Beginning late last week and continuing over the week-end, I've spent quite a few hours reading SEC documents. Based on my findings, I believe we will eventually see a positive disjoint between Com21's share price and Terayon's. If nothing else, it's clear the SEC has taken note of their revenue recognition history and has required a change. I know most won't have time to read this rather lengthy post, but I would appreciate some help on Terayon's numbers regarding customers and geographical regions listed towards the end.
In December 1999, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements" ("SAB 101"). SAB 101 provides guidance on the recognition, presentation and disclosure of revenue in the financial statements of public companies. The accounting profession is currently exploring practical means of implementing the guidelines established by SAB 101. To the extent that SAB 101 is applicable to us, we will be required to change our revenue recognition policy. Changes in our revenue recognition polices will be reported as a change in accounting principle in the second quarter ended June 30, 2000. The change in accounting principle will not result in any restatement of prior periods but will result in a cumulative adjustment in the second quarter to reflect the deferral of revenue previously recognized for shipments that did not meet the revenue recognition criteria established by SAB 101. Any such revenue deferred will be subsequently recognized in the period in which the revenue recognition criteria are met. Revenue for all shipments occurring after April 1, 2000 will be recognized based on the criteria established by SAB 101. We currently cannot determine what effect, if any, that SAB 101 will have on our financial statements. Management believes that SAB 101 will not affect the underlying strength or weakness of our business operations as measured by the dollar value of our product shipments and cash flows.
While Gilder's organization may ignore the fine print of SEC documents, I'm quite certain major funds and institutions don't. The following is a comparison of Terayon's 1998 10-K (March 30, 1999) and its 1999 10-K (March 30, 2000). For easier reading I've put the 1998 segments in normal text and the 1999 in bold. For the most part I've left it to the reader to notice the changes.
Business Segments (98)
Terayon operates in one business segment, the sale of cable modem access systems. Our products are sold together as part of the TeraComm system and we do not report revenue derived from these individual components.
Business Segments (99)
We operate in one business segment, the sale of broadband access systems. Our primary products are sold together as part of systems and we do not report revenue derived from the sale of individual components.
Research and Development (98)
. . . We also currently are designing and developing a DOCSIS 1.2-compliant system, which will include a cable modem and an accompanying headend controller, the TeraLink 2000 Master Controller. These products are in the early stages of development and we do not anticipate commercial deployment of these products until 2000.
Research and Development (99)
. . . We currently are designing and developing a DOCSIS system that includes S-CDMA advanced PHY capabilities, which will include a cable modem and an accompanying headend controller. These products are in the early stages of development and we do not anticipate commercial availability of these products until late 2000. We also are developing a common multimedia platform for current and advanced transmission of data, voice and video over existing broadband infrastructures, includingcable, DSL and wireless. These products also are in the early stages of development and we do not anticipate commercial availability of these products until late 2001.
Overview (98)
We develop, market and sell cable modem systems based upon our S-CDMA technology. Since our inception in January 1993, we have focused on the development of our S-CDMA technology, as well as certain other core technologies, to enable broadband transmission of data over cable networks. We commenced the specification and design of our first ASIC inOctober 1994 and produced the first version of this ASIC in June 1996.At the same time, we developed an end-to-end broadband access system, the TeraComm system, around the ASIC. During late 1996 and through 1997, we commenced limited field trials of the TeraComm system with several cable operators. In the first quarter of 1998, we commenced volume shipments to a small number of cable operators. We had revenues of $31.7 million in 1998 and $2.1 million in 1997. We generally recognize product revenues upon shipment of products to customers. While our existing agreements do not contain price protection provisions and certain returnrig rights, future agreements may contain such provisions. . . .
Overview (99)
Our line of business is to develop, market and sell broadband access systems. Our objective is to be the leading provider of broadband access systems to providers of services to residential and commercial end users. Since our inception in January 1993, we have focused on the development of our patented S-CDMA technology, as well as certain other core technologies, to enable broadband transmission of data over cable networks. We began the specification and design of our first ASIC in October 1994 and produced the first version of this ASIC in September 1996. At the same time, we developed an end-to-end broadband access system, the TeraComm system, around the ASIC. We commenced volume shipments of our TeraComm system in the first quarter of 1998. However, with some recent acquisitions of complimentary technology and businesses, we have also turned our attention to providers of broadband services using existing telephone, copper wire infrastructures and wireless systems. . . .
[98]
In 1998, sales to Shaw represented approximately 40% of our revenues, sales to Cablevision represented approximately 16% and sales to Sumitomo represented approximately 14% of our revenues. In 1997, sales to Telegate represented approximately 30% of our revenues, sales to Sumitomo represented approximately 29% and sales to NET Brasil represented 14% our revenues. We expect that sales to a limited number of customers will continue to account for a substantial portion of our sales for the foreseeable future. If orders from significant customers are delayed, canceled or otherwise fail to occur in any particular period, or if any significant customer delays payment or fails to pay,we could experience significant operating losses in such period. As a result, we expect to experience significant fluctuations in our operating results on a quarterly and annual basis.
[1999]
In 1999, four customers accounted for approximately 66% of our revenues.This compares to approximately 70% of our revenues from three customers in 1998. We anticipate that the timing and maturity of these customers' deployments of the TeraComm system will result in variations in revenues generated from these customers.
[A comparison of the following paragraphs reveals more than any other part of the annual report. It's important to note what's changed over the past year. I've lifted these two paragraphs from the exact same position in each report, listed under "Item 7, Management's discussion and analysis of financial condition and results of operations." ]
[1998:]
The market for broadband access products and services is intensely competitive and is characterized by rapid technological change, new product development and product obsolescence, evolving industry standards and significant price erosion of products over time. We have experienced and expect to continue to experience downward pressure on our unit ASPs. We had negative gross margins from inception until the fourth quarter of 1998. We achieved a positive gross margin for the first time in the quarter ended December 31, 1998. While we have initiated cost reduction programs to offset pricing pressures on our products, we cannot be sure that these cost reduction efforts will continue to keep pace with competitive price pressures or lead to an improved gross margin. If we are unable to reduce costs efficiently, our gross margin and profitability will suffer. Our gross margin also is affected by the sales mix of TeraLink 1000 Master Controllers to TeraLink Gateways and to TeraPro cable modems. The TeraPro modems have significantly lower margins than the TeraLink 1000 Master Controllers and TeraLink Gateway headend products. As a result, the Company's gross margin also is affected by the maturity of TeraComm deployments in any quarter, because new deployments of the TeraComm system involve the sale of headend equipment (which has higher margins). In addition, new deployments generally involve smaller quantities of product, which typically are sold at higher margins than the larger volume sales of product associated with more mature deployments of the TeraComm system. For the foreseeable future, we expect negative or nominal margins on TeraPro cable modems and expect that sales of TeraPro cable modems will continue to constitute a significant portion of our revenues. As a result of these factors, our gross margins and operating results are likely to suffer in the near term. Our components are sold together as part of an entire system, and accordingly we do not report revenue derived from each component.
[1999:]
The market for broadband access products and services is characterized by rapid technological change, new product development, product obsolescence and evolving industry standards. A significant element of our strategy is to advance industry standards and to extend our technology leadership and achieve rapid time to market. In November1998, CableLabs selected us to co-author DOCSIS 1.2, an enhanced version of the DOCSIS cable modem specification based in part on our S-CDMA technology. In September 1999, CableLabs indicated that it intended to proceed with the advanced PHY work on two parallel tracks: one for the development of a prototype based on our S-CDMA technology and one for the inclusion of Advanced TDMA technology, as proposed by other companies. In February 2000, CableLabs further clarified the status of the advanced PHY project regarding a separate release that will includeTDMA technologies. In addition, CableLabs reiterated that it is continuing to work with us on the development of a DOCSIS specification that could include our S-CDMA technology. To that end, CableLabs has requested that we submit a prototype of a DOCSIS system that incorporates an S-CDMA advanced PHY capability for testing. CableLabs has stated that if the testing of this prototype reveals that the S-CDMA advanced PHY works as claimed (including proper backwards compatibility and coexistence with the other aspects of DOCSIS), and if the costs for adding S-CDMA to DOCSIS products are in line with estimates, then it is likely that S-CDMA advanced PHY capabilities will be included in a future version of the DOCSIS specification. The prototype we submit to CableLabs may fail to demonstrate the level of performance that CableLabs seeks, even if it does meet performance expectations there canbe no guarantee that CableLabs will incorporate the technology into a future version of DOCSIS specifications. In addition, if CableLabs does proceed to include S-CDMA in a future DOCSIS specification, there can be no guarantee that the DOCSIS S-CDMA specification will be the same as the specification we incorporated in the prototype submitted for tests, which may require us to further develop our prototype. .We intend to develop future products that are standards compliant and are actively participating in the development of additional industry standards. As part of our efforts to offer standards compliant products we introduced a CableLabs certified DOCSIS 1.0 cable modem to the market in the third quarter of 1999. [My note: this is an OEM-licensed product.]
[The next paragraphs diverge almost completely. In 1998, manufacturing is focused on S-CDMA products; in 1999 broadband access technologies and acquisitions are the focus: ]
[98:]
Our ability to generate revenues also depends on guaranteeing the availability of supplies from our sole sources, increasing the manufacturing and testing capacity of our products by a contractor while ensuring product quality, and continuing deployment of our products by existing and new customers. In the first quarter of 1998, we transitioned our manufacturing operations from CMC to Solectron. We recorded a charge of $1.3 million in the first quarter of 1998 relating to the write-off of inventory as a result of transitioning manufacturing operations to Solectron. A portion of the charge consisted of $750,000 of raw material components that were deemed obsolete due to a design change in our bill of materials during the quarter ended March 31, 1998.The charge also consisted of a $550,000 write-down of parts repurchased from CMC and then resold to Solectron. Since Solectron could purchase the related parts at a lower cost than we had valued the inventory, we wrote down the inventory to the lower of cost or market as part of selling the inventory to Solectron. We currently test and assemble theTeraLink 1000 Master Controller and the TeraLink Gateway headend equipment at our Santa Clara facility. Finished TeraPro cable modems are drop shipped by Solectron to our customers.
[99, covers 2 paragraphs instead of one:]
The rapid evolution of broadband has resulted in cable television operators, providers of telephone service and other service providers seeking to provide a bundle of voice, data and video services to their residential and commercial subscribers over existing and new infrastructures. Consistent with our objective to be a leading provider of broadband access systems, through a series of recent acquisitions, we are building a complete portfolio of broadband products to support high-speed delivery of voice, data and video services over cable, copper wire(DSL) and wireless. In the fall of 1999, we acquired Imedia Corporation and the CherryPicker digital video management system. In November 1999, we completed our acquisition of Radwiz Ltd., a provider of communication access systems based on high-speed IP routing, integrated with telephony, and on January 2, 2000 we completed our acquisition of Telegate Ltd., a developer and manufacturer of telephony and data access platforms that are deployed by service providers to deliver efficient carrier-class voice services over cable. In addition, in February 2000, we entered into definitive agreements to acquire the Access Network Electronics Division (ANE) of Tyco Electronics Corporation, a subsidiary of Tyco International Ltd., and Combox Ltd. In March 2000 we entered into an agreement to purchase certain assets of Internet Telecom Ltd.and an agreement to acquire Ultracom Ltd.
The intensely competitive nature of the market for broadband access systems has resulted in significant price erosion over time. We have experienced and expect to continue to experience downward pressure on our unit ASP or average selling price. We had negative gross margins from inception until the fourth quarter of 1998 when we achieved a positive gross margin for the first time as a result of our execution of cost reduction strategies. A key component of our strategy is to decrease the cost of manufacturing our products to improve our gross margins. For example, in the fourth quarter of 1998, we introduced a cable modem using a single-board design, which has higher gross margins than our original dual board design. Subsequently, we have successfully introduced several cost reduced versions of the single-board modem that have allowed us to continue to improve gross margin performance despite ongoing ASP declines. We intend to continue to engage in and implement cost reduction efforts, including the further integration of ASIC components, other design changes and manufacturing efficiencies.
[98:]
We sustained net losses applicable to common stockholders of $47.1 million $22.5 million and $10.7 million for the years ended December 31,1998, 1997 and 1996, respectively. As a result, we had an accumulated deficit of $84.3 million as of December 31, 1998. Our operating expenses are based in part on our expectations of future sales, and we expect that a significant portion of our expenses will be committed in advance of sales. Operating results may be adversely affected by a reduction in sales if we are unable to adjust expenses quickly in response to any decrease in sales. We expect to increase significantly expenditures in technical development, sales and marketing and manufacturing as we engage in activities related to product enhancement, cost reduction and commercialization of new products. Additionally, we expect to increase capital expenditures and other operating expenses in order to support and expand our operations. We anticipate that we will spend approximately $4.0 million on capital expenditures and approximately $15.0 million on research and development during the 12 months ended December 31, 1999. Anticipated capital expenditures consist of purchases of additional test equipment to support higher levels of production and computer hardware, software and equipment for newly hired employees. As a result of these anticipated increased operating expenses, we expect to continue to incur losses for the foreseeable future.
[Actual expenditures: R&D $17.519 million, Product development assistance agreement $35.147 million, In-process R&D $14.6 million, Purchase property & equipment $4.716 million]
[99; not sure why manufacturing is omitted from list of expected expenditures:]
We sustained net losses applicable to common stockholders of $64.1 million in 1999, $47.1 million in 1998 and $22.5 million in 1997. As a result, we had an accumulated deficit of $148.4 million as of December 31, 1999. Our operating expenses are based in part on our expectations of future sales, and we expect that a significant portion of our expenses will be committed in advance of sales. We expect to continue to increase our expenditures in technical development and sales and marketing as we engage in activities related to product enhancement, cost reduction and increasing market penetration. Additionally, we expect to increase our capital expenditures and other operating expenses in order to support and expand our operations. We anticipate that we will spend approximately $17.0 million on capital expenditures and approximately $35.0 to $45.0 million on research and development during the 12 months ended December 31, 2000. Anticipated capital expenditures consist of purchases of additional test equipment to support higher levels of production and computer hardware, furniture and leasehold improvements for expansion of our facilities, implementation of an ERP system and software and equipment for newly hired employees. As a result of these anticipated increased operating expenses, we expect to continue to incur losses for the foreseeable future.
Results of Operations Years Ended December 31, 1998 and 1997
Revenues.
Our revenues increased to $31.7 million in 1998 from $2.1 million in 1997. Revenues consist primarily of sales of cable modems and headend equipment to new and existing customers. We did not commence selling our products until June 1997 and did not commence selling our products in volume until the first quarter of 1998.
Results of Operations Years Ended December 31, 1999 and 1998
Revenues.
Our revenues increased to $97.0 million in 1999 from $31.7million in 1998. Revenues consist primarily of sales of cable modems and headend equipment to new and existing customers. The increased revenues in 1999 were primarily attributable to the addition of new customers in1999 and continuing deployments of our TeraComm system by existing customers, and, to a lesser extent, the sales of products acquired as a result of our acquisition of Imedia. The impact on revenues resulting from the acquisition of Radwiz was not significant for the year ended December 31, 1999.
We sell our products directly to broadband access service providers, system resellers and distributors. Revenues related to product sales are generally recognized when the products are shipped to the customer. A provision is made for estimated product returns as product shipments are made. Our existing agreements with our system resellers and distributors do not contain price protection provisions and do not grant return rights beyond those provided by the Company's standard warranty.
[The following details the cost of the Rogers' development agreement. There is no comparable section in the 1998 report as the agreement began in March 1999 and appears to have ended at the end of one year.]
Cost of Product Development Assistance Agreement.
In March 1999, we entered into a one-year Product Development Assistance Agreement with Rogers Communications Inc. Under the terms of the Development Agreement,Rogers will assist us with the characterization and testing of our subscriber-end and head-end voice-over-cable equipment. In addition, Rogers will provide us with technology to assist us with our efforts to develop high quality, field proven technology solutions that are DOCSIS-compliant and packet cable-compliant. The Development Agreement has a term of one year. In consideration of Rogers entering into the Development Agreement, we issued Rogers two fully vested and non-forfeitable warrants, each to purchase 1.0 million shares of common stock on a cashless basis. One warrant has an exercise price of $1.00 per share and one warrant has an exercise price of $37.00 per share.The warrants may be exercised at any time in full or in part through March 31, 2000. The fair value of the two warrants was approximately $45.0 million and will result in a noncash charge included in operations over the one-year term of the Development Agreement. As a result of the Development Agreement, our results for 1999 include a noncash charge of $35.1 million. In March 2000, Rogers purchased 1,843,809 shares of our common stock on a net exercise basis, resulting in no proceeds to us.
We May Not Be Able to Adequately Protect or Enforce Our Intellectual Property Rights. (98)
Upon the completion and acceptance of the DOCSIS 1.2 cable modem specification that we are co-authoring, we would contribute some aspects of our S-CDMA technology to the DOCSIS 1.2 intellectual property pool. We would contribute our technology pursuant to a proposed license agreement with CableLabs that we would execute at that time. Under thet erms of the proposed license agreement, we would grant to CableLabs a license for some aspects of our S-CDMA technology that are essential for compliance with the DOCSIS 1.2 cable modem standard. This license would allow CableLabs to utilize and incorporate the licensed technology for the limited use of making and selling products or systems that comply with the DOCSIS 1.2 cable modem specification. As a party to the license agreement, we would have access to the DOCSIS 1.2 intellectual property pool and would have the right to develop products that comply with theDOCSIS 1.2 cable modem specification. As a result, any of our competitors who join the DOCSIS intellectual property pool will have access to some aspects of our technology and will not be required to pay us any royalties or other compensation. Further, some of our competitors have been successful in reverse engineering the technology of other companies, and our contribution to the DOCSIS 1.2 intellectual property pool would expose some aspects of our technology to those competitors.If a competitor is able to duplicate the functionality and capabilities of our technology, we could lose all or some of the time-to-market advantage we might otherwise have. Under the terms of the proposed license agreement, if we sue certain parties to the proposed license agreement on claims of infringement of any copyright or patent right or misappropriation of any trade secret, those parties may terminate ourl icense to the patents or copyrights they contributed to the DOCSIS 1.2 intellectual property pool. If a termination like this were to occur, we would continue to have access to some aspects of the DOCSIS 1.2 intellectual property pool, but we would not be able to develop products that fully comply with the DOCSIS 1.2 cable modem specification. Because of these terms, we may find it difficult to enforce our intellectual property rights against certain companies. Under the terms of proposed license agreement, CableLabs may sublicense the DOCSIS 1.2 intellectual property pool if the sublicensee complies with certain conditions. The sublicensee's rights to some of the DOCSIS 1.2 intellectual property pool could be terminated if it sues certain companies for infringement of any copyright, patent right or trade secret.
In November 1998, CableLabs selected us to co-author DOCSIS 1.2, an enhanced version of the DOSCIS cable modem specification based in part on our S-CDMA technology. In September 1999, CableLabs indicated that it intended to proceed with the advanced PHY work on two parallel tracks:one for the development of a prototype based on our S-CDMA technology and one for the inclusion of Advanced TDMA technology, as proposed by other companies. *****In February 2000, CableLabs further clarified the status of the advanced PHY project regarding a separate release that will include TDMA technologies. ***** In addition, CableLabs reiterated that it is continuing to work with us on the development of a DOCSIS specification that could include our S-CDMA technology. To that end, we have indicated to CableLabs that we would contribute some aspects of our S-CDMA technology to the DOCSIS intellectual property pool if and when a DOCSIS specification is approved that includes our S-CDMA technology. We would contribute our technology pursuant to a license agreement with CableLabs that we would execute at that time, and which contains the terms that CableLabs has established for the inclusion of any intellectual property from any source in the DOCSIS specifications.Under the terms of the proposed license agreement, we would grant to CableLabs a royalty-free license for those aspects of our S-CDMA technology that are essential for compliance with the DOCSIS cable modem standard. So-called implementation know how is not covered by this license-only those aspects of the technology that are essential to implementing a compliant product. CableLabs would have the right to extend royalty-free sublicenses to companies that wish to build DOCSIS-compatible products. These sublicenses would allow participating companies to utilize and incorporate the essential portions of the S-CDMA technology on a royalty free basis for the limited use of making and selling products or systems that comply with the DOCSIS cable modem specification Terayon has already joined the DOCSIS intellectual property pool and, as a result, we have a royalty-free sub license that allows us to ship DOCSIS compatible products which contain intellectual property submitted by other companies. The scope of this license would not extend to the use of the S-CDMA technology in other areas; only for products that comply with the DOCSIS specifications.
(98)
We expect that developers of cable modems increasingly will be subject to infringement claims as the number of products and competitors in our industry segment grows. We have received letters from two individuals claiming that our infringes patents held by these individuals. We have reviewed the allegations made by these individuals and, after consulting with our patent counsel, we do not believe that our technology infringes any valid claim of these
individuals' patents.If the issues are submitted to a court, the court could find that our products infringe these patents. In addition, these individuals may continue to assert infringement. If we are found to have infringed these individuals' patents, we could be subject to substantial damages and/or an injunction preventing us from conducting our business. In addition,other third parties may assert infringement claims against us in the future. An infringement claim, whether meritorious or not, could be time consuming, result in costly litigation, cause product shipment delays or require us to enter into royalty or licensing agreements. These royalty or licensing agreements may not be available on terms acceptable to us or at all. Litigation also may be necessary to enforce our intellectual property rights.
(99)
We May Be Unable to Adequately Protect or Enforce Our Intellectual Property Rights.
As a result, any of our competitors who join or have joined the DOCSIS intellectual property pool will have access to some aspects of our technology without being required to pay us any royalties or other compensation. If and when we submit S-CDMA to the DOCSIS Intellectual Property pool, we are in no way restricted from entering into royalty-bearing license agreements with companies that wish to use the S CDMA technology for purposes other than implementing DOCSIS compatible products, or that do not wish to enter into the DOCSIS intellectual property pool. Further, some of our competitors have been successful in reverse engineering the technology of other companies, and the inclusion of S-CDMA in a future DOCSIS specification would expose some aspects of our technology to those competitors. DOCSIS specifications are available on an open basis once they are approved, not only to companies that are members of the DOCSIS IP Pool. If a competitor is able to duplicate the functionality and capabilities of our technology, we could lose all or some of the time-to-market advantage we might otherwise have. Under the terms of the proposed license agreement, if we sue certain parties to the proposed license agreement on claims of infringement of any copyright or patent right or misappropriation of any trade secret, those parties may terminate our license to the patents or copyrights they contributed to the DOCSIS intellectual property pool. If a termination like this were to occur, we would continue to have access to some aspects of the DOCSIS intellectual property pool, but we would not be able to develop products that fully comply with the DOCSIS cable modem specification. Also, even if we were to be removed from the IP pool, we would not be prevented from developing and selling products that fully comply with the DOCSIS specifications, but we would not be able to do this with the benefit of a royalty-free license, which would increase the cost of our products, assuming we were able to obtain a license agreement for the required technology. Because of these terms, we may find it difficult to enforce our intellectual property rights against certain companies, even in areas that are not directly related to DOCSIS specifications and products.
We anticipate that developers of cable modems increasingly will be subject to infringement claims as the number of products and competitors in our industry segment grows. We have received letters from two individuals claiming that our technology infringes patents held by these individuals. We have reviewed the allegations made by these individuals and, after consulting with our patent counsel, we do not believe that our technology infringes any valid claim
of these individuals' patents.If the issues are submitted to a court, the court could find that our products infringe these patents. In addition, these individuals may continue to assert infringement. If we are found to have infringed theseindividuals' patents, we could be subject to substantial damages and/or an injunction preventing us from conducting our business. In addition,other third parties may assert infringement claims against us in the future. An
infringement claim, whether meritorious or not, could betime-consuming, result in costly litigation |
