1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT
OF 1934.
FOR THE PERIOD ENDED APRIL 2, 2001
COMMISSION FILE NUMBER: 333-94271
DIRECTV BROADBAND, INC.
(FORMERLY 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 CUPERTINO, CALIFORNIA 95014
(Address of principal executive offices) (Zip Code)
(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 30 days. Yes No X_
As of April 2, 2001, 82,468,226 shares of the Registrant's Common Stock, $0.001
par value, were issued and outstanding.
2
DIRECTV BROADBAND, INC.
(FORMERLY TELOCITY DELAWARE, INC.)
INDEX
PAGE NO.
--------
PART I. FINANCIAL INFORMATION (UNAUDITED)
Item 1. Condensed Consolidated Financial Statements
Condensed Consolidated Balance Sheets as of
April 2, 2001 and December 31, 2000 ................................ 2
Condensed Consolidated Statements of Operations for the Two Days
and Period Ended April 2, 2001 and the Three and the Six Months
Ended June 30, 2000 ................................................ 3
Condensed Consolidated Statements of Cash Flows for the Period
January 1, 2001 through April 2, 2001 (Period ended April 2, 2001)
and for the Six Months Ended June 30,2000 .......................... 4
Notes to Condensed Consolidated Financial Statements ................ 5
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations .......................................... 7
Item 3. Qualitative and quantitative disclosures about market risk .......... 9
PART II. OTHER INFORMATION (UNAUDITED)
Item 1. Legal Proceedings ................................................... 14
Item 2. Changes in Securities And Use of Proceeds ........................... 14
Item 3. Reports on Form 8-K ................................................. 14
SIGNATURES .......................................................... 14
1
3
PART I. FINANCIAL INFORMATION
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
DIRECTV BROADBAND, INC.
(FORMERLY TELOCITY DELAWARE, INC.)
CONDENSED CONSOLIDATED BALANCE SHEETS
(AMOUNTS IN 000'S, EXCEPT SHARE AMOUNTS)
APRIL 2, DECEMBER 31,
2001 2000
(UNAUDITED) (NOTE 2)
----------- ------------
ASSETS
Current assets:
Cash and cash equivalents ................................ $ 2,343 $ 38,422
Accounts receivable, net ................................. 828 539
Prepaid expenses and other current assets ................ 8,813 11,803
--------- ---------
Total current assets ............................... 11,984 50,764
Property and equipment, net ................................... 53,548 45,311
Intangibles, net .............................................. 251 278
Other assets .................................................. 31,811 35,990
--------- ---------
Total assets ....................................... $ 97,594 $ 132,343
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities:
Accounts payable ......................................... $ 18,377 $ 23,761
Accrued liabilities ...................................... 39,539 21,662
Deferred revenue ......................................... 1,343 1,026
Capital lease obligations, current ....................... 4,904 5,757
--------- ---------
Total current liabilities .......................... 64,163 52,206
Notes payable, net of current portion ......................... 20,000 --
Capital lease obligations, net of current
portion .................................................. 6,490 6,860
Other liabilities ............................................. 314 264
--------- ---------
Total liabilities ................................... $ 90,967 $ 59,330
--------- ---------
Stockholders' equity:
Common stock: $0.001 par value, 250,000,000
shares authorized; issued and
outstanding: 82,468,226 in 2001 and
81,623,140 in 2000 ..................................... 79 78
Additional paid-in capital ............................... 325,910 326,450
Receivable from stockholders ............................. (3,427) (3,326)
Unearned stock-based compensation ........................ (6,630) (8,022)
Accumulated deficit ...................................... (309,305) (242,167)
--------- ---------
Total stockholders' equity ......................... 6,627 73,013
--------- ---------
Total liabilities and stockholders'
equity ............................................. $ 97,594 $ 132,343
========= =========
The accompanying notes are an integral part of these condensed consolidated
financial statements.
2
4
DIRECTV BROADBAND, INC.
(FORMERLY TELOCITY DELAWARE, INC.)
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(AMOUNTS IN 000'S, EXCEPT SHARE AND PER SHARE AMOUNTS)
(UNAUDITED)
Two-Days Three-Months Six-Months
Ended Ended Period Ended Ended
April 2, June 30, April 2, June 30,
2001 2000 2001 2000
------------ ------------ ------------ ------------
Revenues ..................................... $ 197 $ 1,491 $ 8,050 $ 1,841
------------ ------------ ------------ ------------
Operating costs and expenses:
Network and product costs ............... 294 6,549 18,286 10,799
Sales and marketing ..................... 245 16,710 17,465 29,112
General and administrative .............. 1,618 10,539 21,853 18,655
Research and development ................ 135 4,682 6,166 9,216
Amortization of stock-based
compensation (*) ....................... 109 2,285 5,012 5,485
Depreciation and amortization ........... 142 3,219 6,517 5,304
------------ ------------ ------------ ------------
Total operating expenses .......... 2,543 43,984 75,299 78,571
------------ ------------ ------------ ------------
Loss from operations ......................... (2,346) (42,493) (67,249) (76,730)
Interest income/(expense), net ............... 3 967 135 781
Other expense ................................ -- -- (24) --
------------ ------------ ------------ ------------
Net loss ..................................... $ (2,343) $ (41,526) $ (67,138) $ (75,949)
Accretion on mandatorily redeemable
convertible preferred stock ................ -- -- -- 341
------------ ------------ ------------ ------------
Net loss attributable to common stockholders . $ (2,343) $ (41,526) $ (67,138) $ (76,290)
============ ============ ============ ============
Net loss per share, basic and diluted ........ $ (0.03) $ (0.56) $ (0.86) $ (1.74)
Shares used in computing net loss per
share, basic and diluted ................... 78,726,834 74,499,599 77,769,396 43,903,027
Two-Days Three-Months Six-Months
Ended Ended Period Ended Ended
(*) Amortization of stock-based April 2, June 30, April 2, June 30,
compensation: 2001 2000 2001 2000
------------ ------------ ------------ ------------
Network and product costs ................... $ 2 $ 78 $ 18 $ 267
Sales and marketing ......................... 29 800 4,338 1,174
General and administration .................. 58 1,024 501 3,300
Research and development .................... 20 383 155 744
------------ ------------ ------------ ------------
$ 109 $ 2,285 $ 5,012 $ 5,485
============ ============ ============ ============
The accompanying notes are an integral part of these condensed consolidated
financial statements.
3
5
DIRECTV BROADBAND, INC.
(FORMERLY TELOCITY DELAWARE, INC.)
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(AMOUNTS IN 000'S)
(UNAUDITED)
Period Six-Months
Ended Ended
April 2, June 30,
2001 2000
--------- ---------
Cash flows from operating activities:
Net cash used in operating activities $ (40,719) $ (51,398)
--------- ---------
Cash flow from investing activities:
Proceeds from the sale of property and equipment 23 --
Purchase of property and equipment (14,057) (16,624)
--------- ---------
Net cash used in investing activities (14,034) (16,624)
--------- ---------
Cash flows from financing activities:
Proceeds from issuance of common stock, net 159 120,541
Proceeds from issuance of warrants for common stock 38 536
Proceeds from issuance of notes payable 20,000 --
Repayments of notes payable -- (5,976)
Principal payments on capital lease obligations (1,223) (2,372)
Increase in restricted cash related to commitments (300) (4,561)
--------- ---------
Net cash provided by financing activities 18,674 108,168
--------- ---------
Net increase/(decrease) in cash and cash equivalents (36,079) 40,146
Cash and cash equivalents, beginning of period 38,422 66,978
--------- ---------
Cash and cash equivalents, end of period $ 2,343 $ 107,124
========= =========
The accompanying notes are an integral part of these condensed consolidated
financial statements
4
6
DIRECTV BROADBAND, INC.
(FORMERLY TELOCITY DELAWARE, INC.)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. DESCRIPTION OF BUSINESS
DIRECTV Broadband, Inc. (formerly 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.
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 was successfully completed on April 3, 2001. As of
April 3, 2001, DIRECTV Broadband, Inc. merged with and into the Company and
became a wholly owned subsidiary of HUGHES.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of presentation
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amount reported in the financial statements. Actual
results may differ from those estimates. The consolidated financial statements
of the Company include the accounts of all its wholly owned subsidiaries.
The consolidated financial statements at April 2, 2001 and for the
period ended April 2, 2001 are unaudited, but include all adjustments
(consisting only of recurring adjustments) which, in the opinion of management,
are necessary for a fair presentation of financial position and operating
results. The Company's obligation to report on Form 10-Q ceased on April 3, 2001
when it merged with and into DIRECTV Broadband, Inc. and it became a wholly
owned subsidiary of HUGHES. Operating results for the period ended April 2, 2001
and the six-month period ended June 30, 2000 are not necessarily indicative of
results that may be expected for any future periods.
The consolidated balance sheet at December 31, 2001 has been derived
from the audited consolidated financial statements at that date, but does not
include all of the information and footnotes required by generally accepted
accounting principles for complete financial statements.
The information included in this report should be read in conjunction
with the Company's 2000 Annual Report on Form 10-K.
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 April 2, 2001, the Company had restricted cash of approximately
$6.3 million, of which $4.8 million related to letter of credit facilities with
a bank, which had terms in excess of one year. The current portion of restricted
cash of $1.5 million has been included in "prepaid expenses and other current
assets", while the long term balance of $4.8 million has been included in "other
assets".
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 period ended April 2, 2001 and the
six-month period ended June 30, 2000, software development costs of
approximately $306,000 and $1.4 million, respectively, were capitalized and
included in property and equipment.
5
7
Advertising Costs
Advertising costs are expensed the first time the advertising takes
place. Included in prepaid expenses, other current assets and other assets at
April 2, 2001 and December 31, 2000 is $19.5 million and $23.5 million,
respectively, related to advertising commitments received from National
Broadcasting Company, Inc. and NBC Internet, Inc. in exchange for the issuance
of Series C mandatorily redeemable preferred stock. Advertising expense for the
period ended April 2, 2001 and the six-month period ended June 30, 2000 was
$12.2 million and $15.0 million respectively; advertising expense for the period
ended April 2, 2001, is inclusive of stock-based compensation of $4.0 million.
3. RECLASSIFICATIONS
Certain prior period amounts have been reclassified to conform to April
2, 2001 presentation.
4. NET LOSS PER SHARE
Basic and diluted net loss per share have been computed using the
weighted-average number of shares of common stock outstanding during the period,
less shares subject to repurchase. Diluted net loss per share includes common
equivalent shares outstanding during the period, if dilutive.
The following table represents the calculation of basic and diluted net
loss per share (in thousands, except share and per share amounts):
Period Six-Months
Two Days Three-Months Ended Ended
Ended Ended April 2, June 30,
April 2, 2001 June 30, 2000 2001 2000
------------- ------------- ------------ ------------
Numerator:
Net loss .................... $ (2,343) $ (41,526) $ (67,138) $ (75,949)
Accretion on mandatorily
redeemable convertible
preferred stock ........... - - - 341
------------ ------------ ------------ ------------
Net loss attributable to
common stockholders ....... $ (2,343) $ (41,526) $ (67,138) $ (76,290)
============ ============ ============ ============
Denominator:
Weighted-average common
shares - basic and
diluted ................... 82,468,226 85,206,384 81,897,145 55,868,924
Weighted-average shares
subject to repurchase ..... (3,741,392) (10,706,785) (4,127,749) (11,965,897)
------------ ------------ ------------ ------------
Denominator for basic and
diluted calculation ....... 78,726,834 74,499,599 77,769,396 43,903,027
============ ============ ============ ============
Basic and diluted net loss
per share ................. $ (0.03) $ (0.56) $ (0.86) $ (1.74)
============ ============ ============ ============
Options to purchase 5,922,334 and 795,412 shares of common stock or
convertible preferred stock at an average exercise price of $6.54 and $7.32 per
share, respectively, and warrants to purchase 2,076,870 and 4,657,126 shares of
common or convertible preferred stock at an average exercise price of $3.65 and
$5.98 per share, respectively, have not been included in the computation of
diluted net loss per share for the two-days and the period ended April 2, 2001
and the three and six-months ended June 30, 2000, respectively, as their effect
would have been anti-dilutive.
5. COMPREHENSIVE INCOME
To date, the Company has not had any transactions that are required to
be reported in comprehensive income.
6
8
6. NEW ACCOUNTING PRONOUNCEMENT
In June 1998, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities",
which establishes accounting and reporting standards for derivative instruments
and hedging activities. It requires an entity to recognize all derivatives as
either assets or liabilities in the balance sheet and measure those instruments
at fair value. The Company adopted SFAS No. 133 (as amended by SFAS No. 138) as
required by SFAS No. 137, "Deferral of the Effective Date the FASB Statement No.
133", effective January 1, 2001. The Company, to date, has not engaged in
derivative and hedging activities, and accordingly the adoption of SFAS No. 133
did not have a material effect on the financial statements.
7. BORROWINGS
During February and March 2001, the Company received $20 million from
HUGHES under an 8% convertible subordinated unsecured note which matures on
January 31, 2004. 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).
8. SUBSEQUENT EVENTS
On April 3, 2001, DIRECTV Broadband, Inc. merged with and into the
Company, and the Company became a wholly owned subsidiary of HUGHES, following
the successful completion of HUGHES' tender offer, through its recently formed
subsidiary, DIRECTV Broadband, Inc., to acquire all of the Company's outstanding
shares of common stock at a purchase price of $2.15 per share, or approximately
$178.0 million.
During April 2001, approximately 19,700 of the Company's subscribers who
received DSL connectivity through NorthPoint Communications, Inc. ("NorthPoint";
the "NorthPoint subscribers") lost their service following NorthPoint's decision
to shut down its network. The Company had received notice of the shut down on
March 28, 2001 following the United States Bankruptcy Court's approved sale of
substantially all of NorthPoint's assets. Where possible, the Company has
reprovisioned service to NorthPoint subscribers where it has an alternate,
financially secure, supplier of DSL connectivity. The Company is also entering
into new commercial relationships with suppliers of DSL connectivity in those
geographical markets where it does not currently have an alternate, financially
secure, supplier. Despite these efforts, however, the Company estimates that in
excess of 14,000 subscribers will not be reprovisioned through a combination of
no alternate last mile provider and customers choosing to terminate their
service.
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The discussion in this report on Form 10-Q contains forward-looking
statements that involve risks and uncertainties. The statements contained in
this Report that are not purely historical are forward-looking statements within
the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended, including
statements regarding our expectations, beliefs, intentions or strategies
regarding the future. All forward-looking statements included in this document
are based on information available to us on the date hereof, and we assume no
obligation to update any such forward-looking statements. Our actual results
could differ materially from those described in our forward-looking statements.
Factors that could cause or contribute to such differences include, but are not
limited to, our ability to provision timely, consistent and reliable DSL
services; our unproven business model and a limited operating history in a new
and rapidly evolving industry; our ability to implement our business plan; and
our ability to manage our growth, retain and grow our customer base and expand
our service offerings.
Additional risk factors are discussed under the heading "Risk Factors"
both below and in our 2000 Annual Report on 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
7
9
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
April 2, 2001, we were offering services in more than 150 metropolitan
statistical areas nationwide. At April 2, 2001, we had approximately 65,000
active subscribers, inclusive of approximately 19,700 subscribers who were
provisioned through NorthPoint Communications Inc. ("NorthPoint").
During April 2001, approximately 19,700 of the Company's subscribers who
received DSL connectivity through NorthPoint lost their service following
NorthPoint's decision to shut down its network. The Company had received notice
of the shutdown on March 28, 2001 following the United States Bankruptcy Court's
approved sale of substantially all of NorthPoint's assets. More recently,
Rhythms NetConnections Inc., another one of our DSL access providers, also filed
for bankruptcy. Where possible, the Company has reprovisioned service to
NorthPoint subscribers where it has an alternate, financially secure, supplier
of DSL connectivity and will attempt to do so for any customers adversely
affected by Rhythms' bankruptcy. The Company is also entering into commercial
relationships with suppliers of DSL connectivity in those geographical markets
where it does not currently have an alternate, financially secure, supplier.
Despite these efforts, however, the Company estimates that in excess of 14,000
subscribers will not be reprovisioned through a combination of no alternate last
mile provider and customers choosing to terminate their service.
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 to 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 was
successfully completed on April 2, 2001. As of April 3, 2001, DIRECTV Broadband,
Inc. merged with and into the Company, and the Company became a wholly owned
subsidiary of HUGHES.
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;
- 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. As of April 2,
2001, we had an accumulated deficit of $309.3 million.
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
8
10
incremental expenditures primarily include local access costs and gateway device
costs.
TWO DAYS ENDED APRIL 2, 2001 AND THE PERIOD ENDED APRIL 2, 2001 COMPARED TO THE
THREE AND SIX MONTHS ENDED JUNE 30, 2000
This report on Form 10-Q covers the period from April 1 to April 2, 2001
(period ended April 2, 2001). Our obligation to report on Form 10-Q ceased on
April 3, 2001 when we merged with and into DIRECTV Broadband Inc. and we became
a wholly owned subsidiary of HUGHES.
No meaningful comparisons can be drawn between the two days and the
period ended April 2, 2001, and the three and six-month periods ended June 30,
2000 due to their differences in length.
General and Administrative Expenses. General and administrative expenses
for the two days ended April 2, 2001, is inclusive of investment banking fees of
$1.2 million which were contingent upon the successful sale of the Company.
These fees were expensed following the successful completion of HUGHES' tender
offer, through its recently formed subsidiary, DIRECTV BROADBAND, INC., to
acquire all of the Company's outstanding shares of common stock at a purchase
price of $2.15 per share, or approximately $178.0 million, on April 2, 2001.
LIQUIDITY AND CAPITAL RESOURCES
No cash transactions occurred during the two days ended April 2, 2001.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities",
which establishes accounting and reporting standards for derivative instruments
and hedging activities. It requires an entity to recognize all derivatives as
either assets or liabilities in the balance sheet and measure those instruments
at fair value. The Company adopted SFAS No. 133 (as amended by SFAS No. 138) as
required by SFAS No. 137, "Deferral of the Effective Date the FASB Statement No.
133", effective January 1, 2001. The Company, to date, has not engaged in
derivative and hedging activities, and accordingly the adoption of SFAS No. 133
did not have a material effect on the financial statements.
ITEM 3: 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 intend to maintain our portfolio of cash equivalents
and short-term investments in a variety of securities, including commercial
paper, money market funds, government and non-government debt securities. 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 April 2,
2001, all of our cash and cash equivalents were in money market and checking
funds.
OTHER RISK FACTORS
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
9
11
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. and Rhythms NetConnections Inc., two of our DSL access
providers, recently filed for bankruptcy and Northpoint has shut down its DSL
network, interrupting service to approximately 19,700 of our customers. We are
diligently seeking to reprovision the customers affected by Northpoint's shut
down and may have to do the same for the customers with service through Rhythms
should it also shut down its network; however, a substantial number of these
customers have chosen or may choose to terminate their relationship with us. 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 instances 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.
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.
10
12
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.
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 a provider of
our DSL connections, 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, PacBell would no longer be able to install DSL
connections for our customers, or they may increase the fees they charge us for
providing us with DSL connections. The inability of our contract manufacturer to
provide us with adequate supplies of our gateway and the inability of PacBell to
install DSL connections for new customers
11
13
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.
OUR FAILURE TO MEET CHANGING CUSTOMER REQUIREMENTS AND EMERGING INDUSTRY
STANDARDS WOULD LIMIT OUR ABILITY TO ATTRACT AND RETAIN CUSTOMERS.
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.
12
14
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.
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.
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 ours are changed or vacated, or if new
regulatory mandates degrade competition, our costs will increase and we will
have lower profit margins.
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.
13
15
PART II. OTHER INFORMATION
ITEM 1. 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 filing, we are
not party to any litigation that we believe could adversely affect our business
relationship and our financial results.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
NONE
ITEM 6. REPORTS ON FORM 8-K
The Company filed a report on Form 8-K dated April 4, 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.
DIRECTV Broadband, Inc.,
(formerly TELOCITY DELAWARE, INC.)
Date: August 14, 2001 BY: /s/ Edward Hayes
----------------------------------------
Edward Hayes
President & CEO
/s/ David Wilson
----------------------------------------
David Wilson
Vice President & Chief Financial Officer
14