2 to Form 14D9 (No.
005-60021) filed on February 16, 2001.
Page 59
61
(b) The Company filed Reports on Form 8-K dated on December 28, 2000, as
amended on February 2, 2001, and February 16, 2001.
SIGNATURES
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.
TELOCITY DELAWARE, INC.
Date: April 2, 2001 BY: /s/ Patti Hart
-------------------------------------
Patti Hart
President, Chief Executive Officer and
Director
/s/ Edward Hayes
-------------------------------------
Edward Hayes
Executive Vice President and
Chief Financial Officer
/s/ Scott Martin
-------------------------------------
Scott Martin
Executive Vice President, Chief
Administrative Officer and Corporate
Secretary
/s/ David Finley
-------------------------------------
David Finley
Chief Operating Officer
/s/ David Wilson
-------------------------------------
David Wilson
Vice President, Financial Services
/s/ Randall Strahan
-------------------------------------
Randall Strahan
Director and Member, Audit Committee
/s/ Michael Solomon
-------------------------------------
Michael Solomon
Director and Member, Audit Committee
Page 60
62
TELOCITY DELAWARE INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE
Report of Independent Accountants F-2
Consolidated Balance Sheets F-3
Consolidated Statements of Operations F-4
Consolidated Statements of Stockholders' Equity (Deficit) F-5
Consolidated Statements of Cash Flows F-6
Notes to Consolidated Financial Statements F-7
F-1
63
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and
Stockholders of Telocity Delaware, Inc.:
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations, of stockholders' deficit and of cash
flows present fairly, in all material respects, the financial position of
Telocity Delaware, Inc. at December 31, 1999 and 2000, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 2000 in conformity with accounting principles generally accepted in
the United States of America. These financial statements are the responsibility
of the Company's management; our responsibility is to express an opinion on
these financial statements based on our audits. We conducted our audits of these
statements in accordance with auditing standards generally accepted in the
United States of America, which require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 1 to the
financial statements, the Company has suffered recurring losses from operations
and has a net capital deficiency that raise substantial doubt about its ability
to continue as a going concern. Management's plans in regard to these matters
are also described in Note 1. The financial statements do not include any
adjustments that might result from the outcome of this uncertainty.
San Jose, California
January 26, 2001
F-2
64
TELOCITY DELAWARE, INC.
CONSOLIDATED BALANCE SHEETS
(AMOUNTS IN 000'S, EXCEPT SHARE AND PER SHARE DATA)
DECEMBER 31, DECEMBER 31,
1999 2000
------------ ------------
ASSETS
Current assets:
Cash and cash equivalents .......................................... $ 66,978 $ 38,422
Accounts receivable, net ........................................... 13 539
Prepaid expenses and other current assets .......................... 7,013 11,803
--------- ---------
Total current assets .......................................... 74,004 50,764
Property and equipment, net ............................................ 22,272 45,311
Intangibles, net ....................................................... 380 278
Other assets ........................................................... 43,415 35,990
--------- ---------
Total assets .................................................. $ 140,071 $ 132,343
========= =========
LIABILITIES, MANDATORILY REDEEMABLE CONVERTIBLE
PREFERRED STOCK AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable ................................................... $ 9,141 $ 23,761
Accrued expenses and other current liabilities ..................... 4,383 21,662
Deferred revenue ................................................... 33 1,026
Notes payable, current ............................................. 2,292 --
Capital lease obligations, current ................................. 4,426 5,757
--------- ---------
Total current liabilities ..................................... 20,275 52,206
Notes payable, net of current portion .................................. 3,135 --
Capital lease obligations, net of current portion ...................... 8,859 6,860
Other liabilities ...................................................... 64 264
--------- ---------
Total liabilities ............................................. 32,333 59,330
--------- ---------
Mandatorily redeemable convertible preferred stock:
Series A; no par value, 13,553,126 authorized shares in
1999; issued and outstanding: 13,150,000 in 1999 ............ 6,567 --
Series A warrants ............................................. 106 --
Series B; no par value, 14,699,998 authorized shares in
1999; issued and outstanding: 13,181,818 in 1999 ............ 14,490 --
Series B warrants ............................................. 1,431 --
Series C; no par value, 27,000,000 authorized shares in
1999; issued and outstanding: 24,332,061 in 1999 ............ 126,293 --
Series C warrants ............................................. 7,133 --
--------- ---------
Total mandatory redeemable convertible preferred stock ............. 156,020 --
--------- ---------
Commitments (Note 6)
Stockholders' equity (deficit):
Common Stock: $0.001 par value, 90,000,000 and 250,000,000
shares authorized in 1999 and 2000, respectively; issued and
outstanding: 20,282,270 in 1999 and 81,623,140 in 2000 ........... 17 78
Additional paid-in capital ......................................... 39,478 326,450
Receivable from stockholders ....................................... (5,457) (3,326)
Unearned stock-based compensation .................................. (13,883) (8,022)
Accumulated deficit ................................................ (68,437) (242,167)
--------- ---------
Total stockholders' equity (deficit) .......................... (48,282) 73,013
--------- ---------
Total liabilities, mandatorily redeemable convertible
preferred stock and stockholders' equity (deficit) .......... $ 140,071 $ 132,343
========= =========
The accompanying notes are an integral part of these consolidated financial
statements.
F-3
65
TELOCITY DELAWARE, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(AMOUNTS IN 000'S, EXCEPT SHARE AND PER SHARE AMOUNTS)
YEAR ENDED
DECEMBER 31,
--------------------------------------------------
1998 1999 2000
------------ ------------ ------------
Revenues ............................................ $ -- $ 187 $ 9,352
------------ ------------ ------------
Operating costs and expenses:
Network and product costs ....................... -- 2,080 29,090
Sales and marketing ............................. 240 13,081 45,784
General and administrative ...................... 1,906 5,903 43,954
Research and development ........................ 4,723 15,900 18,336
Amortization of stock-based compensation(*) ..... 145 3,095 32,779
Depreciation and amortization ................... 424 2,253 15,592
------------ ------------ ------------
Total operating expenses ................... 7,438 42,312 185,535
------------ ------------ ------------
Loss from operations ................................ (7,438) (42,125) (176,183)
Interest expense .................................... (187) (1,448) (2,934)
Interest income ..................................... 35 379 5,728
Other income/(expense), net ......................... -- (225) --
------------ ------------ ------------
Net loss ............................................ (7,590) (43,419) (173,389)
Deemed dividend and accretion on mandatorily
redeemable convertible preferred stock .......... -- (16,750) (341)
------------ ------------ ------------
Net loss attributable to common stockholders ........ $ (7,590) $ (60,169) $ (173,730)
============ ============ ============
Net loss per share, basic and diluted ............... $ (1.39) $ (7.32) $ (2.89)
============ ============ ============
Shares used in computing net loss per share,
basic and diluted ............................... 5,471,617 8,219,183 60,079,659
============ ============ ============
(*) Amortization of stock-based compensation:
Network and product costs ......................... $ -- $ -- $ 643
Sales and marketing ............................... 12 490 20,357
General and administrative ........................ 112 1,780 8,630
Research and development .......................... 21 825 3,149
------------ ------------ ------------
$ 145 $ 3,095 $ 32,779
============ ============ ============
The accompanying notes are an integral part of these consolidated financial
statements.
F-4
66
TELOCITY DELAWARE, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
(AMOUNTS IN 000'S, EXCEPT SHARE AND PER SHARE DATA)
TOTAL
COMMON STOCK ADDITIONAL RECEIVABLE UNEARNED STOCKHOLDERS'
------------------------- PAID-IN FROM STOCK-BASED ACCUMULATED EQUITY
SHARES AMOUNT CAPITAL STOCKHOLDERS COMPENSATION DEFICIT (DEFICIT)
----------- ----------- ----------- ------------ ------------ ----------- ------------
Balance at December 31, 1997 ..... 9,904,000 $ 4 $ -- $ (3) $ -- $ (678) $ (677)
Warrants issued for services ..... -- -- 92 -- -- -- 92
Issuance of common stock for
purchase acquisition ........... 40,572 -- -- -- -- -- --
Issuance of common stock
options for purchase
acquisition .................... -- -- 7 -- -- -- 7
Repurchase of common stock for
completed technology ........... (504,000) -- -- -- -- -- --
Issuance of common stock at
$0.005 per share ............... 3,076,000 3 12 (15) -- -- --
Repurchase of common stock at
$0.0005 per share .............. (2,816,000) (1) -- 1 -- -- --
Issuance of common stock upon
exercise of stock options ...... 2,176,934 2 107 (101) -- -- 8
Common stock options
issued for services ............ -- -- 40 -- -- -- 40
Unearned stock-based
compensation ................... -- -- 328 -- (328) -- --
Amortization of stock-based
compensation ................... -- -- -- -- 13 -- 13
Net loss ......................... -- -- -- -- -- (7,590) (7,590)
----------- ----------- ----------- ----------- ----------- ----------- -----------
Balance at December 31, 1998 ..... 11,877,506 8 586 (118) (315) (8,268) (8,107)
Warrants issued in connection
with property lease ............ -- -- 85 -- -- -- 85
Warrants issued for services ..... -- -- 247 -- -- -- 247
Warrants issued in connection
with licensing agreement ....... -- -- 79 -- -- -- 79
Issuance of common stock upon
exercise of stock options ...... 9,693,062 10 5,628 (5,455) -- -- 183
Common stock options issued
for services ................... -- -- 1,097 (177) -- 920
Repurchase of common stock ....... (1,288,298) (1) (115) 116 -- -- --
Unearned stock-based
compensation ................... -- -- 15,195 -- (15,195) -- --
Amortization of stock-based
compensation ................... -- -- -- 1,804 -- 1,804
Deemed dividend on issuance of
Series C preferred ............. -- -- 16,676 -- -- (16,676) --
Accretion on mandatorily
redeemable convertible
preferred stock ................ -- -- -- -- -- (74) (74)
Net loss ......................... -- -- -- -- -- (43,419) (43,419)
----------- ----------- ----------- ----------- ----------- ----------- -----------
Balance at December 31, 1999 ..... 20,282,270 17 39,478 (5,457) (13,883) (68,437) (48,282)
Accretion on mandatorily
redeemable convertible
preferred stock ................ -- -- -- -- -- (341) (341)
Conversion of preferred stock
to common stock ................ 50,663,878 50 156,311 -- -- -- 156,361
Issuance of common stock in
initial public
offering, net
of issuance costs .............. 11,000,000 11 120,716 -- -- -- 120,727
Issuance of common stock under
stock plans .................... 2,686,493 3 16,800 (16,459) -- -- 344
Issuance of common stock options
and warrants for services ...... -- -- 136 -- -- -- 136
Exercise of warrants ............. 1,320,682 1 649 -- -- -- 650
Repurchase of common stock ....... (2,322,793) (2) (8,466) 5,731 2,737 -- --
Unearned stock based
compensation ................... -- -- 5,010 -- (5,010) -- --
Amortization of stock-based
compensation ................... -- -- -- -- 7,949 -- 7,949
Payment received on notes
receivable from stockholder .... -- -- -- 124 -- -- 124
Rescission of .................... (2,007,390) (2) (4,184) 12,735 185 -- 8,734
stockholder notes
Net loss ......................... -- -- -- -- -- (173,389) (173,389)
----------- ----------- ----------- ----------- ----------- ----------- -----------
Balance at December 31, 2000 ..... 81,623,140 $ 78 $ 326,450 $ (3,326) $ (8,022) $ (242,167) $ 73,013
=========== =========== =========== =========== =========== =========== ===========
The accompanying notes are an integral part of these consolidated financial
statements.
F-5
67
TELOCITY DELAWARE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(AMOUNTS IN 000'S, EXCEPT SHARE AND PER SHARE AMOUNTS)
YEAR ENDED
DECEMBER 31
-------------------------------------
1998 1999 2000
--------- --------- ---------
Cash flows from operating activities:
Net loss .................................................. $ (7,590) $ (43,419) $(173,389)
Adjustments to reconcile net loss to net cash used
in operating activities:
Depreciation and amortization .......................... 424 2,253 15,592
Amortization of stock-based compensation ............... 13 1,804 7,949
Rescission of stockholder notes ........................ -- -- 8,734
Services received in exchange for Series C
Preferred Stock ...................................... -- -- 15,345
Issuance of common stock and common stock
options in exchange for services ..................... 40 920 244
Warrant related non-cash expenses ...................... 104 863 993
Provision for doubtful accounts ........................ -- -- 287
(Gain)/loss on sale of property and equipment .......... -- 225 (25)
Change in operating assets and liabilities:
Accounts receivable ................................ -- (13) (813)
Prepaid expenses and other current assets .......... 73 (1,584) (8,510)
Other assets ....................................... (51) (2,487) 1,028
Accounts payable ................................... 1,487 7,553 14,620
Accrued expenses and other current liabilities ..... 144 4,264 17,279
Deferred revenue ................................... -- 33 993
Other liabilities .................................. -- 64 200
--------- --------- ---------
Net cash used in operating activities ..................... (5,356) (29,524) (99,473)
--------- --------- ---------
Cash flow from investing activities:
Proceeds from the sale of property and equipment .......... -- 288 138
Acquisition of intangibles ................................ -- (15) --
Acquisition of subsidiary, net of cash acquired ........... (51) -- --
Purchase of property and equipment ........................ (975) (9,377) (34,938)
--------- --------- ---------
Net cash used in investing activities ..................... (1,026) (9,104) (34,800)
--------- --------- ---------
Cash flows from financing activities:
Proceeds from issuance of mandatorily redeemable
convertible preferred stock, net ........................ 4,050 96,876 --
Proceeds from issuance of common stock, net ............... 8 183 121,195
Proceeds from issuance of warrants for preferred
stock ................................................... 67 -- 650
Proceeds from issuance of notes payable ................... 3,924 13,000 --
Repayments of notes payable ............................... (178) (4,757) (728)
Early extinguishment of debt .............................. -- -- (5,248)
Principal payments on capital lease obligations ........... (108) (818) (4,456)
Increase in restricted cash related to commitments ........ -- (280) (5,696)
--------- --------- ---------
Net cash provided by financing activities ................. 7,763 104,204 105,717
--------- --------- ---------
Net increase (decrease) in cash and cash equivalents ........... 1,381 65,576 (28,556)
Cash and cash equivalents, beginning of year ................... 21 1,402 66,978
--------- --------- ---------
Cash and cash equivalents, end of year ......................... $ 1,402 $ 66,978 $ 38,422
========= ========= =========
The accompanying notes are an integral part of these consolidated financial
statements
F-6
68
TELOCITY DELAWARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - FORMATION AND BUSINESS OF THE COMPANY:
Telocity Delaware, Inc. (the "Company") develops, markets, integrates
and delivers interactive online services to the residential market over
high-speed, or broadband, connections. The Company has a single operating
segment and has no organizational structure dictated by product lines, geography
or customer type. All revenues earned to date have been generated from U.S.
based customers.
The Company has been successful in completing several rounds of
financing with its last round arising from its initial public offering in March
2000 that raised approximately $120.7 million, net of issuance costs. However,
the Company has incurred substantial losses and negative cash flows from
operations every year since inception. For the year ended December 31, 2000,
the Company incurred a loss from operations of approximately $176.2 million and
negative cash flows from operations of $99.5 million. As of December 31, 2000,
the Company has an accumulated deficit of approximately $242.2 million.
Management expects operating losses and negative cash flows to continue for the
foreseeable future and anticipates that losses will increase significantly from
current levels because of additional costs and expenses related to subscriber
acquisition. Failure to raise additional capital or reduce certain discretionary
spending will have a material adverse effect on the Company's ability to
continue as a going concern and to achieve its intended business objectives.
On December 21, 2000, the Company and HUGHES Electronics Corporation
("HUGHES") announced an agreement in which HUGHES, through a recently formed
subsidiary, DIRECTV Broadband, Inc., would acquire all the Company's outstanding
shares of common stock at a purchase price of $2.15 per share, or approximately
$178.0 million, subject to the satisfaction of certain conditions. The cash
tender offer for these shares commenced February 1, 2001 and is scheduled to
expire on April 2, 2001, unless extended. The consummation of the tender offer
remains subject to customary closing conditions. Failure to complete the
transaction with HUGHES or, in the event the transaction does not close, failure
to secure sufficient additional capital, will likely force the Company to
discontinue operations as it has insufficient cash on hand to fund operations
through April 15, 2001.
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Principles of consolidation
These consolidated financial statements include the accounts of the
Company and its wholly-owned subsidiaries. All significant intercompany balances
and transactions have been eliminated.
Use of estimates
Preparation of the accompanying financial statements in conformity with
generally accepted accounting principles requires management to make certain
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenue and expenses during
the reporting period. Actual results could differ from those estimates.
Cash and cash equivalents
The Company considers all highly-liquid investments with original or
remaining maturities of three months or less, at the date of purchase, to be
cash equivalents. At December 31, 2000, the Company had restricted cash of
approximately $6.0 million, of which $4.5 million related to letter of credit
facilities with a bank, which had terms in excess of one year. The current
portion of restricted cash
F-7
69
of $1.5 million has been included in "prepaid expenses and other current
assets," while the long-term balance of $4.5 million has been included in "other
assets."
Certain risks and concentrations
The Company's financial instruments that are exposed to concentration of
credit risk consist primarily of cash and cash equivalents.
The Company's cash and cash equivalents are deposited with major
financial institutions in the United States. At times, such deposits may be in
excess of the amount of insurance provided on such deposits. The Company has not
experienced any losses on its deposits of cash and cash equivalents.
The success of the Company's business is substantially dependent upon
its ability to develop strategic partnerships for content, develop a
recognizable brand, secure distribution channels for its subscriber-based
broadband services and the continued supply of gateways from its sole contract
manufacturer.
Fair value of financial instruments
The fair value of the Company's cash and cash equivalents, accounts
receivable, accounts payable and notes payable approximate their carrying value
due to the short maturity or market rate structure of those instruments.
Property and equipment
Property and equipment are stated at cost and depreciated using the
straight-line method over the estimated useful lives of the related assets,
generally two to seven years. Leasehold improvements are amortized over the
shorter of the related lease term or the useful life of the improvement.
Intangibles
Intangible assets consist of completed technology which is stated at
cost and is being amortized using the straight-line method over the estimated
useful life of five years.
Accounting for long-lived assets
The Company evaluates the recoverability of its long-lived assets in
accordance with Statement of Financial Accounting Standards No. 121, "Accounting
for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed
of" ("SFAS 121"). SFAS 121 requires recognition of impairment of long-lived
assets in the event the net book value of such assets exceeds the future
undiscounted cash flows attributable to such assets.
Revenue recognition
The Company generates revenue from the provision of broadband services
and applications. Revenues are derived primarily from an initial non-recurring
charge and monthly recurring charges for services. The initial charge is related
to the provision of a residential gateway, a high speed digital subscriber line
and service activation. Primarily all revenues, including the initial and
monthly service charges, are recognized ratably over the term of the service.
Research and development
Research and development costs are expensed as incurred, except for
certain software development costs. In January 1999, the Company adopted
Statement of Position ("SOP") 98-1, which requires software development costs
associated with internal use software to be charged to operations until certain
capitalization criteria are met. For the years ended December 31, 1999 and 2000,
software development costs of approximately $1.3 million and $3.6 million,
respectively, were capitalized and included in property and equipment.
F-8
70
Advertising costs
Advertising costs are expensed the first time the advertising takes
place. Included in prepaid expenses and other current assets and other assets at
December 31, 1999 and 2000 is $38.8 million and $23.5 million, respectively,
related to advertising commitments received from National Broadcasting
Corporation and NBC Internet Inc. in exchange for the issuance of Series C
mandatorily redeemable preferred stock. Advertising expense for the years ended
December 31, 1998, 1999, and 2000 was $44,000, $7.9 million, and $43.6 million,
respectively; advertising expense for the year 2000 is inclusive of stock-based
compensation of $15.3 million.
Stock-based compensation
The Company has elected to continue accounting for stock-based
compensation issued to employees using the intrinsic value method of Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees,"
and, accordingly, presents disclosure of pro forma information required under
Statement of Financial Accounting Standards Board Statement No. 123 or SFAS 123,
"Accounting for Stock-Based Compensation". The Company accounts for the
rescission of the exercise of employee stock options in accordance with SEC
staff announcement Topic No. D-93 "Accounting for the Rescission of the Exercise
of Employee Stock Options". Stock and other equity instruments issued to
non-employees have been accounted for in accordance with SFAS No. 123 and
Emerging Issues Task Force Issue No. 96-18, "Accounting for Equity Instruments
Issued to Other than Employees for Acquiring, or in Conjunction with Selling
Goods or Services" and valued using the Black-Scholes model.
Income taxes
The Company accounts for its income taxes in accordance with the
liability method. Under this method, deferred tax assets and liabilities are
determined based on temporary differences between the financial reporting and
tax basis of assets and liabilities, measured at tax rates that will be in
effect for the year in which the differences are expected to affect taxable
income. Valuation allowances are established when necessary to reduce deferred
tax assets to the amounts expected to be realized.
Comprehensive income
The Company has adopted the provisions of SFAS No. 130, or SFAS 130,
"Reporting Comprehensive Income." SFAS 130 establishes standards for reporting
comprehensive income (loss) and its components in financial statements.
Comprehensive income (loss), as defined, includes all changes in equity during a
period from non-owner sources. There has been no difference between the
Company's net loss and its total comprehensive loss through December 31, 2000.
Stock split
On October 13, 1999, the Company effected a 2:1 common and preferred
stock split. All share information in the consolidated financial statements and
notes has been restated to reflect the stock split.
Net loss per common share
Basic net loss per common share is computed by dividing the net loss
available to common stockholders for the period by the weighted average number
of common shares outstanding for the period net of common shares subject to
repurchase. Diluted net loss per common share is computed by dividing the net
loss for the period by the weighted average number of common and common
equivalent shares outstanding during the period, net of common shares subject to
repurchase. Common equivalent shares, composed of common shares issuable upon
exercise of stock options and warrants and upon conversion of Series A, Series B
and Series C mandatorily redeemable convertible preferred shares are included in
the diluted net loss per share computation to the extent such shares are
dilutive. A reconciliation of the numerator and denominator used in the
calculation of basic and diluted net loss per common share follows (in
thousands, except share and per share data):
F-9
71
YEAR ENDED
DECEMBER 31,
----------------------------------------------
1998 1999 2000
------------ ------------ ------------
Numerator:
Net loss attributable to common
Stockholders .......................... $ (7,590) $ (60,169) $ (173,730)
============ ============ ============
Denominator:
Weighted average common shares --
basic and diluted ..................... 10,111,750 17,792,602 69,468,680
Weighted average shares subject to
repurchase ............................ (4,640,133) (9,573,419) (9,389,021)
------------ ------------ ------------
Denominator for basic and diluted
calculation ........................... 5,471,617 8,219,183 60,079,659
============ ============ ============
Net loss per common share -- basic and
diluted ................................. $ (1.39) $ (7.32) $ (2.89)
============ ============ ============
Diluted net loss per share does not include the effect of the following
antidilutive common equivalent shares:
YEAR ENDED
DECEMBER 31,
--------------------------------------
1998 1999 2000
---------- ---------- ----------
Common stock options and warrants ......... 1,858,363 2,992,316 10,734,404
Convertible preferred stock ............... 13,150,000 50,663,878 --
Convertible preferred stock warrants ...... 403,125 3,256,400 --
---------- ---------- ----------
15,411,488 56,912,594 10,734,404
========== ========== ==========
Recent accounting pronouncements
In June 1998, Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities" ("FAS 133"). The new standard requires companies to
record derivatives on the balance sheet as assets or liabilities, measured at
fair value. Under FAS 133, gains or losses resulting from changes in the values
of derivatives are to be reported in the statement of operations or as a
deferred item, depending on the use of the derivatives and whether they qualify
for hedge accounting. The key criterion for hedge accounting is that the
derivative must be highly effective in achieving offsetting changes in fair
value or cash flows of the hedged items during the term of the hedge. The
Company is required to adopt FAS 133 in the first quarter of 2001. To date, the
Company has not engaged in any foreign currency or interest hedging activities
and does not expect adoption of this new standard to have a significant impact
on the Company.
In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 101 or SAB 101, Revenue Recognition in Financial
Statements, which provides guidance on the recognition, presentation, and
disclosure of revenue in financial statements filed with the Commission. SAB 101
outlines the basic criteria that must be met to recognize revenue and provides
guidance for disclosures related to revenue recognition policies. The
implementation of SAB 101 did not have a material effect on the Company's
financial position or results of operations.
In March 2000, the Financial Accounting Standards Board issued
Interpretation No. 44, "Accounting for Certain Transactions Involving Stock
Compensation" an
F-10
72
interpretation of APB Opinion No. 25 ("FIN 44"). This Interpretation clarifies
the definition of employee for purposes of applying Accounting Practice Board
Opinion No. 25, Accounting for Stock Issued to Employees ("APB 25"), the
criteria for determining whether a plan qualifies as a non-compensatory plan,
the accounting consequence of various modifications to the terms of a previously
fixed stock option or award, and the accounting for an exchange of stock
compensation awards in a business combination. This Interpretation was effective
July 1, 2000 and did not have a material impact on the financial statements.
In January 2001 the SEC issued Staff Announcement Topic No. D-93
"Accounting for the Rescission of the Exercise of Employee Stock Options". This
announcement clarifies how the rescission of a previous exercise of a stock
option by an employee is treated under APB25. One of the conditions of closing
the transaction with HUGHES (See Note 1) was that a minimum of 80% of the
out-of-the-money early stock option exercises, financed by the Company under
full recourse notes, were rescinded by December 31, 2000. The net result of the
rescission is that employees hold options at the original option exercise price
and the full recourse note is cancelled. The Company accounted for the
rescissions as modifications of the original options which resulted in a new
measurement date. Accordingly, the Company recorded a charge in the statement of
operations of $8.7 million in accordance with Topic D-93.
NOTE 3 - RELATED PARTY TRANSACTIONS:
On March 27, 1998 the Company acquired Aspen Internet Systems, Inc., in
which two of the Company's founders held a minority interest, for an aggregate
purchase price of $509,000. This constituted an asset acquisition of completed
technology that has been incorporated into the Company's residential gateway.
A former executive of the Company was also a member of the Board of
Directors and a shareholder of a supplier of outsourced sales support services
to the company. This commercial relationship commenced in March 2000. During the
executives' period of service, expenses of $507,000 were attributed to this
supplier.
NOTE 4 - BALANCE SHEET COMPONENTS:
DECEMBER 31,
----------------------
1999 2000
-------- --------
(IN THOUSANDS)
ACCOUNTS RECEIVABLE, NET:
Accounts receivable .......................... $ 13 $ 826
Less: allowance for doubtful accounts ........ -- (287)
-------- --------
$ 13 $ 539
======== ========
The allowance for doubtful accounts increased by $287,000 during 2000.
There was no allowance for doubtful accounts prior to the year ended December
31, 2000.
DECEMBER 31,
----------------------
1999 2000
-------- --------
(IN THOUSANDS)
PREPAID EXPENSES AND OTHER CURRENT ASSETS:
Deferred subscriber installation costs ....... $ 552 $ 2,924
Prepaid advertising .......................... 5,220 --
Other current assets and prepaid expenses .... 1,241 8,879
-------- --------
$ 7,013 $ 11,803
======== ========
DECEMBER 31,
----------------------
1999 2000
-------- --------
(IN THOUSANDS)
PROPERTY AND EQUIPMENT, NET:
Network software and equipment ...................... $ 18,104 $ 32,708
Furniture and fixtures .............................. 495 1,174
Leasehold improvements .............................. 762 4,108
Subscriber based broadband gateways ................. 5,455 25,355
-------- --------
24,816 63,345
Less: accumulated depreciation and amortization ..... (2,544) (18,034)
-------- --------
$ 22,272 $ 45,311
======== ========
Property and equipment includes $14.7 million and $19.5 million under
capital leases at December 31, 1999 and December 31, 2000, respectively.
Accumulated amortization of assets under capital leases totaled $1.3 million and
$8.1 million at December 31, 1999 and 2000, respectively. Depreciation expense
for the years ended
F-11
73
December 31, 1998, 1999, and 2000 was $383,000, $2.2 million, and $15.5 million,
respectively.
DECEMBER 31,
--------------------
1999 2000
------ ------
(IN THOUSANDS)
Intangibles, net:
Completed technology .............................. $ 524 $ 524
Less: accumulated amortization .................... (144) (246)
------ ------
$ 380 $ 278
====== ======
Annual amortization expense for the years ended December 31, 1999 and
2000 was $102,000.
DECEMBER 31,
---------------------
1999 2000
-------- --------
(IN THOUSANDS)
Other assets:
Prepaid advertising ................................ $ 33,604 $ 23,479
Deferred warrant costs ............................. 6,993 6,525
Other prepaid expenses and deferred costs .......... 2,538 1,510
Restricted cash, net of current portion ............ 280 4,476
-------- --------
$ 43,415 $ 35,990
======== ========
DECEMBER 31,
---------------------
1999 2000
-------- --------
(IN THOUSANDS)
Accrued expenses and other current liabilities:
Accrued network costs .............................. $ -- $ 7,608
Employee compensation accruals ..................... 1,142 5,727
Accrued property and other taxes ................... -- 2,306
Accrued advertising ................................ 1,453 570
Other accrued liabilities .......................... 1,788 5,451
-------- --------
$ 4,383 $ 21,662
======== ========
NOTE 5 - BORROWINGS:
During the years ended December 31, 1998 and 1999, the Company issued
notes payable to Comdisco, Inc., and MMC/GATX Partnership #1, with detachable
warrants to acquire Series A and Series B mandatorily redeemable convertible
preferred stock.
In May 2000, the Company prepaid notes payable to Comdisco, Inc. and
MMC/GATX Partnership #1 with an outstanding principal value of approximately
$5.2 million. These notes were collateralized by all tangible assets owned by
the Company, bore interest at a weighted average rate of 11.1% per annum, and
were repayable in installments through January 2002. The loss arising from the
early extinguishment of this debt was $564,000 and is included in interest
expense.
Bridge financing
In October 1999, the Company entered into a bridge loan transaction with
a financing company for $4.0 million that bore interest at 12% per annum and had
a term of 60 days. This loan was repaid in December 1999.
In November 1999, the Company entered into convertible bridge loan
transactions with two of its officers for a combined total of $5.0 million. Each
loan was made at an annual interest rate of 12%. The loans were converted into a
combined total of 954,198 shares of Series C mandatorily redeemable preferred
stock in December 1999.
F-12
74
Capital leases
Future minimum lease payments under capital leases as of December 31,
2000, bearing interest cost at rates ranging from 10.5% to 17.1% per annum in
2000, are as follows (in thousands):
YEARS ENDING DECEMBER 31,
2001 ....................................................... $ 6,812
2002 ....................................................... 5,501
2003 ....................................................... 1,758
2004 ....................................................... 175
--------
Total principal payments ................................... 14,246
Less: amount representing finance costs .................... (1,629)
--------
12,617
Less: current portion ...................................... (5,757)
--------
$ 6,860
========
NOTE 6 - COMMITMENTS:
The Company leased additional office space and equipment under
non-cancelable operating leases and entered into certain non-cancelable service
agreements. These agreements have various expiration dates through December
2010. The Company also sublet certain property for the period from August 1999
to October 2002. Rent expense for the years ended December 31, 1998, 1999, and
2000 was $258,000, $940,000 and $3.6 million, respectively.
Future minimum payments under noncancelable operating leases and service
agreements including future minimum sublease rental receipts under noncancelable
operating lease, at December 31, 2000 are as follows (in thousands):
OPERATING
LEASES AND
SERVICE SUBLEASE
YEARS ENDING DECEMBER 31, AGREEMENTS INCOME
- ------------------------- ---------- --------
2001 ................................................. $ 16,924 $ 339
2002 ................................................. 14,885 287
2003 ................................................. 6,141 --
2004 ................................................. 3,218 --
2005 ................................................. 2,323 --
Later years .......................................... 7,761 --
-------- --------
Total minimum lease and service payments and
sublease income .................................... $ 51,252 $ 626
======== ========
Operating agreement
On December 10, 1999, the Company entered into a fifteen-year Operating
Agreement with NBC Internet, Inc ("NBCi"). The agreement provides for the joint
development, design services and content to be owned and branded by both
companies.
F-13
75
The services and content include entertainment, electronic commerce,
search applications and other features designed for use exclusively by broadband
users. The Company's customers will be able to utilize these online services
through a Web portal user interface that the Company has developed jointly with
NBCi.
On December 21, 2000, the Company entered into an amendment to the
Operating Agreement ("the Amendment") whereby, among other things, that upon the
consummation of the Company's merger with HUGHES (see Note 1), the Operating
Agreement shall terminate, provided that, however, certain provisions of the
Operating Agreement survive. The Amendment requires that the Company conducts
good faith discussions with NBCi regarding the possibility of an ongoing
commercial relationship.
NOTE 7 - MANDATORILY REDEEMABLE CONVERTIBLE PREFERRED STOCK:
At December 31, 2000, authorized preferred stock was 10,000,000, none of
which was issued and outstanding. At December 31, 1999, convertible preferred
stock consisted of the following:
SHARES
SHARES ISSUED AND LIQUIDATION
AUTHORIZED OUTSTANDING VALUE
---------- ----------- ----------
Series A .............. 13,553,126 13,150,000 $ 6,575
Series B .............. 14,699,998 13,181,818 $ 14,500
Series C .............. 27,000,000 24,332,060 $ 127,500
The holders of mandatorily redeemable Convertible Preferred Stock were
entitled to voting rights equivalent to the number of shares of Common Stock
into which it was convertible. In addition, holders of Series A, B, and C
Convertible Preferred Stock were entitled to receive noncumulative dividends at
the per annum rate of $0.025, $0.055, and $0.262 per share, respectively, when
and if declared by the Board of Directors, as well as a liquidation preference
of $0.50, $1.10, and $5.24 per share, respectively, in the event of the
dissolution of the Company.
At anytime on or after December 1, 2004, each holder of mandatorily
redeemable convertible preferred stock had the right to cause the Company to
redeem all of the shares held by such stockholder. The redemption price of the
Series A, Series B, and Series C preferred stock was $0.50, $1.10, and $5.24 per
share, respectively, plus any declared but unpaid dividends and would have been
paid in three equal annual installments.
All shares of mandatorily redeemable convertible preferred stock were
converted into common stock upon the closing of the Company's initial public
offering in March 2000.
Warrants for convertible preferred stock
The Company has issued warrants, the fair value of which has been
estimated using the Black-Scholes pricing model at the date of grant, using the
term of the warrant and the following assumptions: Risk-free rate of 4.6% - 5.6%
and 5.8% - 6.2% in 1998 and 1999, respectively, no expected dividends and
volatility of 60%.
NUMBER OF
EXPIRATION SHARES UNDER EXERCISE FAIR
ISSUANCE DATE DATE THE WARRANTS PRICE VALUE
- ------------- ---------------- ------------ ------------- -------
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
March and September 1998 September 2008 403,125 $0.50 - $0.80 $ 106
May, August, October November 2004
and December 31, 1999 to December 2009 833,498 $1.10 - $5.13 1,197
August 1999 August 2009 38,126 $1.10 120
October 1999 October 2002 44,628 $4.48 114
December 1999 December 2004 47,710 $5.24 121
December 1999 December 2004 1,889,313 $5.24 $ 7,012
During 2000 warrants to purchase 1,030,865 shares with a weighted
average exercise price of $1.24 were exercised on a net exercise basis resulting
in issuance of 924,454 shares of common stock. At December 31, 1999 and 2000
1,363,434 and 252,272 warrants were outstanding with a weighted average exercise
price of $1.44 and $1.10 respectively.
F-14
76
In connection with notes payable and capital leases, the Company issued
warrants to purchase 403,125 shares of Series A mandatorily redeemable
convertible preferred stock in March 1998 and September 1998, respectively. The
fair value of the warrants is being amortized over the term of the notes and
capital leases. The Company recognized $12,000, $32,000, and $32,000 as interest
expense associated with these warrants for the year ended December 31, 1998,
1999 and 2000, respectively.
During 1999, in connection with notes payable and capital leases, the
Company issued warrants to purchase 833,498 shares of Series B mandatorily
redeemable convertible preferred stock. The fair value of the warrants is being
amortized to interest expense over the term of the notes and capital leases. The
Company recognized $218,000 and $400,000 as interest expense associated with
these warrants for the years ended December 31, 1999 and 2000, respectively.
In August 1999, in connection with a line of credit, the Company issued
warrants to purchase 38,126 shares of Series B mandatorily redeemable
convertible preferred stock. The fair value of the warrants is being amortized
to interest expense over the term of the letter of credit. The Company
recognized $7,000 and $21,000 as interest expense associated with these warrants
for the years ended December 31, 1999 and 2000, respectively.
In October 1999, in connection with a bridge loan the Company issued
warrants to purchase 44,628 shares of Series B mandatorily redeemable
convertible preferred stock. The fair value of the warrants was amortized to
interest expense over the term of the bridge financing. The Company recognized
$114,000 as interest expense associated with these warrants for the year ended
December 31, 1999.
In December 1999, in connection with bridge loans received from two of
its directors, the Company issued warrants to purchase 47,710 shares of Series C
mandatorily redeemable preferred stock. The fair value of the warrants was
amortized to interest expense over the term of the bridge loan. The Company
recognized $121,000 as interest expense associated with these warrants for the
year ended December 31, 1999.
In December 1999, in connection with an operating agreement the Company
issued warrants to acquire 1,039,122 and 850,191 shares of Series C preferred
stock to NBCi and NBC, respectively. The fair value of the warrants is being
amortized over the term of the agreement. The Company recognized $19,000 and
$468,000 as sales and marketing expenses associated with these warrants for the
years ended December 31, 1999 and 2000, respectively.
All unexercised warrants for mandatorily redeemable convertible
preferred stock were converted into warrants for common stock upon the closing
of the Company's initial public offering in March 2000.
NOTE 8 - COMMON STOCK:
On March 29, 2000 the Company completed its initial public offering in
which it sold 11 million shares of common stock at $12.00 per share, for net
proceeds after issuance costs of $120.7 million.
The Company's Articles of Incorporation, as amended, authorize the
Company to issue 250,000,000 shares of common stock. A portion of the shares
sold are subject to a right of repurchase by the Company subject to vesting,
which is generally over a four year period from the earlier of grant date or
employee hire date, as applicable, until vesting is complete. At December 31,
1998, 1999, and 2000, there were 5,284,148, 12,814,213, and 4,598,658 shares
subject to repurchase, respectively.
Common stock warrants
The Company has issued warrants, the fair value of which has been
estimated using the Black-Sholes pricing model at the date of grant, using the
term of the
F-15
77
warrant and the following assumptions: Risk-free interest rate of 4.6% and 5.1%
- - 6.0% in 1998 and 1999, respectively, no expected dividends and 60% volatility.
NUMBER OF
EXPIRATION SHARES UNDER EXERCISE FAIR
ISSUANCE DATE DATE THE WARRANTS PRICE VALUE
- ------------- ------------- ------------ ----------- -------
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
September 1998 November 2003 765,018 $0.05 $ 91
March and November 1999 March and
November 2004 65,000 $0.11-$1.50 $ 85
June 1999 June 2006 268,856 $0.35 $ 247
November 1999 November 2009 20,000 $1.50 $ 79
February 2000 March 2003 11,667 $9.00 $ 137
During 2000 warrants to purchase 268,856 shares with a weighted average
exercise price of $0.35 were exercised on a net exercise basis resulting in
issuance of 250,932 shares of common stock. At December 31, 1999 and 2000
3,008,187 and 2,685,998 warrants were outstanding with a weighted average
exercise price of $3.35 and $3.75 respectively.
The Company issued a warrant to purchase 765,018 shares of common stock
in September 1998 to a company with which they were considering developing a
strategic relationship. The Company recognized $91,000 as general and
administrative expenses associated with these warrants for the year ended
December 31, 1998.
In March and November 1999, in connection with facility lease financing,
the Company issued warrants to purchase 65,000 shares of common stock. The
Company recognized $85,000 as rent expense in general and administrative
expenses associated with these warrants for the year ended December 31, 1999.
In June 1999, in connection with professional services received, the
Company issued warrants to purchase 268,856 shares of common stock. The fair
value of the warrants will be recognized as general and administrative expense.
The Company recognized $247,000 as general and administrative expense associated
with these warrants for the year ended December 31, 1999.
In November 1999, in connection with a license agreement, the Company
issued warrants to purchase 20,000 shares of common stock. The fair value of the
warrants will be recognized as sales and marketing expense over the term of the
license agreement. The Company recognized $20,000 and $59,000 as sales and
marketing expense associated with these warrants for the years ended December
31, 1999 and 2000, respectively.
In February, 2000 in connection with a line of credit, the Company
issued warrants to acquire 11,667 shares of common stock to Comdisco, Inc. with
an exercise price of $9.00 per share. The fair value of the warrants of $137,000
has been estimated using the Black-Scholes pricing model at the date of grant,
using the terms of the warrant and the following assumptions: Risk free rate of
6%, no expected dividends and 60% volatility. The Company recognized $13,000 as
interest expense for the year ended December 31, 2000.
In February 2000, the Company entered into a two-year master broadband
services agreement with GE and its affiliates. Under the services agreement, the
Company will provide residential services to GE and its affiliates'
telecommuters, other employees at discounted rates, as well as non-employee
users introduced to the Company by GE. In addition, under this agreement GE will
help market and promote the Company's services. The Company has issued GE
warrants for the contingent purchase of up to 200,000 shares of our common stock
at an exercise price of $12.00, per share, based upon the achievement of certain
customer-based milestones during the term of the agreement.
GE must meet these milestones within 30 months and the warrants must be
exercised within 12 months of reaching the associated milestone. The warrants
will be valued using the Black-Scholes pricing model and revalued at each
reporting date until the milestones are met. The fair value attributable to
these warrants will be recorded when it is probable that the milestone will be
met; on the basis of the current level of demand, the Company has not recorded
the fair value of any of these warrants.
In April 2000, the Company entered into a 27-month affinity agreement
with Citi f/i, the online virtual bank from Citibank and Citicorp Investment
Services. Under the agreement, Citi f/i will promote the use of the Company's
residential services among its on-line banking customers. The Company has issued
warrants for the contingent purchase of up to 1,250,000 shares of our common
stock at an exercise price of $12.00, per share, based upon the achievement of
certain customer-based milestones during the term of the agreement. In July
2000, Citi f/I was disbanded and rolled up into Citibank's online banking
initiative. The Company is involved in ongoing discussions with Citibank to
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78
explore the future commercial application of this agreement.
Citibank must meet these milestones within 27 months and the warrants must
be exercised within 6 months of reaching the associated milestone. The warrants
will be valued using the Black-Scholes pricing model and revalued at each
reporting date until the milestones are met. The fair value attributable to
these warrants will be recorded when it is probable that the milestone will be
met; on the basis of the current level of demand, the Company has not recorded
the fair value of any of these warrants.
Employee stock purchase plan
A total of 2,500,000 shares of common stock are reserved for issuance
under the 2000 Employee Stock Purchase Plan ("ESPP"), cumulatively increased on
January 1, 2001 and each January 1, thereafter. The ESPP permits employees,
including officers and employee directors, to purchase common stock through
payroll deductions of up to 20% of the participant's base salary and
commissions, but not to exceed the established maximum. Such amounts are applied
to the purchase from the Company of shares of common stock at the end of each
offering period at a price which is generally 85% of the lower of the fair
market value of the common stock on either the first or last of the offering
period. During 2000, 62,702 shares were purchased at $2.44 per share and $27,000
was expensed as stock based compensation for the discount to market at the
issuance date.
Stock option plans
In January 2000, the Company's Board of Directors approved the 2000
Equity Incentive Plan, the 2000 Employee Stock Purchase Plan and the 2000
Outside Directors Stock Plan. The shareholders subsequently approved these plans
in March 2000. Each plan is administered by the Board or by a committee of the
Board.
A total of 24,000,000 shares of common stock are authorized and reserved
for issuance under the 2000 Equity Incentive Plan ("Equity Incentive Plan"),
including 13,950,000 shares that were authorized and reserved under our 1998
Stock Option Plan prior to its restatement. The cumulative number of shares
authorized for issuance will be increased automatically on January 1, 2001 and
each January 1 thereafter. The Equity Incentive Plan allows awards to be granted
in the form of incentive stock options, nonstatutory stock options, restricted
stock purchase rights and bonuses, performance shares and performance units with
a maximum term of 10 years. Unless terminated sooner by the Board, the Equity
Incentive Plan will terminate automatically in 2009 on the tenth anniversary of
its adoption by the Board.
A total of 400,000 shares of common stock are authorized and reserved
for issuance under the 2000 Outside Directors Stock Plan ("Outside Directors
Stock Plan"), cumulatively increased on January 1, 2001 and each January 1
thereafter. The Outside Directors Stock Plan establishes an initial, automatic
grant of an option to purchase 20,000 shares of our common stock to each
non-employee director who is first elected to our Board of Directors after the
effective date of this offering. The Outside Directors Stock Plan also permits
each non-employee director to elect to receive additional equity awards in lieu
of between 25% to 100% of the cash compensation otherwise payable to the
director for service on the Board.
A total of 220,000 shares of common stock are authorized and reserved
for issuance under the Consultants Stock Option Plan. The Consultants Stock
Option Plan authorizes the grant of non-statutory stock options to persons
engaged by the Company as independent contractors with a maximum exercise
period of 10 years. Unless terminated sooner by the Board, the Consultants
Stock Option Plan will terminate automatically in 2008 on the tenth anniversary
of its adoption by the Board.
The following table summarizes activity under the Plans (in thousands,
except share and per share data):
SHARES
AVAILABLE OPTIONS EXERCISE
FOR GRANT OUTSTANDING PRICE
----------- ----------- --------
Shares reserved at plan inception .......... 1,624,000 --
Additional shares authorized ............... 1,906,000 --
Options granted ............................ (3,270,278) 3,270,278 $ 0.05
Options exercised .......................... (2,176,934) $ 0.05
----------- -----------
Balances, December 31, 1998 ................ 259,722 1,093,344 $ 0.05
Options authorized ......................... 10,420,000 --
Options granted ............................ (10,595,660) 10,595,660 $ 0.93
Options exercised .......................... -- (9,693,062) $ 0.58
Options cancelled .......................... 122,500 (122,500) $ 0.55
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79
Exercised options forfeited and returned
to plans ................................. 1,288,298 -- $ 0.09
----------- -----------
Balances, December 31,1999 ................. 1,494,860 1,873,442 $ 2.26
Options authorized ......................... 10,670,000 --
Options granted ............................ (6,016,365) 6,016,365 $ 6.25
Options exercised .......................... -- (2,579,332) $ 5.67
Options cancelled .......................... 971,731 (971,731) $ 5.75
Option exercises rescinded ................. -- 2,007,390 $ 6.34
Exercised options forfeited and returned
to plans ................................. 2,322,793 --
----------- -----------
Balances, December 31, 2000 ................ 9,443,019 6,346,134 $ 6.28
=========== ===========
The options outstanding, and currently exercisable by exercise price at
December 31, 2000, are as follows (in thousands, except per share data):
WEIGHTED
AVERAGE
REMAINING WEIGHTED
EXERCISE NUMBER NUMBER CONTRACTUAL AVERAGE
PRICE OUTSTANDING EXERCISABLE LIFE (YEARS) PRICE
- --------------------- ----------- ----------- ------------ --------
$0.05-$1.00 111,158 41,158 8.51 $ 0.64
$1.00-$4.00 2,595,002 411,655 9.25 $ 2.95
$4.00-$6.00 2,381,544 27,250 9.53 $ 5.35
$9.00-$12.00 1,258,430 113,750 9.13 $ 10.34
--------- ---------
6,346,134 593,813 9.32 $ 5.28
========= =========
At December 31, 1998 and 1999 vested options outstanding were 243,000
and 123,158, respectively.
Options granted include options to acquire 240,538, 392,758 and 67,500
shares of common stock issued to consultants and other service providers of the
Company during the year ended December 31, 1998, 1999 and 2000 respectively. The
fair value of the common stock options was estimated to be $40,000, $1.1 million
and $403,000 for 1998, 1999 and 2000 respectively, using the Black-Scholes
pricing model at the date of grant, the expected term of the option and the
following assumptions: Risk free rate of 4.5%-4.6%, 4.6%-5.2% and 6.1% in 1998,
1999 and 2000, respectively, no expected dividends and volatility of 60%.
Stock-based compensation related to stock options granted to consultants is
recognized as earned. At each reporting date, the Company re-values the
stock-based compensation using the Black-Scholes pricing model. As a result, the
stock-based compensation expense will fluctuate as the fair market value of our
common stock fluctuates. In connection with the grant of stock options to
consultants and other service providers, the Company recorded stock-based
compensation expense of $40,000, $920,000, and $217,000 for the years ended
December 31, 1998, 1999, and 2000, respectively. There is no future stock-based
compensation expense for these options since all services have been rendered.
In connection with certain stock option grants to employees during the
years ended December 31, 1998, 1999, and 2000, the Company recorded unearned
stock-based compensation totaling $328,000, $15.3 million and $5.0 million,
respectively, which is being amortized over the vesting periods of the related
options which is generally four years using the method set out in FASB
Interpretation No. 28 ("FIN 28"). Under the FIN 28 method, each vested tranche
of options is accounted for as a separate option grant awarded for past
services. Accordingly, the compensation expense is recognized over the period
during which the services have been provided. This method results in higher
compensation expense in the earlier vesting periods of the related options.
Amortization of this stock-based compensation recognized during the years ended
December 31, 1998, 1999, and 2000, totaled approximately $13,000, $1.8 million,
and $7.9 million, respectively.
Pro forma stock-based compensation
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80
The Company has adopted the disclosure-only provisions of Statement of
Financial Accounting Standards No. 123, "Accounting for Stock based
Compensation," ("SFAS No. 123") for option grants to employees. Had compensation
cost been determined based on the fair value at the grant date for the awards in
1998, 1999, and 2000, consistent with the provisions of SFAS No. 123, the
Company's net loss for 1998, 1999, and 2000 would have been as follows (in
thousands):
1998 1999 2000
--------- --------- ---------
Net loss - as reported ...................... $ (7,590) $ (60,169) $(173,730)
Net loss - pro forma ........................ $ (7,613) $ (60,499) $(176,664)
Net loss per common share - basic and diluted
as reported ............................... $ (1.39) $ (7.32) $ (2.89)
Net loss per common share - basic and diluted
pro forma ................................. $ (1.39) $ (7.36) $ (2.94)
Such pro forma disclosures may not be representative of future
compensation cost because options vest over several years and additional grants
are made each year.
The weighted average fair value of options issued during 1998, 1999, and
2000 was $0.11, $1.77, and $3.48, respectively. The fair value of each option
grant is estimated on the date of grant using the minimum value method with the
following assumptions used for grants:
Risk-free interest rate ..................... 4.221%-6.10%
Expected life of option ..................... 5 years
Volatility .................................. 0%-60%
Expected dividends .......................... 0%
NOTE 9 - 401(k):
The Company sponsors an employee savings and retirement plan intended to
qualify under section 401(k) of the Internal Revenue Code. All eligible
employees may contribute up to 20% of compensation, subject to annual
limitations, which are fully vested at all times. The Company retains the
options of matching employees' contributions with a discretionary employer
contribution. To date, no employer contributions have been made.
NOTE 10 - SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED):
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER
------- ------- ------- -------
(AMOUNTS IN 000'S, EXCEPT PER SHARE DATA)
2000
Total Revenue .................................. $ 350 $ 1,491 $ 2,851 $ 4,660
Loss from operations ........................... (34,237) (42,493) (40,025) (59,428)
Net loss attributable to common stockholders ... (34,764) (41,526) (38,646) (58,794)
Net loss per share, basic and diluted .......... $ (2.61) $ (0.56) $ (0.51) $ (0.76)
1999
Total Revenue .................................. $ -- $ -- $ 57 $ 130
Loss from operations ........................... (4,435) (5,351) (8,588) (23,751)
Net loss ....................................... (4,477) (5,721) (8,780) (41,191)
Net loss per share, basic and diluted .......... $ (0.61) $ (0.71) $ (1.00) $ (4.72)
NOTE 11 - INCOME TAXES:
No provisions for income taxes have been recorded as the Company has
incurred net losses since inception.
The Company's effective tax rate varies from the statutory rate as
follows:
1998 1999 2000
-------- -------- --------
U.S. Federal income tax rate .................. (34.00)% (34.00)% (34.00)%
State taxes, net of federal tax benefit ....... (5.84) (5.84) (5.84)
Permanent differences ......................... 0.07 9.06 4.04
Other ......................................... -- (1.91) 3.35
Valuation allowance ........................... 39.77 32.69 32.45
-------- -------- --------
-- -- --
======== ======== ========
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The components of the net deferred tax asset as of December 31, 1999 and
2000 are as follows (in thousands):
DECEMBER 31,
--------------------------
1999 2000
-------- --------
Deferred tax assets:
Net operating loss carryforwards .......... $ 21,626 $ 73,606
Other ..................................... 1,394 5,206
-------- --------
23,020 78,812
Valuation allowance ......................... (22,448) (78,812)
-------- --------
-- --
Net deferred tax asset ...................... 572 --
Deferred tax liabilities:
Depreciation .............................. $ (572) --
-------- --------
Net deferred tax assets ..................... -- --
======== ========
At December 31, 2000, the Company had approximately $195.5 million of
federal and state net operating loss carryforwards available to offset future
taxable income which expire in varying amounts beginning in 2013 and 2005,
respectively. Under the Tax Reform Act of 1986, the amounts of and benefits from
net operating loss carryforwards may be impaired or limited in certain
circumstances. Such amount, if any, has not been determined. Events which cause
limitations in the amount of net operating losses that the Company may utilize
in any one year include, but are not limited to, a cumulative ownership change
of more than 50%, as defined, over a three year period.
Management believes that, based on a number of factors, the available
objective evidence creates sufficient uncertainty regarding the realizability of
the deferred tax assets such that a full valuation allowance has been recorded.
For the years ended December 31, 1998, 1999 and 2000, the valuation allowance
increased by approximately $2.9 million, $19.2 million and $56.4 million,
respectively.
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82
NOTE 12 - SUPPLEMENTAL CASH FLOW INFORMATION:
FOR THE YEAR ENDED
DECEMBER 31,
-----------------------------------
1998 1999 2000
-------- -------- --------
(In thousands)
SUPPLEMENTAL CASH FLOW INFORMATION:
Cash paid for interest ..................................... $ 109 $ 831 $ 2,649
-------- -------- --------
SUPPLEMENTAL NON CASH INVESTING AND FINANCING ACTIVITY:
Conversion of Mandatorily redeemable preferred stock
to common ............................................... $ -- $ -- $156,360
-------- -------- --------
Acquisition of subsidiary ................................. $ 509 $ -- $ --
Less notes payable issued for acquisition ................. (405) -- --
Less common stock options issued in acquisition ........... (7) -- --
Net cash payment .......................................... (51) -- --
-------- -------- --------
Liabilities assumed on acquisition of subsidiary .......... $ 46 $ -- $ --
-------- -------- --------
Property and equipment acquired under capital leases ...... $ 1,855 $ 12,819 $ 3,592
-------- -------- --------
Conversion of convertible promissory notes into
mandatorily redeemable preferred stock .................. $ 2,455 $ 5,000 $ --
-------- -------- --------
Conversion of accrued interest on convertible
promissory notes into mandatorily redeemable
preferred stock ......................................... $ 60 $ 11 $ --
-------- -------- --------
Issuance of warrants in connection with capital
leases .................................................. $ 39 $ 547 $ --
-------- -------- --------
Issuance of warrants in connection with borrowings ........ $ -- $ 1,005 $ --
-------- -------- --------
Issuance of warrants in connection with
facilities lease and other services ..................... $ 92 $ 411 $ --
-------- -------- --------
Issuance of warrants in connection with operating
agreement ............................................... $ -- $ 7,012 $ --
-------- -------- --------
Advertising received for Series C mandatorily
convertible redeemable preferred stock .................. $ -- $ 38,824 $ --
-------- -------- --------
Deemed dividend on issuance Series C preferred stock ...... $ -- $ 16,676 $ --
-------- -------- --------
Accretion of mandatorily redeemable convertible
preferred stock ......................................... $ -- $ 74 $ 341
-------- -------- --------
Unearned stock-based compensation related to
common stock option grants to employees, net of
cancellations ........................................... $ 328 $ 15,195 $ 5,099
-------- -------- --------
Grant of common stock and warrants for services ........... $ 40 $ 1,097 $ 403
-------- -------- --------
NOTE 13 - SUBSEQUENT EVENTS (UNAUDITED)
During February and March 2001, the Company received $20 million from
HUGHES under an 8%, $20 million convertible subordinated unsecured note. The
note was issued to the Company, by HUGHES, in connection with the December 21,
2000 "Agreement and Plan of Merger by and among Telocity, HUGHES and DirecTV
Broadband Inc." (see Note 1).
On March 28, 2001, the Company received notice from NorthPoint
Communications Inc. ("NorthPoint"), a major supplier of DSL connections, that
following the United States Bankruptcy Court approved sale of substantially all
of NorthPoint's assets, NorthPoint would begin the shut down of its network. As
of March 28, 2001, the Company had approximately 19,700 active subscribers using
NorthPoint connections (the "NorthPoint Subscribers"). It is probable that all
the NorthPoint subscribers will experience an interruption to their service for
a minimum of three weeks while their DSL line is reprovisioned with a different
carrier with whom the Company has an existing relationship. In order to
compensate the NorthPoint subscribers, the Company will immediately suspend
billing when service is interrupted and offer a free month of service to each
subscriber that is successfully reprovisioned. The Company estimates that the
impact of the interruption and reprovisioning of service to the NorthPoint
subscribers will likely reduce 2001 revenue by a minimum of $2.0 million and
result in $2.4 million of incremental operating costs.
F-21
83
INDEX TO EXHIBITS
Exhibit
Number Description
- ------- -----------
23.1 Consent of Independent Accountants