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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q/A
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE PERIOD ENDED SEPTEMBER 30, 2001
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER: 000-27707
AETHER SYSTEMS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 52-2186634
(State or other jurisdiction of incorporation or (IRS Employer Identification
organization) Number)
11460 CRONRIDGE DR. OWINGS MILLS, MD 21117
(Address of principal executive offices) (Zip Code)
(Registrant's telephone number, including area code): (410) 654-6400
Securities registered Pursuant to Section 12(b) of the Act: NONE.
Securities Registered Pursuant to Section 12(g) of the Act:
COMMON STOCK, PAR VALUE $.01
CONVERTIBLE SUBORDINATED NOTES DUE 2005
---------------
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No [ ]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date:
As of November 9, 2001, 40,978,743 shares of the Registrant's common stock, $.01
par value per share, were outstanding.
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1
AETHER SYSTEMS, INC.
QUARTERLY REPORT ON FORM 10-Q/A
FOR THE QUARTER ENDED SEPTEMBER 30, 2001
INDEX
[The purpose of this amendment is to move cash paid for interest from financing
activities to operating activities in the Statement of Cash Flows in Part I,
Item 1 and to make a conforming change in the Management's Discussion and
Analysis in Part I, Item 2.]
PART I: FINANCIAL INFORMATION
ITEM 1: FINANCIAL STATEMENTS
CONDENSED CONSOLIDATED BALANCE SHEETS AS OF SEPTEMBER 30, 2001-
UNAUDITED AND DECEMBER 31, 2000
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND OTHER
COMPREHENSIVE LOSS FOR THE THREE AND NINE MONTH PERIODS ENDED
SEPTEMBER 30, 2001 AND 2000 - UNAUDITED
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE NINE
MONTHS ENDED SEPTEMBER 30, 2001 AND 2000 --UNAUDITED
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
2
PART I -- FINANCIAL INFORMATION
ITEM 1: FINANCIAL STATEMENTS
AETHER SYSTEMS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
SEPTEMBER 30, DECEMBER 31,
2001 2000
----------- -----------
ASSETS (unaudited)
Current assets:
Cash and cash equivalents $ 581,620 $ 856,391
Restricted cash 10,320 16,356
Short-term investments 2,532 2,648
Trade accounts receivable, net of allowance for doubtful
accounts of $10,131 and $5,695 at September 30, 2001 and
December 31, 2000, respectively 27,333 30,263
Inventory, net of allowance for obsolescence of $13,969 and
$137 at September 30, 2001 and December 31, 2000, respectively 25,898 19,130
Prepaid expenses and other current assets 16,242 17,081
----------- -----------
Total current assets 663,945 941,869
Property and equipment, net 66,875 53,223
Investments 35,210 182,444
Intangibles, net 269,987 1,478,485
Other assets, net 23,416 21,354
----------- -----------
$ 1,059,433 $ 2,677,375
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 4,151 $ 9,747
Accrued expenses 35,413 66,949
Restructuring reserve 14,388
Accrued employee compensation and benefits 13,641 12,566
Deferred revenue 17,718 14,170
Accrued interest payable 681 5,072
Current portion of notes payable 15,219 13,741
----------- -----------
Total current liabilities 101,211 122,245
Convertible subordinated notes payable and other
notes payable, less current portion 300,842 321,201
Deferred tax liability 691 10,694
Restructuring reserve 12,492
Deferred revenue 6,974 --
Minority interest in net assets of a subsidiary -- 55,537
Stockholders' equity:
Preferred stock, $0.01 par value; 1,000,000 shares authorized;
0 shares issued and outstanding at September 30, 2001 and
December 31, 2000 -- --
Common stock, $0.01 par value;
1,000,000,000 shares authorized; 40,726,724
and 40,415,722 shares issued and outstanding at
September 30, 2001 and December 31, 2000, respectively 407 404
Additional paid-in capital 2,571,606 2,552,016
Accumulated deficit (1,932,634) (385,314)
Foreign currency translation adjustment (710) (113)
Unrealized gain (loss) on investments available for sale (1,446) 705
----------- -----------
$ Total stockholders' equity 637,223 2,167,698
----------- -----------
$ 1,059,433 $ 2,677,375
=========== ===========
3
AETHER SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND OTHER COMPREHENSIVE LOSS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2001 2000 2001 2000
--------- --------- ----------- ----------
Subscriber revenue $ 11,179 $ 7,562 $ 32,987 $ 16,534
Engineering services revenue 642 2,514 5,786 5,554
Software and related services revenue 8,205 5,260 29,874 8,691
Device sales 4,922 886 19,045 1,599
--------- --------- ----------- ---------
Total revenue 24,948 16,222 87,692 32,378
Cost of subscriber revenue 6,805 3,165 19,657 7,378
Cost of engineering services revenue 314 1,870 3,099 3,511
Cost of software and related services revenue 2,892 1,913 9,549 3,442
Cost of device sales 17,560 1,012 33,699 2,280
--------- --------- ----------- ---------
Total cost of revenue 27,571 7,960 66,004 16,611
--------- --------- ----------- ---------
Gross profit (loss) (2,623) 8,262 21,688 15,767
--------- --------- ----------- ---------
Operating expenses:
Research and development (exclusive of option and warrant
expense) 16,170 6,201 52,045 11,962
General and administrative (exclusive of option and
warrant expense) 21,955 20,437 71,439 35,706
Selling and marketing (exclusive of option and warrant
expense) 14,780 10,529 55,507 32,338
In-process research and development related to
acquisitions -- 3,900 -- 6,060
Depreciation and amortization 32,068 72,305 153,312 156,756
Option and warrant expense:
Research and development 691 1,712 5,295 4,422
General and administrative 1,846 2,004 4,648 4,567
Selling and marketing 976 304 2,507 1,081
Impairment of intangibles 129,201 -- 1,090,781 --
Restructuring charge 18,230 -- 34,089 --
--------- --------- ----------- ---------
(235,917) 117,392 (1,469,623) 252,892
--------- --------- ----------- ---------
Operating loss (238,540) (109,130) (1,447,935) (237,125)
Other income (expense):
Interest income (expense), net 1,061 14,564 10,661 31,540
Equity in losses of investments (16,762) (17,572) (48,285) (31,400)
Investment gains (losses) including impairments, net (45,661) -- (141,553) --
Minority interest 47,394 4,303 55,541 5,965
--------- --------- ----------- ---------
Loss before income taxes, extraordinary item and cumulative effect
of change in accounting principle (252,508) (107,835) (1,571,571) (231,020)
Income tax benefit 9,129 574 10,003 574
--------- --------- ----------- ---------
Loss before extraordinary item and cumulative effect
of change in accounting principle (243,379) (107,261) (1,561,568) (230,446)
Extraordinary item relating to early extinguishment of debt -- -- 7,684 --
--------- --------- ----------- ---------
Loss before cumulative effect of change in accounting principle $(243,379) $(107,261) $(1,553,884) $(230,446)
Cumulative effect of change in accounting principle relating to
adoption of SFAS 133, Accounting for Derivatives -- -- 6,564 --
--------- --------- ----------- ---------
Net loss $(243,379) $(107,261) $(1,547,320) $(230,446)
========= ========= =========== =========
Other comprehensive loss:
Unrealized holding gain (loss) on investments available
for sale 18,015 (53,034) (2,151) 5,842
Foreign currency translation adjustment (133) -- (710) --
--------- --------- ----------- ---------
Comprehensive loss $(225,497) $(160,295) $(1,550,181) $(224,604)
========= ========= =========== =========
Loss per share - basic and diluted - before extraordinary item and
cumulative effect of change in accounting principle $ (5.98) $ (2.80) $ (38.50) $ (6.53)
Extraordinary item relating to early extinguishment of debt $ -- $ -- $ 0.19 $ --
Cumulative effect of change in accounting principle related to
adoption of SFAS 133, Accounting for Derivatives $ -- $ -- $ 0.16 $ --
--------- --------- ----------- ---------
Net loss per share-basic and diluted $ (5.98) $ (2.80) $ (38.15) $ (6.53)
========= ========= =========== =========
Weighted average shares outstanding--basic and
diluted 40,694 38,343 40,561 35,308
========= ========= =========== =========
See accompanying notes to condensed consolidated financial statements.
4
AETHER SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
(UNAUDITED)
NINE MONTHS ENDED
SEPTEMBER 30,
2001 2000
----------- -----------
Cash flows from operating activities:
Net loss $(1,547,320) $ (230,446)
Adjustments to reconcile net loss to net cash used by
operating activities:
Depreciation and amortization 153,312 156,756
Provision for doubtful accounts 8,533 --
Provision for inventory obsolescence 14,371 --
Equity in losses of investments 48,285 31,400
Option and warrant expense 12,450 10,070
Minority interest (55,541) (5,965)
Income tax benefit (10,003) (609)
In process research and development related to
acquisitions -- 6,060
Restructuring charge 34,089 --
Extraordinary item (7,684) --
Cumulative effect of change in accounting principle (6,564) --
Impairment charges related to goodwill from acquisitions 1,090,781 --
Realized loss on long-term investments, including
impairments 141,553 --
Changes in assets and liabilities, net of acquired
assets and liabilities:
Increase in trade accounts receivable (5,603) (8,218)
Increase in inventory (21,830) (4,099)
(Increase) decrease in prepaid expenses and other assets 312 (13,286)
Increase (decrease) in accounts payable (5,596) 2,499
Increase (decrease) in accrued expenses, accrued
employee compensation and benefits, and interest payable (10,637) 25,366
Increase in deferred revenue and other long
term liabilities 10,523 3,167
----------- -----------
Net cash used by operating activities (156,569) (27,305)
----------- -----------
Cash flows from investing activities:
Sales and maturities of investments 7,864 6,755
Purchases of short-term investments (3,411) (4,858)
Purchases of property and equipment (34,954) (30,234)
Cost of investments (36,973) (114,000)
Costs of acquisitions, net of cash acquired (42,116) (252,797)
Increase in restricted cash -- 5,803
Increase in other intangible assets 311 --
Increase in other assets (3,017) --
----------- -----------
Net cash used in investing activities (112,296) (389,331)
----------- -----------
Cash flows from financing activities:
Proceeds from issuance of common stock -- 1,057,065
Proceeds from issuance of convertible debt -- 300,564
Repayment of notes payable including buyback of convertible debt (12,899) --
Borrowings under notes payable -- --
Decrease in restricted cash 315 --
Exercise of options and warrants 1,518 2,446
Contributions from a minority shareholder of a subsidiary 5,160 20,818
----------- -----------
Net cash provided by (used in) financing activities (5,906) 1,380,893
----------- -----------
Net increase (decrease) in cash and cash equivalents (274,771) 964,257
Cash and cash equivalents, at beginning of period 856,391 78,542
----------- -----------
--Cash and cash equivalents, at end of period $ 581,620 $ 1,042,799
=========== ===========
Supplemental disclosure of cash flow information:
Cash paid during the year for interest $ 18,243 $ 9,315
=========== ===========
Supplemental disclosure of non-cash investing and financing activities:
For the nine months ended September 30, 2001 and 2000, the Company incurred an
unrealized net holding gain (loss) associated with its investments available for
sale totaling ($2.2) million and $5.8 million, respectively. These amounts have
been reported as changes in stockholders' equity.
For the nine months ended September 30, 2001 and 2000, the Company recorded
additions to stockholders equity of $6.1 million and $73.3 million,
respectively, from the issuance of stock by
5
Omnisky Inc. to third parties at per share amounts in excess of the book value
per share of the Company's investment in Omnisky Inc.
In January 2000, approximately $600,000 of trade receivables owed to the Company
by OmniSky, Inc. were offset by the Company's additional investment made in
OmniSky, Inc.
In March 2000, the Company acquired Riverbed Technologies, Inc. for 4,537,281
shares of the Company's common stock and converted existing options held by
Riverbed employees into options to acquire 862,480 shares of the Company's
common stock. The value of the common stock and replacement options of $1.136
billion was allocated to the fair value of the assets purchased and
liabilities assumed with a corresponding increase in stockholders' equity.
In connection with the acquisition of IFX and the formation of Sila, the Company
established a deferred tax liability of $11.2 million. Such amount was offset by
an equal increase in goodwill.
In September of 2000, the Company acquired Cerulean for 462,412 shares of the
Company's common stock and converted existing options held by Cerulean employees
into options to acquire 94,275 shares of the Company's common stock plus $75.0
million in cash. The value of the common stock and vested replacement options of
$69.9 million was allocated to the fair value of the assets purchased and
the liabilities assumed with a corresponding increase in stockholders' equity.
In connection with the acquisitions of Cerulean and Sinope, the Company had
accrued $47.3 million as of September 30, 2000 for purchase price and
acquisition costs. Such amount has been allocated to the fair value of the
assets purchased and the liabilities assumed.
See accompanying notes to condensed consolidated financial statements.
6
AETHER SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(1) ORGANIZATION, DESCRIPTION OF BUSINESS AND BASIS OF PRESENTATION
ORGANIZATION AND DESCRIPTION OF BUSINESS
Aether Systems, Inc. and its subsidiaries (the "Company") provide
technologies that enable businesses to extend their data and commercial
transactions to wireless and mobile handheld devices. From its inception until
March 1997, the Company primarily provided wireless engineering services,
including the development of wireless software applications for customers. In
March 1997, the Company began offering services that provide the users of
wireless handheld devices access to real-time financial information. During
1997, the Company made a strategic decision to focus a significant portion of
its engineering resources on the development of these and other wireless data
services and systems, including the Aether Intelligent Messaging(TM) ("AIM")
package of wireless messaging software and software development tools.
In 1998 and 1999, the Company continued to develop financial information
services--as well as financial transaction services--internally and through the
acquisition of Mobeo, Inc. ("Mobeo"). In 1999, the Company also completed its
initial public offering and began to expand its service offerings to areas other
than financial information and transactions.
In 2000, the Company continued its expansion into other vertical markets
through several acquisitions and through organic growth. Also in 2000, the
Company moved into the European marketplace with the acquisition of IFX Group
Plc ("IFX") and the related formation of Sila Communications Limited ("Sila").
During the current year, the Company has focused on the integration of it's
acquisitions and the creation and deployment of Aether Fusion(TM), a
comprehensive wireless technology foundation designed to provide customers and
partners with a single-source solution for accessing essential data and
applications wirelessly.
Recently the Company entered into a strategic alliance with AOL Time
Warner whereby Aether Fusion(TM) technology would extend AOL's Netbusiness,
email and instant messaging to wireless platforms for small and medium
enterprises.
BASIS OF PRESENTATION
The condensed consolidated financial statements include the accounts of
Aether Systems, Inc. and its subsidiaries. The condensed consolidated balance
sheet as of September 30, 2001, the condensed consolidated statements of
operations and other comprehensive loss for the three and nine months ended
September 30, 2001 and 2000, and the condensed consolidated statements of cash
flows for the nine months ended September 30, 2001 and 2000 have been prepared
by the Company, without audit. In the opinion of management, all adjustments
have been made, which
7
include normal recurring adjustments necessary to present fairly the condensed
consolidated financial statements. Operating results for the three and nine
months ended September 30, 2001 are not necessarily indicative of the operating
results for the full year. Certain information and footnote disclosures normally
included in financial statements prepared in accordance with accounting
principles generally accepted in the United States of America have been
condensed or omitted. The Company believes that the disclosures provided are
adequate to make the information presented not misleading. These condensed
consolidated financial statements should be read in conjunction with the audited
consolidated financial statements and related notes included in the Company's
Annual Report for the year ended December 31, 2000 on Form 10-K.
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a) Revenue Recognition
The Company derives subscriber revenue from the provision of real-time
access to business information integrated into existing wireless communication
platforms. Subscriber revenue consists of fixed charges for usage recognized as
the service is provided, and one-time non-refundable activation fees recognized
ratably over the expected life of the customer relationship. For certain of the
Company's products, the subscribers' monthly fee includes the use of a wireless
handheld device. Revenue for such devices is recognized as the related service
is provided. Direct activation costs are expensed as incurred. Certain of the
Company's customers are billed in advance with revenue deferred and recognized
on a monthly basis over the term of the agreement. Also included in subscriber
revenue are market exchange fees for access to financial information from the
securities exchanges and markets, which are recognized as the service is
provided. The Company also recognizes fees for managing data through its network
operations center. Such fees are recognized ratably over the contract period.
Engineering services revenue is derived from the provision of wireless
integration consulting under time-and-materials and fixed-fee contracts. Revenue
on time-and-materials contracts is recognized as services are performed. Revenue
on fixed-fee contracts is recognized on the percentage-of-completion method
based on costs incurred in relation to total estimated costs. Anticipated
contract losses are recognized as soon as they become known and estimable.
Software and related services revenues are generated from licensing
software and providing services, including maintenance and technical support,
training and consulting. Software revenue consists of fees for licenses of the
Company's software products. The Company recognizes the revenue when the license
agreement is signed, the license fee is fixed and determinable, delivery of the
software has occurred, and collectibility of the fees is considered probable.
Revenue from software licensing and related wireless engineering consulting
services for which the software requires significant customization and
modification is recognized using the percentage of completion method in
accordance with Statement of Position (SOP) 97-2, Software Revenue Recognition,
based on the hours incurred in relation to the total estimated hours. Service
revenues consists of maintenance and technical support, which consists of
unspecified when-and-if available product updates and customer telephone support
services and are recognized ratably over the term of the service period. Other
service revenues are recognized as the related services are provided. In
situations where the Company hosts the software and the customer has the option
to take possession of the software at any time during the hosting period without
significant penalty and it is feasible for the customer to either run the
software on its own hardware or contract with another party unrelated to the
Company to host the software, the software element is accounted for in
accordance with SOP 97-2 as discussed above.
8
Device sales are derived from the sales of wireless handheld devices at or
near our cost. Revenues on these device sales are either recognized upon
shipment of the devices or recognized over the expected life of the customer
relationship in accordance with SAB 101.
(b) Cost of Revenues
Cost of subscriber revenue consists primarily of airtime costs, financial
data costs, and securities and market exchange fees. Cost of subscriber revenue
excludes depreciation related to the Company's network operations centers and
certain customer fulfillment costs. Cost of engineering services revenue
consists of cash compensation and related costs for engineering personnel and
materials. The cost of software license revenue consists primarily of third
party royalties. The cost of maintenance, consulting and support revenue
consists primarily of personnel-related costs. Cost of device sales consists of
the cost of the hardware from the manufacturer or wholesaler. The cost of
wireless handheld devices is recognized on delivery when sold or amortized over
the expected life of the customer relationship. The cost of device sales also
includes charges for inventory obsolesence.
(c) Fair Value of Financial Instruments
The carrying amounts of the Company's financial instruments, which include
cash equivalents, short-term investments, accounts receivable, accounts payable,
accrued expenses and notes payable (excluding the convertible subordinated
notes), approximate their fair values due to the relatively short duration of
the instruments.
The fair value of the convertible subordinated notes at September 30, 2001
was $171.5 million based on their quoted market price.
(d) Credit Risk
Financial instruments which potentially subject the Company to credit risk
consist primarily of cash, cash equivalents and trade receivables.
The Company invests cash not immediately needed for operations in money
market securities of various financial institutions, commercial paper and
certificates of deposit. The money market securities represent underlying
investments in commercial paper issued by financial institutions and other
companies with high credit ratings and securities issued by or backed by the
U.S. Government. The amounts invested in some cases exceed the F.D.I.C. limits.
The Company has not experienced any losses in its cash and cash equivalents and
believes it is not exposed to any significant credit risk on these amounts.
Trade accounts receivable subject the Company to the potential for credit
risk. The Company extends credit to customers on an unsecured basis in the
normal course of business. Some of these customers have a limited operating
history and have reported significant losses since inception. They are subject
to many of the same risks and uncertainties as the Company, including rapid
changes in technology, no established markets for their products, and intense
competition, among others. In addition, some of these companies will require
significant infusions of capital to continue operations. The availability of
such capital has been curtailed and some of these companies may not be able to
raise sufficient funds to continue to operate, which could limit the Company's
ability to generate further revenues from these companies as well as to collect
the outstanding receivables.
9
The Company's policy is to perform an analysis of the recoverability of
its trade accounts receivable at the end of each reporting period and to
establish allowances for those accounts considered uncollectible. If market
conditions for these companies continue to deteriorate, the Company may be
required to record additional allowances for doubtful accounts in the future.
(e) Inventory
Inventory, net of allowance for obsolete and slow-moving inventory,
consists of finished goods such as handheld and laptop computers, pagers,
wireless modems, and accessories and is stated at the lower of cost or market.
Cost is determined using a standard costing method, which approximates the
first-in, first-out method. The Company's inventory is subject to rapid
technological changes that could have an adverse impact on its realization in
future periods. In addition, there are a limited number of suppliers of the
Company inventory. During the three and nine month periods ended September 30,
2001, the Company recorded an inventory reserve of approximately $12.5 and $14.4
million, respectively, due to obsolescence and excess inventory.
(f) Investments
The Company accounts for those investments in which the Company exercises
significant influence or has an ownership interest greater than twenty percent
under the equity method. For equity method investments, the Company records its
proportionate share of the investee's net income or loss. Generally, the Company
accounts for its investments in which the Company has an ownership interest of
less than twenty percent under the cost method for its private investments.
Investments in marketable equity securities, if not considered equity
method investments, are considered available-for-sale securities. Investments
carried at cost are written down if circumstances indicate the carrying amount
of the investment may not be recoverable, and such losses are considered other
than temporary. Investments available for sale are carried at fair value based
on quoted market prices. Net unrealized holding gains and losses are excluded
from income and are reported as a separate component of stockholders' equity,
unless such losses are considered other than temporary. Realized gains and
losses are included in income.
(g) Intangibles and Recovery of Long-Lived Assets
Cost in excess of the fair value of tangible and identifiable intangible
net assets acquired is amortized on a straight-line basis over three to seven
years. Identifiable intangible net assets consist of completed technology,
assembled workforce, trademarks, and acquired subscribers. Identifiable
intangible net assets are amortized on a straight-line basis over two to seven
years.
The Company's policy is to review its long-lived assets for impairment
whenever events or changes in circumstances indicate that the carrying amount
may not be recoverable. The Company may recognize an impairment when the sum of
the expected future undiscounted cash flows is less than the carrying amount of
the asset. The measurement of the impairment losses to be recognized is based
upon the difference between the fair value and the carrying amount of the
assets.
(h) Restructuring Charges
The Company records charges for costs associated with a restructuring plan
only when
10
the exit plan is committed to by the Company, the costs associated with the plan
are incremental to other costs incurred by the Company in the conduct of its
activities prior to the commitment date and will be incurred as a direct result
of the exit plan, the costs associated with the plan represent amounts to be
incurred by the enterprise under a contractual obligation that existed prior to
the commitment date and will either continue after the exit plan is completed
with no economic benefit to the Company or be a penalty incurred by the Company
to cancel the contractual obligation, and the cost of the component of the plan
being accrued for can be reasonably estimated.
(i) Use of Estimates
The preparation of condensed consolidated financial statements in
conformity with accounting principles generally accepted in the United States of
America requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosure of contingent assets
and liabilities at the dates of the condensed consolidated financial statements
and the reported amounts of revenue and expenses during the reporting period.
Actual results could differ from those estimates. Estimates are used in
accounting for, among other things, long-term contracts, allowances for
uncollectible receivables, inventory obsolescence, recoverability of long-lived
assets and investments, depreciation and amortization, employee benefits, taxes
and contingencies. Estimates and assumptions are reviewed periodically and the
effects of revisions are reflected in the condensed consolidated financial
statements in the period they are determined to be necessary.
(j) Recent Accounting Pronouncements
On January 1, 2001, the Company adopted Statement of Financial Accounting
Standards (SFAS), Accounting for Derivative Instruments and Hedging Activities.
SFAS 133, as amended by SFAS 137 and further amended by SFAS 138, established
accounting and reporting standards for derivative financial instruments and
associated hedging activities as well as hedging activities in general. The
adoption of SFAS 133, as amended, created a benefit of $6.6 million on the
adoption date of January 1, 2001, as reflected in the condensed consolidated
statement of operations. The benefit was derived from the valuation, as of
January 1, 2001, of certain warrants to purchase stock of two of our investee
companies. The warrants include net settlement provisions and are, therefore,
considered derivatives. These warrants are revalued at the end of each quarter,
which caused reductions of approximately $406,000 and $6.4 million in the
investment balance which is included in realized loss on investment in the
condensed consolidated statement of operations for the three and nine months
ended September 30, 2001, respectively.
In July 2001, the Financial Accounting Standards Board (FASB) issued SFAS
141, Business Combinations, and SFAS 142, Goodwill and Other Intangible Assets.
SFAS 141 requires that the purchase method of accounting be used for all
business combinations initiated after June 30, 2001 as well as all purchase
method business combinations completed after June 30, 2001. SFAS 141 also
specifies criteria intangible assets acquired in a purchase method business
combination must meet to be recognized and reported apart from goodwill, noting
that any purchase price allocable to an assembled workforce may not be accounted
for separately. SFAS 142 requires
11
that goodwill and intangible assets with indefinite useful lives no longer be
amortized, but instead tested for impairment at least annually in accordance
with the provisions of SFAS 142. SFAS 142 also requires that intangible assets
with definite useful lives be amortized over their respective estimated useful
lives to their estimated residual values, and reviewed for impairment in
accordance with SFAS 121, Accounting for the Impairment of Long-Lived Assets and
for Long-Lived Assets to Be Disposed Of.
The Company is required to adopt the provisions of SFAS 141 immediately,
except with regard to business combinations initiated prior to July 1, 2001,
which it expects to account for using the purchase method, and SFAS 142
effective January 1, 2002. Furthermore, any goodwill and any intangible asset
determined to have an indefinite useful life that are acquired in a purchase
business combination completed after June 30, 2001 will not be amortized, but
will continue to be evaluated for impairment in accordance with the appropriate
pre-SFAS 142 accounting literature. Goodwill and intangible assets acquired in
business combinations completed before July 1, 2001 will continue to be
amortized prior to the adoption of SFAS 142.
SFAS 141 requires upon adoption of SFAS 142, that the Company evaluate its
existing intangible assets and goodwill that were acquired in a prior purchase
business combination, and to make any necessary reclassifications in order to
conform with the new criteria in SFAS 141 for recognition apart from goodwill.
Upon adoption of SFAS 142, the Company will be required to reassess the useful
lives and residual values of all intangible assets acquired in purchase business
combinations, and make any necessary amortization period adjustments by the end
of the first interim period after adoption. In addition, to the extent an
intangible asset is identified as having an indefinite useful life, the Company
will be required to test the intangible asset for impairment in accordance with
the provisions of SFAS 142 within the first interim period. Any impairment loss
will be measured as of the date of adoption and recognized as the cumulative
effect of a change in accounting principle in the first interim period.
In connection with the transitional goodwill impairment evaluation, SFAS
142 will require the Company to perform an assessment of whether there is an
indication that goodwill is impaired as of the date of adoption. To accomplish
this the Company must identify its reporting units and determine the carrying
value of each reporting unit by assigning the assets and liabilities, including
the existing goodwill and intangible assets, to those reporting units as of the
date of adoption. The Company will then have up to six months from the date of
adoption to determine the fair value of each reporting unit and compare it to
the reporting unit's carrying amount. To the extent a reporting unit's carrying
amount exceeds its fair value, an indication exists that the reporting unit's
goodwill may be impaired and the Company must perform the second step of the
transitional impairment test. In the second step, the Company must compare the
implied fair value of the reporting unit's goodwill, determined by allocating
the reporting unit's fair value to all of it's assets (recognized and
unrecognized) and liabilities in a manner similar to a purchase price allocation
in accordance with SFAS 141, to its carrying amount, both of which would be
measured as of the date of adoption. This second step is required to be
completed as soon as possible, but no later than the end of the year of
adoption. Any transitional impairment loss will be recognized as the cumulative
effect of a change in accounting principle in the Company's statement of
operations.
As of the date of adoption, the Company expects to have unamortized
identifiable intangible assets in the amount of approximately $79.7 million
which will be subject to the transition provisions of SFAS 141 and 142. Because
of the extensive effort needed to comply with adopting SFAS 141 and 142, it is
not practicable to reasonably estimate the impact of adopting
12
these Statements on the Company's financial statements at the date of this
report, including whether any transitional impairment losses will be required to
be recognized as the cumulative effect of a change in accounting principle.
In August 2001, the Financial Accounting Standards Board issued FASB Statement
No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets
(Statement 144), which supersedes both FASB Statement No. 121, Accounting for
the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of
(Statement 121) and the accounting and reporting provisions of APB Opinion
No. 30, Reporting the Results of Operations--Reporting the Effects of Disposal
of a Segment of a Business, and Extraordinary, Unusual and Infrequently
Occurring Events and Transactions (Opinion 30), for the disposal of a segment
of a business (as previously defined in that Opinion). Statement 144 retains
the fundamental provisions in Statement 121 for recognizing and measuring
impairments losses on long-lived assets held for use and long-lived assets to
be disposed of by sale, while also resolving significant implementation issues
associated with Statement 121. For example, Statement 144 provides guidance on
how a long-lived asset that is used as part of a group should be evaluated for
impairment, establishes criteria for when a long-lived asset is held for sale,
and prescribes the accounting for a long-lived asset that will be disposed of
other than by sale. Statement 144 retains the basic provisions of Opinion 30 on
how to present discontinued operations in the income statement but broadens
that presentation to include a component of an entity (rather than a segment of
a business). Unlike Statement 121, an impairment assessment under Statement 144
will never result in a write-down of goodwill. Rather, goodwill is evaluated
for impairment under Statement No. 142, Goodwill and Other Intangible Assets.
The Company is required to adopt Statement 144 no later than the year beginning
after December 15, 2001, and plans to adopt its provisions for the quarter
ending March 31, 2002. Management does not expect the adoption of Statement 144
for long-lived assets held for use to have a material impact on the Company's
financial statements because the impairment assessment under Statement 144 is
largely unchanged from Statement 121. The provisions of the Statement for
assets held for sale or other disposal generally are required to be applied
prospectively after the adoption date to newly initiated disposal activities.
Therefore, management cannot determine the potential effects that adoption of
Statement 144 will have on the Company's financial statements.
(3) ACQUISITIONS
The Company has made the following acquisitions:
PURCHASE PRICE
-----------------------------------------------------------------------------
CASH
INCLUDING
RELATED
NAME ACQUISITION DATE EXPENSES EQUITY ISSUED
----------------------------- ------------------ ------------- ------------------------------------------------------------
Mobeo, Inc. August 19, 1999 $11.5 million $ 374,000 consisting of 46,105 options
LocusOne Communications, Inc. February 3, 2000 $40.2 million --
Riverbed Technologies, Inc. March 6, 2000 $16.9 million $ 1.136 billion, consisting of 4,537,281 shares of common
stock and 862,480 options
IFX Group Plc April 6, 2000 $85.0 million --
NetSearch, LLC April 20, 2000 $35.4 million --
Cerulean Technology, Inc. September 14, 2000 $79.8 million $ 69.9 million consisting of 462,412 shares of common
stock and 94,952 options
SunPro, Inc. September 18, 2000 $10.8 million --
Sinope, Inc. September 25, 2000 $2.8 million --
Portion of Motient Corp. November 30, 2000 $49.2 million --
RTS Wireless, Inc. December 20, 2000 $34.2 million $ 78.0 million consisting of 1,259,752 shares of common
--------------------------------- stock and 90,248 options
Total $365.8 million $ 1.284 billion consisting of 6,259,445 shares of common
================================= stock and 1,093,785 options.
13
The following summary, prepared on a pro forma basis, presents the results of
the Company's operations (unaudited) as if all of the acquisitions occurring
after January 1, 2000 had been completed as of January 1, 2000:
(UNAUDITED)
---------------------------------------------------
NINE MONTHS ENDED
SEPTEMBER 30, 2000
---------------------------------------------------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Revenue $70,981
Net loss $(364,471)
Net loss per share -- basic and diluted $(9.67)
The unaudited pro forma results of operations are not necessarily
indicative of what actually would have occurred if the acquisitions had taken
place as of January 1, 2000, nor are they a projection of the Company's results
of operations for any future period. Additionally, the unaudited proforma
results of operations exclude the impairment charges related to goodwill and
investments which were incurred in 2001.
During 2000 and 1999, the Company recorded approximately $1.7 billion in
goodwill and other intangibles related to its acquisitions.
A number of factors indicated that impairments may have occurred in the
three months ended March 31, 2001. Consideration for some of the Company's
acquisitions was partially or fully funded through the issuance of shares of the
Company's common stock at a time when its stock price was at historically high
prices. The Company's stock price ranged from $40.81 to $266.00 at the time of
these acquisitions. At March 31, 2001, the Company's stock price was $13.00.
Most of the companies that the Company acquired or invested in were start-up or
newly formed entities. Most of these companies were privately-held and their
fair values are highly subjective and not readily determinable. At the time of
these acquisitions and investments, market valuations and the availability of
capital for such companies were at historically high levels. From the end of
2000 through March 31, 2001, stock prices and market valuations in the Company's
industry and similar industries fell substantially in response to a variety of
factors, including a general downturn in the economy, a curtailment in the
availability of capital and a general reduction in technology expenditures.
Based on the factors described above, the Company determined that the
goodwill in its acquisitions and investments may have become impaired as of
March 31,2001. In accordance with SFAS No. 121, the Company performed an
undiscounted cash flow analysis of its acquisitions to determine whether an
impairment existed. When the undiscounted cash flows for an acquired company was
less than the carrying value of the net assets, management determined a range of
fair values using a combination of valuation methodologies. The methodologies
included:
- Discounted cash flow analysis, which is based upon converting expected
future cash flows to present value.
- Changes in market value since the date of acquisition relative to the
following:
- the Company's stock price;
14
- comparable companies;
- the NASDAQ composite index; and
- a composite of companies that operate with in the Company's
industry.
- Market price multiples of comparable companies.
- Contribution to the Company's market valuation.
The methodologies used were consistent with the specific valuation methods
used when the original purchase price was determined. The Company's best
estimate of the fair value was determined from the range of possible values
after considering the relative performance, future prospects and risk profile of
the acquired company.
In connection with the valuation of the Riverbed Technologies, Inc.
acquisition, the Company engaged an independent third party to determine the
fair value of the acquired business because of the magnitude of the acquisition
and the associated potential impairment.
As a result of its review, management determined that the carrying value
of goodwill and certain other intangible assets related to its acquisitions were
not fully recoverable. Accordingly, at March 31, 2001, the Company recorded an
impairment charge of approximately $959 million, which represents the difference
between the carrying value and fair value of its goodwill and other intangible
assets. The impairment of goodwill and other intangible assets from the
acquisition of Riverbed Technologies, Inc. amounted to approximately $775
million, or 81% of the total impairment charge recorded. The Company also
recorded impairment charges to goodwill and other intangibles related to the
acquisitions of LocusOne Communications, Inc., NetSearch, LLC, Cerulean
Technology, Inc., Sunpro and RTS Wireless, Inc. of approximately $184 million.
At June 30, 2001, the Company performed a review of each of its
acquisitions similar to the review performed at March 31, 2001. The results of
its review indicated that of the aggregate carrying value of goodwill and
certain other intangible assets related to our acquisitions, the value of
the work force-in-place resulting from certain acquisitions had become further
impaired in the quarter ended June 30, 2001. Accordingly, the Company reduced
the carrying value of this asset by $2.2 million.
At September 30, 2001 the Company again performed a review of each of its
acquisitions similar to the review performed at March 31, 2001 and June 30,
2001. The results of its review indicated that several intangible assets had
become impaired in the quarter ended September 30, 2001. Accordingly, the
Company reduced the carrying value of these assets by $129.2 million, most of
which related to certain intangible assets obtained in connection with our
acquisition of IFX and the subsequent formation of Sila. As a result, as of
September 30, 2001, the adjusted book value of goodwill and other intangibles
was approximately $270.0 million.
Because the conditions underlying the factors the Company uses to evaluate
its acquisitions change from time to time, the Company could determine that it
is necessary to take additional material impairment charges in future periods.
(4) INVESTMENTS
(a) Investments Under the Equity Method of Accounting
15
The Company has six investments that are recorded using the equity method
of accounting: Omnisky (22.6% interest as of September 30, 2001), Inciscent
(27.5% interest as of September 30, 2001), VeriStar (25.3% interest as of
September 30, 2001), MindSurf (49.8% interest as of September 30, 2001), Spring
Wireless (28.6% interest as of September 30, 2001) and Mobiya (40.0% interest as
of September 30, 2001). The Company recorded approximately $16.8 million and
$48.3 million in expenses for the three and nine months ended September 30,
2001, respectively, to reflect its proportionate share of the losses in these
companies based upon preliminary unaudited financial information. The Company
recorded approximately $17.6 million and $31.4 million in expenses for the three
and nine month periods ended September 30, 2000, respectively, to reflect its
proportionate share of the losses in these companies based on unaudited
financial information. At September 30, 2001, the carrying value of these
investments was $15.7 million, net of proportionate share of losses and
impairment charges. For the three and nine months ended September 30, 2001, the
Company generated $0.8 and $7.0 million in revenue, respectively, from products
or services provided to these companies. For the three and nine month periods
ended September 30, 2000, the Company generated $3.0 million and $5.3 million in
revenue, respectively, from products or services provided to these companies. In
addition, the Company had $0.5 million and approximately $2.7 million in
accounts receivable at September 30, 2001 and December 31, 2000, respectively,
due from these companies.
On June 5, 2001 the Company entered into a forward purchase contract with
Credit Suisse First Boston (CSFB) which provides for the Company to deliver no
more than 2,439,100 shares of Omnisky stock to CSFB on June 5, 2002. In return
CSFB has paid the Company $5.2 million in the second quarter of 2001 which has
been recorded as a note payable in the accompanying balance sheet as of
September 30, 2001. The Company has recorded a gain on the forward purchase
contract of $4.8 million during the three months ended September 30, 2001 due to
the decline in the fair value of OmniSky stock.
(b) Other Investments
The Company has investments in five publicly traded companies.
Prior to September 20, 2001, the Company had an interest in Data Critical
Corp. ("Data Critical"). Effective September 20, 2001 Data Critical was sold to
General Electric. The Company received proceeds of $4.6 million from the sale
and realized a gain on the sale totaling $2.8 million.
The Company also has investments in eleven private companies. The Company
accounts for these investments at cost unless circumstances indicate the
carrying amount of the investment may not be recoverable, at which time the
carrying value of the investment is adjusted to fair value.
Prior to August 28, 2001, the Company had an interest in Strategy.com,
Inc. ("Straegy.com"). Effective August 28, 2001 Strategy.com was sold to
MicroStrategy Incorporated. In return for its interest in Strategy.com, the
Company received 500,000 shares of MicroStrategy. The Company recorded a
realized loss of $8.8 million as a result of this transaction.
For the three and nine months ended September 30, 2001, the Company
generated approximately $78,000 and $1.3 million, respectively in revenue from
products or services provided to these investees. In addition, the Company has
approximately $79,000 in accounts receivable, net of reserves, at September 30,
2001 due from these investees.
(c) Impairment Charges
16
The Company adjusts the carrying value of its available-for-sale
investments in public companies to market and records the change in market value
to other comprehensive income. In accordance with SAB 59, Accounting for
Noncurrent Marketable Equity Securities, the Company assessed the decline in
market value in certain of its public company investments as other than
temporary after reviewing the following factors: length of time and extent to
which the market value of the investment has been below cost, the financial
position and the near-term prospects of the issuer, and the intent and ability
of the Company to retain its investment in the investee for a period of time
sufficient to allow for any anticipated recovery in market value. As of March
31, 2001, in accordance with SAB 59, the Company recorded a realized loss of
$27.0 million related to these other than temporary declines.
At June 30, 2001, the Company performed a review of each of its
available-for-sale investments in public companies. Based on this review, the
company determined that no additional adjustments were required to its
available-for-sale investments as a result of other than temporary declines.
At September 30, 2001, the Company performed a review of each of its
available-for-sale investments in public companies. Based on this review, the
Company determined that adjustments to its available-for-sale investments of
$28.0 million were required as a result of declines that the Company deemed to
be other than temporary.
With respect to investments in non-public companies, the Company's
management performs on-going reviews based on quantitative and qualitative
measures. In evaluating its non-public company investments, management
determined a range of market values based on a combination of the following
valuation methods where applicable:
- Recent funding rounds.
- Changes in market value since the date of investment relative to the
following:
- the Company's stock price;
- comparable companies;
- the NASDAQ composite index
- a composite of companies that operate with in the Company's
industry; and
- market price multiples of comparable companies.
The fair value was determined from the range of possible values, after
considering the strength of the investee's financial position, future prospects
and risk profile of the invested company. During the first quarter of fiscal
2001, the Company recorded an impairment charge of approximately $61.8 million
related to these non-public company investments.
At June 30, 2001, the Company performed a review of its investments in
non-public companies similar to the review performed at March 31, 2001. As a
result of the review, the Company reduced the carrying value of one of its
investments by $1.1 million.
At September 30, 2001 the Company performed a review of its investment in
non-public companies similar to the review performed at March 31, 2001. As a
result of the review, the Company reduced the carrying value of its investments
by $16.1 million.
Because the conditions underlying the factors the Company uses to evaluate
its investments change from time to time, the Company could determine that it is
necessary to take additional material impairment charges in future periods.
(5) RESTRUCTURING CHARGES
17
(a) During the second quarter, Aether implemented an expense reduction plan as
part of its integration strategy focused on improving operational efficiencies
and the implementation of other measures in order to reduce planned expenses.
These efforts have resulted in the consolidation of excess facilities and
elimination of redundant positions from acquired companies. As a result of this
restructuring plan, the Company recorded a charge to earnings in the second
quarter of $15.9 million. The charge related mainly to a workforce reduction of
over 250 positions and the closing of six facilities. Employee separation
benefits of $4.9 million under the restructuring plan include severance,
medical, and other benefits. Facility closure costs of $11.0 million include
expected losses on subleases, brokerage commissions, asset impairment charges,
and other costs. As of June 30, 2001, the accrued liability related to the
restructuring had been reduced to $13.7 million as a result of payments of
approximately $2.2 million during the second quarter.
(b) During the third quarter, Aether continued its expense reduction plan as
part of its integration strategy focused on improving operational efficiencies
and the implementation of other measures in order to reduce planned expenses.
These efforts have resulted in the further consolidation of excess facilities
and elimination of positions. As a result of this restructuring plan, the
Company recorded a charge to earnings in the third quarter of $18.2 million (net
of adjustments of approximately $367,000). The charge related mainly to a
workforce reduction of over 230 positions and the closing or consolidation of
six facilities. Employee separation benefits of $4.1 million under the
restructuring plan include severance, medical, and other benefits. Facility
closure and other costs of $14.5 million include expected losses on subleases,
brokerage commissions, asset impairment charges, contract termination costs and
other costs.
A rollforward of the restructuring accrual is as follows:
Beginning Ending
Accrual Additional Cash Accrual
June 30, 2001 Accrual Payments Adjustments September 30, 2001
---------------- --------------- ------------- -------------- ---------------------
Employee Separation Benefits $ 4,268 4,070 $ (3,463) $ (147) $ 4,728
Facility Closure Costs & Other 9,394 14,528 (1,550) (220) $ 22,152
---------------- --------------- ------------- -------------- ---------------------
13,662 18,598 $ (5,013) $ (367) $ 26,880
(6) STOCK OPTIONS AND WARRANTS
(a) Options
In January 2001, the Company's employees were given the right to exchange
existing options for shares of restricted stock. 567 employees agreed to have
their options canceled in exchange for approximately 756,000 shares of
restricted stock. The Company expects to record $26.6 million of expense over
the next four years associated with the issuance of the restricted stock. The
Company recorded approximately $1.6 million and $3.3 million of expense
associated with the issuance of the restricted stock for the three and nine
months ended September 30, 2001, respectively.
(b) 3COM Warrants
In connection with the sale of an equity interest in the Company to 3Com,
the Company granted a conditional warrant to 3Com to purchase 893,665 shares at
an exercise price of $0.01
18
per share. On September 23, 2001, 3Com exercised 143,665 warrants which had
vested during 1999. 3Com vests in the remainder of the warrants upon performance
of certain services and achievement of specific criteria. As of September 30,
2001, warrants to purchase 750,000 shares had not been earned by 3Com. On
October 29, 2001, the exercise term elapsed without 3Com having attained the
aforementioned milestones, accordingly, no expense relating to the remaining
warrants has been recorded, or will ever be recorded.
1. Class Action Complaint for Violations of Federal Securities Laws, Jury
Trial Demanded, Civil Action No. 01 CV-7712, filed August 17, 2001. In
the United States District Court for the Southern District of New York,
George Murphy v. Aether Systems, Inc., Merrill Lynch, Pierce, Fenner &
Smith Inc., FleetBoston Robertson Stephens, Inc., Credit Suisse First
Boston Corp., US Bancorp Piper Jaffray Inc., Bank of America Securities
LLC, Morgan Stanley & Co. Inc., and inds., defendants.
2. Class Action Complaint for Violations of Federal Securities Laws, Jury
Trial Demanded, Civil Action No. 01 CV-7634, filed August 16, 2001. In
the United States District Court for the Southern District of New York,
Jerry Krim v. Aether Systems, Inc., Merrill Lynch, Pierce, Fenner &
Smith Inc., BancBoston Robertson Stephens Inc., Donaldson Lufkin &
Jenrette Securities Corp., US Bancorp Piper Jaffray Inc., Deutsche Bank
Securities Inc., Friedman, Billing, Ramsey & Co. Inc., and inds.,
defendants. NOTE: THIS CASE HAS BEEN CONSOLIDATED WITH CV-5570 AND
CLOSED ON SEPTEMBER 4, 2001.
(7) COMMITMENTS, CONTINGENCIES AND SUBSEQUENT EVENTS
Legal Proceedings
Aether and certain of its officers and directors are among the defendants
named in eight purported class action lawsuits. These actions were filed on
behalf of persons and entities who acquired Aether's common stock after its
initial public offering in October 21, 1999. The suits seek damages on account
of alleged violations of securities laws. Among other things, the complaints
claim that prospectuses, dated October 21, 1999 and September 27, 2000 and
issued by Aether in connection with the public offerings of its common stock,
allegedly contained untrue statements of material fact or omissions of material
fact in violation of securities laws because the prospectuses allegedly failed
to disclose that the offerings' underwriters had solicited and received
additional and excessive fees, commissions and benefits beyond those listed in
the arrangements with certain of their customers which were designed to
maintain, distort and/or inflate the market price of Aether's common stock in
the aftermarket. The actions seek unspecified monetary damages and rescission.
The Company believes the claims are without merit and plans to vigorously
contest these actions. Two of the eight actions were filed since the 10-Q for
the period ended June 30, 2001.
1. Class Action Complaint for Violations of Federal Securities Laws, Jury
Trial Demanded, Civil Action No. 01 CV-7712, filed August 17, 2001. In
the United States District Court for the Southern District of New York,
George Murphy v. Aether Systems, Inc., Merrill Lynch, Pierce, Fenner &
Smith Inc., FleetBoston Robertson Stephens, Inc., Credit Suisse First
Boston Corp., US Bancorp Piper Jaffray Inc., Bank of America Securities
LLC, Morgan Stanley & Co. Inc., and inds., defendants.
2. Class Action Complaint for Violations of Federal Securities Laws, Jury
Trial Demanded, Civil Action No. 01 CV-7634, filed August 16, 2001. In
the United States District Court for the Southern District of New York,
Jerry Krim v. Aether Systems, Inc., Merrill Lynch, Pierce, Fenner &
Smith Inc., BancBoston Robertson Stephens Inc., Donaldson Lufkin &
Jenrette Securities Corp., US Bancorp Piper Jaffray Inc., Deutsche Bank
Securities Inc., Friedman, Billing, Ramsey & Co. Inc., and inds.,
defendants. NOTE: THIS CASE HAS BEEN CONSOLIDATED WITH CV-5570 AND
CLOSED ON SEPTEMBER 4, 2001.
19
The Company is also a party to other legal proceedings in the normal
course of business. Based on evaluation of these matters and discussions with
counsel, management believes that liabilities arising from these matters will
not have a material adverse effect on the consolidated results of operations or
financial position of the Company.
20
Purchase Commitments
a) On April 11, 2000, the Company entered into a marketing agreement
with Research in Motion Limited (RIM). This agreement includes joint
commitments between Aether and RIM concerning sales and marketing
and development efforts and allows Aether to license the Blackberry
wireless messaging software for use in the Aether network operating
center. The agreement includes a commitment to purchase up to
140,000 RIM handheld devices over the following three years. The
total commitment is dependent upon certain conditions being met by
RIM over the period of the agreement. As of September 30, 2001, the
Company has met its obligation for purchases over the next three
quarters.
b) The Company is committed to take delivery of 10,420 Novatel wireless
modems. 5,420 of these modems have already been paid for.
c) In connection with the acquisition of Motient's retail
transportation segment, the Company signed airtime purchase
commitments with Motient in the amount of $15 million over three
years.
Acquisitions and Investments
The Company is committed to make the following payments during the remainder of
2001 relating to its acquisitions and investments:
(a) Motient--In connection with the acquisition of Motient's retail
transportation business, the Company is committed to pay up to an
additional $22.5 million if certain revenue and other incentive
targets are met in 2001. As of September 30, 2001, these targets
have not been met, and as such the Company has not made any payments
pursuant to this commitment.
(b) Sila Communications--The Company has committed to provide additional
funding of up to $3.4 million in 2001 to its majority-owned
subsidiary, Sila Communications, Limited.
(c) In July 2001, the Company entered into a joint venture, which would
commit the Company to $20 million in funding, assuming the joint
venture meets certain operational milestones. As of September 30,
2001, the Company funded approximately $5 million of these
commitments. For the three and nine months ended September 30, 2001,
the Company recorded revenue of approximately $49,000 and $1.4
million, respectively, from the sale of products and services to the
joint venture partner and held a receivable of approximately $1.2
million as of September 30, 2001. As of the date of this filing,
none of the operational milestones had been met.
Subsequent Events
Subsequent to September 30, 2001, the Company and America Online, Inc. entered
into a strategic alliance to develop and market wireless solutions to small and
medium sized businesses. Aether Fusion technology will extend AOL's Netbusiness
email and instant messaging to wireless platforms for the small and medium
enterprise. Aether will promote these new products, as well as Aether's current
and future wireless data products and services, across the family of America
Online interactive brands as well as AOL Time Warner's broad range of media
properties. In addition, America Online will make a minority investment in
Aether Systems.
21
(8) SEGMENT INFORMATION
The Company's operating segments include Vertical Markets, European
Operations and Corporate and Other. Each of these segments has distinct
management teams. The Vertical Markets segment provides similar integrated
wireless products and services to a variety of markets including but not
limited to transportation, logistics, government, health care and financial
services. Our European Operations segment consists of Sila, the Company's
European joint venture with Reuters, which has the majority of its customers in
the European financial services industry. Corporate and Other consists mainly
of special programs revenue and cost of sales, SG&A expenses and corporate
assets.
During 2000 and again in 2001, the Company's reportable segments
changed--and the Company expects them to continue to change--as its operating
structure, business and the markets in which it operates evolve.
Segment detail is summarized as follows:
Vertical European Corporate and
Markets Operations other Total
THREE MONTHS ENDED
SEPTEMBER 30, 2001
------------------
Revenue $ 20,709 $ 3,008 $ 1,231 $ 24,948
Gross Profit (loss) $ 8,436 $ 1,713 $ (12,772) $ (2,623)
Total Assets $ 319,024 $ 35,415 $ 704,994 $1,059,433
THREE MONTHS ENDED
SEPTEMBER 30, 2000
------------------
Revenue $ 10,941 $ 5,281 $ 0 $ 16,222
Gross Profit $ 5,528 $ 2,734 $ 0 $ 8,262
Total Assets $1,235,013 $183,645 $1,307,652 $2,727,310
NINE MONTHS ENDED
SEPTEMBER 30, 2001
------------------
Revenue $ 74,222 $ 10,227 $ 3,243 $ 87,692
Gross Profit (loss) $ 32,570 $ 4,214 $ (15,096) $ 21,688
NINE MONTHS ENDED
SEPTEMBER 30, 2000
------------------
Revenue $ 23,760 $ 8,618 $ 0 $ 32,378
Gross Profit $ 11,433 $ 4,334 $ 0 $ 15,767
The Company derives revenue primarily from the U.S. and Europe. Information
regarding our revenues and long lived assets in different geographic regions is
as follows (in thousands):
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30
----------------------------------------- --------------------------------
2001 2000 2001 2000
------------- --------------- ----------- -----------
Revenue:
U.S. $ 21,484 $ 10,726 $ 73,950 $ 23,491
22
Aggregate Foreign 3,464 5,496 13,742 8,887
------------- --------------- ----------- -----------
$ 24,948 $ 16,222 $ 87,692 $ 32,378
============= =============== =========== ===========
Long-Lived Assets
U.S. $ 322,855 $ 1,271,024
Aggregate Foreign 14,008 162,526
------------- ---------------
$ 336,863 $ 1,433,550
============= ===============
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
You should read the following description of our financial condition and
results of operations in conjunction with our Condensed Consolidated Financial
Statements and Notes thereto and other financial data appearing elsewhere in
this Form 10-Q.
This report includes forward-looking statements that involve risks and
uncertainties. When used herein, the words "anticipate," "believe," "estimate,"
"intend," "may," "will," and "expect" and similar expressions as they relate to
Aether Systems, Inc. ("Aether" or "Company") or its management are intended to
identify such forward-looking statements. The Company's actual results,
performance or achievements could differ materially from the results expressed
in, or implied by, these forward-looking statements. Factors that could cause or
contribute to such differences include those discussed in "Management's
Discussion and Analysis of Financial Condition and Results of Operations and
Business." in the section entitled "Factors Affecting Operating Results" in Item
7 of our annual report on Form 10-K filed with the SEC on April 2, 2001 plus the
effects of past or future terrorist attacks. Aether undertakes no obligation to
update or revise any forward-looking statements, whether as a result of new
information, future events or otherwise.
OVERVIEW
Aether Systems, Inc. was originally formed as Aeros, L.L.C. in January
1996. We changed our name to Aether Technologies International, L.L.C. effective
August 1996 and to Aether Systems L.L.C. effective September 1999. Immediately
prior to the completion of our initial public offering of common stock on
October 26, 1999, the limited liability company was converted into a Delaware
corporation and our name was changed to Aether Systems, Inc.
From our inception until March 1997, we primarily provided wireless
engineering services, including the development of wireless software
applications for customers. In March 1997, we began offering services that
provide the users of wireless handheld devices access to real-time financial
information. During 1997, we made a strategic decision to focus a significant
portion of our engineering resources on the development of these and other
wireless data services and systems, including our Aether Intelligent
Messaging(TM) (AIM) package of wireless messaging software and software
development tools.
23
In 1998 and 1999, we continued to develop financial information
services--as well as financial transaction services--internally and through our
acquisition of Mobeo, Inc. In 1999, we also completed our initial public
offering and began to expand our service offerings to areas other than financial
information and transactions.
In 2000, the Company continued its expansion into other vertical markets
through several acquisitions and through organic growth. Also in 2000, the
Company moved into the European marketplace with the acquisition of IFX Group
Plc ("IFX") and the related formation of Sila Communications Limited ("Sila").
During the current year, the Company has focused on the integration of its
acquisitions and the creation and deployment of Aether Fusion(TM), a
comprehensive wireless technology foundation designed to provide customers and
partners with a single-source solution for accessing essential data and
applications wirelessly.
Recently the Company entered into a strategic alliance with AOL Time
Warner whereby Aether Fusion(TM) technology would extend AOL's Netbusiness,
email and instant messaging to wireless platforms for small and medium
enterprises.
The Company's current operating segments include Vertical Markets,
European Operations and Corporate and Other. During 2000, and again in 2001,
our reportable segments changed--and we expect them to continue to change--as
our operating structure, business and the market in which we operate evolve.
Each of our segments has distinct management teams.
FACTORS AFFECTING COMPARABILITY
Our results of operations in 2001 and 2000 have been affected by
acquisitions, investments, impairment charges and the formation of Sila. In
addition, a combination of factors has resulted in operating losses that we
expect will continue for some time. The factors identified below have had a
significant impact on our operations and should be considered in comparing our
results of operations in 2001 to those in 2000.
Acquisitions
We have acquired companies to expand our product offerings and geographic
markets and to acquire additional engineering resources to develop products.
From September 1999 through December 31, 2000, we acquired 10 businesses (or
parts of businesses) for an aggregate consideration (not including contingent
payments that had not yet been earned) of $365.8 million and equity valued at
the time of acquisition of $1.284 billion, consisting of 6,259,445 shares of our
common stock and 1,093,785 replacement options. These acquisitions included the
following:
- During 1999, we acquired Mobeo for a purchase price and related
expenses of $11.5 million in cash and 46,105 options valued at
$374,000.
- In early 2000, we acquired LocusOne, NetSearch, and IFX for purchase
prices aggregating approximately $160.6 million.
- On March 6, 2000, we acquired Riverbed for 4,537,281 shares of our
common stock and 862,480 options with an aggregate value of $1.136
billion. In connection with our
24
acquisition of Riverbed, we incurred costs totaling approximately
$16.9 million.
- In September 2000, we acquired Cerulean, SunPro and Sinope for
purchase prices and related expenses aggregating approximately $93.4
million and 462,412 shares of our common stock and 94,952 options
with an aggregate value of $69.9 million.
- On November 30, 2000, we acquired Motient's retail transportation
business unit for $49.2 million in cash and related expenses plus an
additional sum of up to $22.5 million depending on whether certain
revenue and other incentive targets are met in 2001.
- On December 22, 2000, we acquired RTS for a purchase price of $34.2
million in cash and related expenses plus 1,259,752 shares of our
common stock and 90,248 options with an aggregate value of $78.0
million.
Our acquisitions increase our operating revenues and expenses from the
date of acquisition. In the discussion of results below, we quantify the effects
of acquisitions on our revenues and expenses. Acquisitions also increase
depreciation and amortization significantly as we amortize the value of
acquisition intangibles. Amortization related to acquisition intangibles was
$26.8 million and $138.1 million for the three and nine months ended September
30, 2001, respectively, and $70.1 million and $152.8 million for the three and
nine months ended September 30, 2000, respectively. The decrease in the third
quarter 2001 compared to third quarter of 2000 was primarily due to the
write-down of Riverbed goodwill at March 31, 2001. Finally, acquisitions affect
non-cash compensation when we issue options to employees at the time of an
acquisition.
Formation of Sila
On May 4, 2000, we formed Sila with Reuters to extend our operations to
the European market. We contributed our IFX subsidiary (which we purchased for
$85.0 million shortly before forming Sila), plus $13.5 million in cash to
acquire a 60.0% interest in Sila. Reuters contributed cash of approximately
$20.8 million and Futures Pager Limited, a European paging company, for the
remaining 40.0% interest. The results of Sila are consolidated in our financial
statements.
Investments
We have made investments through Aether Capital, L.L.C., our wholly-owned
subsidiary, to promote the development of new technologies that are compatible
with the services we offer or that we may wish to integrate into our services.
These investments include:
- In August 1999, we formed a new company called OpenSky, which was
renamed OmniSky in October 1999. We have invested a total of $9.2
million in OmniSky. We formed OmniSky with 3Com to pursue
opportunities in the emerging consumer and business mass markets for
wireless e-mail, Internet access and other electronic transactions
applications. As of September 30, 2001, we owned approximately 22.6%
of OmniSky after completion of OmniSky's initial public offering. We
account for our investment in OmniSky under the equity method of
accounting.
- In March 2000, we acquired a 27.5% interest in Inciscent in the form
of preferred stock for a purchase price of $9.9 million. We formed
Inciscent with Metrocall, PSINet, and Hicks, Muse, Tate & Furst and
other investors to develop wireless e-mail, Internet access
25
and other applications for the small office and home office markets.
We account for our investment in Inciscent under the equity method
of accounting.
- In July 2000, we entered into an agreement with Sylvan to establish
Mindsurf, a new company focused on educational services. We have
committed to acquire a 47% interest in Mindsurf for $32.9 million in
cash. Sylvan has also committed to acquire a 47% interest for $32.9
million in cash while the remaining 6% will be owned by other
minority investors. As of September 30, 2001, we have funded $16.3
million of our commitment to Mindsurf. We can agree with Sylvan at
any time to cease funding for Mindsurf. We account for our
investment in Mindsurf under the equity method of accounting.
Investments also include five publicly-traded companies. We account for
these five investments at fair value based on quoted market prices. Net
unrealized holding gains and losses on these available-for-sale securities are
excluded from income and recorded as a separate component of stockholders'
equity unless the decline is deemed to be other than temporary. Subsequent to
our investment, the market values of these investments have decreased
significantly. In some cases we have determined the decline in market value of
our investments in publicly-traded companies to be other than temporary, and as
such have recorded realized losses on these investments, which are included in
net income.
Investments also include eleven private companies. The Company accounts
for these investments at cost unless circumstances indicate the carrying amount
of the investment may not be recoverable, at which time the carrying value of
the investment is adjusted to fair value.
IMPAIRMENT CHARGES
From 1999 through September 30, 2001, the Company recorded approximately
$1.7 billion in goodwill and other intangibles related to its acquisitions. In
addition, the Company has made investments in other businesses totaling
approximately $192.9 million during this period. The Company's management
performs an on-going analysis of the recoverability of its goodwill and other
intangibles and the value of its investments in accordance with SFAS No. 121,
Accounting for the Impairment of Long-Lived Assets and For Long-Lived Assets to
be Disposed Of. Based on quantitative and qualitative measures, the Company
assesses the need to record impairment losses on long-lived assets used in
operations when impairment indicators are present. The impairment conditions
evaluated by management may change from period to period, given that the Company
operates in a volatile business environment.
A number of factors indicated that impairments may have occured in the
period ended March 31, 2001. Consideration for some of the Company's
acquisitions was partially or fully funded through the issuance of shares of the
Company's common stock at a time when its stock price was at historically high
prices. The Company's stock price ranged from $40.81 to $266.00 at the time of
these acquisitions. At March 31, 2001, the Company's stock price was $13.00.
Most of the companies the Company acquired or invested in are start-up or newly
formed entities. Most of these companies were privately-held and their fair
values are highly subjective and not readily determinable. At the time of these
acquisitions and investments, market valuations and the availability of capital
for such companies was at historically high levels. Between the end of 2000 and
March 31, 2001, stock prices and market valuations in the
26
Company's industry and similar industries had fallen substantially in response
to a variety of factors, including a general downturn in the economy, a
curtailment in the availability of capital and a general reduction in technology
expenditures.
Based on the factors described above, the Company determined at March 31,
2001 that the goodwill in its acquisitions and investments may have become
impaired. In accordance with SFAS No. 121, the Company performed an undiscounted
cash flow analysis of its acquisitions to determine whether an impairment
existed. When the undiscounted cash flows for an acquired company was less than
the carrying value of the net assets, management determined a range of fair
values using a combination of valuation methodologies. The methodologies
included:
- Discounted cash flow analysis, which is based upon converting expected
future cash flows to present value.
- Changes in market value since the date of acquisition relative to the
following:
- the Company's stock price;
- comparable companies;
- the NASDAQ composite index; and
- a composite of companies that operate with in the Company's
industry.
- Market price multiples of comparable companies.
- Contribution to the Company's market valuation.
The methodologies used were consistent with the specific valuation methods
used when the original purchase price was determined. The Company's best
estimate of the fair value was determined from the range of possible values
after considering the relative performance, future prospects and risk profile of
the acquired company.
In connection with the valuation of the Riverbed Technologies, Inc.
acquisition, the Company engaged an independent third party to determine the
fair value of the acquired business, because of the magnitude of the acquisition
and the associated potential impairment.
As a result of its review, management determined that the carrying value
of goodwill and certain other intangible assets related to its acquisitions were
not fully recoverable. Accordingly, at March 31, 2001, we recorded an impairment
charge of approximately $959 million, which represents the difference between
the carrying value and fair value of its goodwill and other intangible assets.
The impairment of goodwill and other intangible assets from the acquisition of
Riverbed Technologies, Inc. amounted to approximately $775 million, or 81% of
the total impairment charge. We also recorded impairment charges to goodwill and
other intangibles related to the acquisitions of LocusOne Communications, Inc.,
NetSearch, LLC, Cerulean Technology, Inc., Sunpro and RTS Wireless, Inc. of
approximately $184 million.
At June 30, 2001, we performed a review of each of our acquisitions
similar to the review performed at March 31, 2001. The results of our review
indicated that of the aggregate carrying value of goodwill and certain other
intangible assets related to our acquisitions, only the value of the
work-force-in-place resulting from certain acquisitions had become further
impaired in the
27
quarter ended June 30, 2001. Accordingly, the Company reduced the carrying value
of this asset by $2.2 million.
At September 30, 2001 the Company again performed a review of each of its
acquisitions similar to the review performed at March 31, 2001 and June 30,
2001. The results of its review indicated that several intangible assets had
become impaired or further impaired in the quarter ended September 30, 2001.
Accordingly, the Company reduced the carrying value of these assets by $129.2
million, most of which related to certain intangible assets obtained in
connection with our acquisition of IFX and the subsequent formation of Sila. As
a result, as of September 30, 2001, the adjusted book value of goodwill and
other intangibles was approximately $270.0 million.
The Company adjusts the carrying value of its available-for-sale
investments in public companies to market and records the change in market value
to other comprehensive income. In accordance with SAB 59, Accounting for
Noncurrent Marketable Equity Securities, the Company assessed the decline in
market value in certain of its public company investments as other than
temporary after reviewing the following factors: length of time and extent to
which the market value of the investment has been below cost, the financial
position and the near-term prospects of the issuer, and the intent and ability
of the Company to retain its investment in the investee for a period of time
sufficient to allow for any anticipated recovery in market value. As of March
31, 2001, in accordance with SAB 59, the Company recorded a realized loss of
$27.0 million related to these other than temporary declines.
At June 30, 2001, the Company performed a review of each of its
available-for-sale investments in public companies. Based on this review, the
Company determined that no additional adjustments were required to its
available-for-sale investments as a result of other than temporary declines.
At September 30, 2001, the Company performed a review of each of its
available-for-sale investments in public companies. Based on this review, the
Company determined that adjustments to its available-for-sale investments of
$28.0 million were required as a result of declines that the Company deemed to
be other than temporary.
With respect to investments in non-public companies, the Company's
management performs on-going reviews based on quantitative and qualitative
measures. In evaluating its non-public company investments, management
determined a range of market values based on a combination of the following
valuation methods where applicable:
- Recent funding rounds.
- Changes in market value since the date of investment relative to the
following:
- the Company's stock price;
- comparable companies;
- the NASDAQ composite index
- a composite of companies that operate with in the Company's
industry.
- market price multiples of comparable companies.
28
The fair value was determined from the range of possible values, after
considering the strength of the investee's financial position, future prospects
and risk profile of the invested company. During the first quarter of fiscal
2001, the Company recorded an impairment charge of approximately $61.8 million
related to these non-public company investments.
At June 30, 2001, we performed a review of our investments in non-public
companies similar to the review performed at March 31, 2001. As a result of our
review, we reduced the carrying value of one of our investments by $1.1 million.
At September 30, 2001 the Company performed a review of our investment in
non-public companies similar to the review performed at March 31, 2001. As a
result of the review, we reduced the carrying value of our investments by $16.1
million.
Because the conditions underlying the factors the Company uses to evaluate
its acquisitions and investments changes from time to time, the Company could
determine that it is necessary to take additional material impairment charges in
future periods.
OPERATING REVENUES AND EXPENSES
We describe below the components of our operating revenues and expenses.
Subscriber revenue and expenses
We derive recurring revenue from subscribers in the Vertical Markets and
European Operations segments.
Subscriber revenue may consist of:
- a one-time non-refundable activation fee, which we recognize ratably
over the expected life of the customer relationship;
- monthly per-subscriber service fees, which we recognize as services
are provided;
- monthly per-subscriber exchange fees for access to financial
information from the securities exchanges and markets, which we
recognize as services are provided; and
- monthly fees for providing access to our network operations center,
which we recognize as services are provided, ratably over the
contract period.
For certain of our products, our subscribers' monthly fee includes the use
of a wireless handheld device. Revenue for such devices is recognized as the
related service is provided. Contracts with our wireless data subscribers are
generally for a one-year period and include a termination penalty if cancelled
by the subscriber before the one-year period expires. These contracts are
generally renewable at the option of the subscriber for additional one-year
periods or otherwise continue on a monthly basis until cancelled by the
subscriber.
Cost of subscriber revenue consists primarily of airtime costs, financial
data costs, and securities exchange and market fees. Our airtime costs are
determined by agreements we have with several wireless carriers. Typically, we
have one-year contracts to buy data network capacity either for an agreed amount
of kilobytes at a flat fee or on a cents-per-kilobyte basis.
29
Cost of subscriber revenue excludes depreciation on our network operations
center and certain costs of customer fulfillment, which is included in sales and
marketing expense.
Engineering services revenue and expenses
Revenue from wireless engineering services consists of amounts billed to
our customers for engineering time on an hourly basis or fixed fees on a per
project basis. This revenue is recognized as the work is performed. Cost of
engineering services revenue consists of cash compensation and related costs for
engineers and other project-related costs.
Software and related services revenue and expenses
We derive revenue from the licensing of software products, including the
AIM platform, the ScoutWare software suite, the e-Mobile software suite, the
PacketCluster software suite, the FireRMS software suite and the Advantage
software suite. In future quarters we expect to generate revenue from the
licensing of our new software foundation Aether Fusion(TM). Cost of software and
related services revenue consists of costs of licensing, including royalty
payments and personnel costs.
Device sales and expenses
We generate revenue by providing our subscribers the option to purchase
wireless handheld devices from us at or near cost, which we recognize as revenue
upon shipment of the devices, or over the expected term of the customer
relationship. Cost of device sales consists of the cost of the hardware from the
hardware manufacturer or wholesaler.
Research and development expenses
Research and development expenses consist primarily of cash compensation
and related costs for engineers 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.
General and administrative and selling and marketing expenses
General and administrative expenses consist primarily of cash compensation
and related costs for general corporate and business development personnel,
along with rent and other costs. Selling and marketing expenses consist
primarily of advertising and promotions, sales and marketing personnel, travel
and entertainment, certain customer fulfillment and other costs.
Depreciation and amortization expenses
Depreciation and amortization expenses consist primarily of the
amortization of intangible assets obtained in connection with our acquisitions.
Depreciation and amortization expenses also include depreciation expenses
arising from equipment purchased for our network operations centers and other
property and equipment purchases.
Option and warrant expenses
Option and warrant expense consists of expenses recorded to account for
the difference, on the date of grant, between the fair market value and the
exercise price of stock options issued to employees, restricted stock granted to
employees and the fair value of equity-based awards to non-employees. We
commonly issue options and/or warrants at prices below market value in
30
connection with our acquisitions. Given our numerous acquisitions since our
inception and our restricted stock plan, we expect to continue to have
substantial option and warrant expense.
Impairment of intangibles
Impairment of intangibles expense consists of the amount of goodwill and
other intangibles, written down in accordance with SFAS 121, Accounting for the
Impairment of Long-Lived Assets and for Assets to Be Disposed Of. The impaired
goodwill related to our acquisitions of Riverbed Technologies, Inc., LocusOne
Communications, Inc., NetSearch, Inc. Cerulean Technology, Inc. SunPro, Inc.,
IFX and the related formation of Sila and RTS Wireless, Inc.
Restructuring Charge
The restructuring charge consists primarily of the costs that we estimate
we will incur associated with the plan we have begun to implement to consolidate
excess facilities and eliminate redundant positions from acquired companies.
Interest income (expense), net
Interest income (expense), net consists primarily of interest income from
cash equivalents and short-term investments, interest expense and realized gains
(losses) on sale of our investments.
Equity in losses of investments
Equity in losses of investments consists of our proportionate share of the
net losses of OmniSky, Inciscent, MindSurf, VeriStar Corporation, Mobiya, and
Spring Wireless, which are recorded under the equity method of accounting.
Minority interest
Minority interest consists wholly of Reuters' ownership interest in Sila.
Investment gains (losses), including impairments, net.
Investment gains (losses), including impairments, net, consists of the
loss taken on investments where the decline in market value was deemed to be
other than temporary. Investment losses also include amounts related to the
decline in the fair value of derivative instruments, offset by gains on the
sales of investments.
Income tax benefit
Income tax benefit consists of a foreign deferred tax benefit associated with
the losses generated by Sila.
Cumulative effect of change in accounting principle
Cumulative effect of change in accounting principle consists entirely of
the cumulative benefit of the implementation of SFAS 133, Accounting for
Derivative Instruments and Hedging Activities.
Extraordinary Item
The extraordinary item consists entirely of the gain realized from the
early extinguishment of $20.0 million in convertible subordinated notes payable.
31
COMPARISON OF RESULTS FOR THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2001 AND
2000
Subscriber revenue. Subscriber revenue increased to $11.2 million for the
three months ended September 30, 2001 from $7.6 million for the three months
ended September 30, 2000, while subscribers increased to 60,033 at September 30,
2001 from 22,919 at September 30, 2000. The increase between periods was
primarily due to $2.6 million in sales of our Mobile Max product line and about
$1.0 million increase in sales to our financial services customers. Subscriber
revenue increased to $33.0 million for the nine months ended September 30, 2001
from $16.5 million for the nine months ended September 30, 2000. The increase
between periods was due to $7.9 million in sales of our Mobile Max product line
and a $2.1 million increase in sales to our financial services customers. The
remaining increase was primarily due to the revenue resulting from the increased
number of subscribers offerings to large enterprise customers. The Mobile Max
product line was obtained in connection with an acquisition made after September
30 of last year.
Cost of subscriber revenue. Cost of subscriber revenue increased to $6.8
million for the three months ended September 30, 2001 from $3.2 million for the
three months ended September 30, 2000. We generally expect the cost of
subscriber revenue to increase proportionately with any increase in subscriber
revenue. The increase between periods was due to costs of sales of our Mobile
Max product line of $1.9 million and a increase of approximately $1.5 million in
cost of sales to our financial services customers. The remaining increase was
due to the cost of revenue resulting from the increased number of subscribers
that signed on to our offerings to large enterprise customers. Cost of
subscriber revenue increased to $19.7 million for the nine months ended
September 30, 2001 from $7.4 million for the nine months ended September 30,
2000. The increase between periods was due to costs of sales of our Mobile Max
product line of $5.5 million and an increase of approximately $2.2 million in
cost of sales to our financial services customers. The remaining increase was
primarily due to the cost of revenue resulting from the increased number of
subscribers that signed on to our offerings to large enterprise customers.
Engineering services revenue. Engineering services revenue decreased to
$642,000 for three months ended September 30, 2001 from $2.5 million for the
three months ended September 30, 2000. Engineering services revenue decreased as
several large engineering projects were completed in early 2001. Engineering
services revenue increased to $5.8 million for nine months ended September 30,
2001 from $5.6 million for the nine months ended September 30, 2000.
Approximately $1.0 million of the change between periods was due to our
engineering services contracts with Sun Microsystems, partially offset by the
completion of several large projects in early 2001.
Cost of engineering services revenue. Cost of engineering services revenue
decreased to $314,000 for three months ended September 30, 2001 from $1.9
million for the three months
32
ended September 30, 2000. This decrease was due primarily to the decrease in
engineering services performed as discussed above. Cost of engineering services
revenue decreased to $3.1 million for nine months ended September 30, 2001 from
$3.5 million for the nine months ended September 30, 2000. This decrease was due
primarily to the decrease in engineering services performed as discussed above.
Software and related services revenue. Software and related services
revenue was $8.2 million for the three months ended September 30, 2001 and $5.3
million for the three months ended September 30, 2000. The increase between
periods was primarily due to sales of licenses of the PacketCluster software
suite and the FireRMS suite which we obtained in conjunction with acquisitions
ocurring in or after the three months ended September 30, 2001. Software and
related services revenue was $29.9 million for the nine months ended September
30, 2001 and $8.7 million for the nine months ended September 30, 2000. The
increase between years was primarily due to sales of licenses and services of
the PacketCluster software suite, FireRMS software suite AIM and the ScoutWare
software platform, all of which were obtained in conjunction with acquisitions
occurring in 2000.
Cost of software and related services revenue. Cost of software and
related services revenue was $2.9 million for the three months ended September
30, 2001 and approximately $1.9 million for the three months ended September 30,
2000. Cost of software and related services revenue was $9.5 million for the
nine months ended September 30, 2001 and $3.4 million for the nine months ended
September 30, 2000. The increase between periods was due to the increase in
software sales and services as discussed above.
Device sales. Revenue from device sales was $4.9 million for the three
months ended September 30, 2001 and approximately $886,000 for the three months
ended September 30, 2000. Revenue from device sales was $19.0 million for the
nine months ended September 30, 2001 and approximately $1.6 million for the nine
months ended September 30, 2000. The increase in device sales between periods
relates primarily to the increase of subscribers between periods and the sales
of devices to resellers.
Cost of device sales. Cost of device sales was $17.6 million for the three
months ended September 30, 2001 and approximately $1.0 million for the three
months ended September 30, 2000. Cost of device sales was $33.7 million for the
nine months ended September 30, 2001 and $2.3 million for the nine months ended
September 30, 2000. The increase in the cost of device sales between periods
relates to the increase in device sales between periods. Included in our results
are bulk sales of hardware at or below cost made primarily to reduce inventory.
Additionally, the cost of device sales increased for the nine months ended
September 30, 2001 due to an inventory write-down due to obsolesence and excess
inventory of $1.9 million and $12.5 million taken in the first and third
quarters of 2001, respectively.
Research and development expenses. Research and development expenses,
including in-process research and development related to acquisitions, increased
to $16.2 million for the three months ended September 30, 2001 from $10.1
million for the three months ended September 30, 2000. The increase between
periods was due to increased expenses of $3.7 million associated with
acquisitions made late in the third quarter and in the fourth quarter of last
year. The remaining increase was due to the hiring of additional engineers and
consultants for increased research and development activities associated with
the development of our software products, mobile computing platforms, including
Aether Fusion (TM), and wireless data services. Research and development
expenses, including in-process research and development related to acquisitions,
increased to $52.0 million for the nine months ended September 30, 2001 from
$18.0 million for the nine months ended September 30, 2000. The increase between
periods was due to increased expenses of $17.8 million associated with
acquisitions made late in the third
33
quarter and in the fourth quarter of last year. The remaining increase was due
to the hiring of additional engineers and consultants for increased research and
development activities associated with the development of our software products,
mobile computing platforms, including Aether Fusion (TM), and wireless data
services. Research and development expenses have begun to decline as our
restructuring plans have been executed. We anticipate additional declines in
future periods as we continue to execute on our restructuring plans and cost
saving initiatives.
General and administrative expenses. General and administrative expenses
increased to $22.0 million for the three months ended September 30, 2001 from
$20.4 million for the three months ended September 30, 2000. The increase
between periods was primarily due to additional personnel and consultants
performing general corporate activities and due to increased general and
administrative costs associated with our acquisitions since the prior year,
partially offset by reductions in cost as we have implemented our restructuring
plans. General and administrative expenses increased to $71.4 million for the
nine months ended September 30, 2001 from $35.7 million for the nine months
ended September 30, 2000. The increase between periods was primarily due to
additional personnel and consultants performing general corporate activities,
additional facilities and our acquisitions since the prior year. The increased
scope of our business has required additional personnel and other expenses, such
as consulting and facilities, in all areas including: customer service, network
operations, project management, legal and accounting. General and administrative
expenses have begun to decline as our restructuring plans have been executed. We
anticipate additional declines in future periods as we continue to execute on
our restructuring plans and cost saving initiatives.
Selling and marketing expenses. Selling and marketing expenses increased
to $14.8 million for the three months ended September 30, 2001 from $10.5
million for the three months ended September 30, 2000. The increase between
periods was due primarily to expenses for the quarter of $4.7 million associated
with acquisitions made late in the third quarter and in the fourth quarter of
last year, partially offset by reduced spending for our branding and advertising
campaign. Selling and marketing expenses increased to $55.5 million for the nine
months ended September 30, 2001 from $32.3 million for the nine months ended
September 30, 2000. The increase in 2001 was primarily due to expenses for the
nine months of $18.7 million associated with acquisitions made late in the third
quarter and in the fourth quarter of last year. The remaining increase between
periods was due to the increased first quarter expenses for the Aether
Fusion(TM) branding campaign. Selling and marketing expenses have begun to
decline as our restructuring plans have been executed. We anticipate additional
declines in future periods as we continue to execute on our restructuring plans
and cost saving initiatives.
Depreciation and amortization. Depreciation and amortization decreased to
$32.1 million for the three months ended September 30, 2001 from $72.3 million
for the three months ended September 30, 2000. Depreciation and amortization
decreased to $153.3 million for the nine months ended September 30, 2001 from
$156.8 million for the nine months ended September 30, 2000. This decrease was
primarily a result of the impairment charge recorded in the first quarter of
2001 which significantly reduced the carrying value of the goodwill and other
intangibles.
Option and warrant expense. Option and warrant expense decreased to $3.5
million for the three months ended September 30, 2001 from $4.0 million for the
three months ended September 30, 2000. Option and warrant expense increased to
$12.5 million for the nine months ended September 30, 2001 from $10.1 million
for the nine months ended September 30, 2000. The increase between the periods
was due primarily to amortized option and warrant expense related to options
with strike prices below market value on the date of grant, granted in
conjunction with acquisitions made late in the third quarter and in the fourth
quarter of last year, and the amortization of expense related to restricted
stock granted in January 2001.
Restructuring charge. During the second quarter, Aether implemented an
expense reduction plan as part of its integration strategy focused on improving
operational efficiencies and the implementation of other measures in order to
reduce planned expenses. These efforts have resulted in the consolidation of
excess facilities and elimination of redundant positions from acquired
companies. As a result of this restructuring plan, the Company recorded a charge
to
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earnings in the second quarter of $15.9 million. The charge related mainly to a
workforce reduction of over 250 positions and the closing of six facilities.
Employee separation benefits of $4.9 million under the restructuring plan
include severance, medical, and other benefits. Facility closure costs of $11.0
million include expected losses on subleases, brokerage commissions, asset
impairment charges, and other costs including expected contract termination
costs.
During the third quarter, Aether continued its expense reduction plan as
part of its integration strategy focused on improving operational efficiencies
and the implementation of other measures in order to reduce planned expenses.
These efforts have resulted in the further consolidation of excess facilities
and elimination of positions. As a result of this restructuring plan, the
Company recorded a charge to earnings in the third quarter of $18.2 million
(net of adjustments of approximately $367,000). The charge related mainly to a
workforce reduction of over 230 positions and the closing or consolidation of
six facilities. Employee separation benefits of $4.1 million under the
restructuring plan include severance, medical, and other benefits. Facility
closure costs and other costs of $14.5 million include expected losses on
subleases, brokerage commissions, asset impairment charges, contract
termination, and other costs.
Interest income, net. Net interest income decreased to $1.1 million for
the three months ended September 30, 2001 from $14.6 million for the three
months ended September 30, 2000. Net interest income decreased to $10.7 million
for the nine months ended September 30, 2001 from $31.5 million for the nine
months ended September 30, 2000. The decrease between 2001 and 2000 was
primarily due to a decrease in interest earned on cash and cash equivalents as
our cash on hand decreased between periods related to investing and operating
activities. The remaining decrease was due to the lowering of interest rates in
2001.
Equity in losses of investments. Equity in losses of investments was $16.8
million for the three months ended September 30, 2001 and $17.6 million for the
three months ended September 30, 2000. Equity in losses of investments was $48.3
million for the nine months ended September 30, 2001 and $31.4 million for the
nine months ended September 30, 2000. The increase related to our proportionate
share of losses from OmniSky, Inciscent, MindSurf, VeriStar, Spring Wireless,
and Mobiya, which are all accounted for under the equity method of accounting.
We expect to continue to record equity losses in investments as these companies
continue to develop their operations.
Investment gains (losses), including impairments, net. Investment gain
(losses), including impairments, net was $45.7 million for the three months
ended September 30, 2001. There was no such loss for the three months ended
September 30, 2000. Investment loss, including impairments was $141.6 million
for the nine months ended September 30, 2001. There was no such loss for the
nine months ended September 30, 2000. The increase for the three and nine
months ended September 30, 2001 was due primarily to the loss taken on
investments where the decline in market value was deemed to be other than
temporary. The Company also recorded a loss of approximately $406,000 and $6.4
million for the three and nine months ended September 30, 2001, respectively,
relating to the decline in the fair value of derivative instruments, offset by
gains on the sales of investments.
Minority interest. Minority interest was $47.4 million for the three
months ended September 30, 2001 and $4.3 million for the three months ended
September 30, 2000. Minority interest was $55.5 million for the nine months
ended September 30, 2001 and $6.0 million for the nine months ended September
30, 2000. Minority interest relates to Reuters' proportional share of losses in
Sila, which was formed in May 2000 and is consolidated into our financial
statements. We expect that Sila will continue to incur losses as it develops its
operations.
35
Income tax benefit. Income tax benefit was approximately $9.1 and $574,000
for the three months ended September 30, 2001 and 2000 and approximately $10.0
million and $574,000 for the nine months ended September 30, 2001 and 2000. This
increase was due to a foreign deferred tax benefit associated with the losses
generated by Sila, which was formed in May 2000.
Extraordinary Item. The extraordinary item consists entirely of the gain
realized from the early extinguishment of $20.0 million in convertible
subordinated notes payable.
Cumulative effect of change in accounting principle. Cumulative effect of
change in accounting principle was $0 for the three months ended September 30,
2001 and $6.6 million for the nine months ended September 30, 2001 and was due
entirely to the adoption of SFAS 133, Accounting for Derivative Instruments and
Hedging Activities. SFAS 133 provides that derivatives should be carried as an
asset on the balance sheet at fair value, and that changes in fair value between
periods should be included in net income. Our derivatives include warrants
obtained in connections with several of our investments. Such warrants are
considered derivatives as they include provisions which allow for net
settlement.
SEGMENT RESULTS
Vertical European Corporate and
Markets Operations other Total
THREE MONTHS ENDED
SEPTEMBER 30, 2001
------------------
Revenue $ 20,709 $ 3,008 $ 1,231 $ 24,948
Gross Profit (loss) $ 8,436 $ 1,713 $ (12,772) $ (2,623)
Total Assets $ 319,024 $ 35,415 $ 704,994 $ 1,059,433
THREE MONTHS ENDED
SEPTEMBER 30, 2000
------------------
Revenue $ 10,941 $ 5,281 $ 0 $ 16,222
Gross Profit $ 5,528 $ 2,734 $ 0 $ 8,262
Total Assets $ 1,235,013 $ 183,645 $ 1,307,652 $ 2,727,310
NINE MONTHS ENDED
SEPTEMBER 30, 2001
------------------
Revenue $ 74,222 $ 10,227 $ 3,243 $ 87,692
Gross Profit (loss) $ 32,570 $ 4,214 $ (15,096) $ 21,688
NINE MONTHS ENDED
SEPTEMBER 30, 2000
------------------
Revenue $ 23,760 $ 8,618 $ 0 $ 32,378
Gross Profit $ 11,433 $ 4,334 $ 0 $ 15,767
The type of revenue we earn in each of our segments varies from segment to
segment.
Vertical markets. We operate in a wide variety of vertical markets. Our
vertical markets segment can have subscriber revenue, engineering services
revenue, device sales and software and related services revenue depending on the
needs of the customer. Revenue in the vertical markets segment increased to
$20.7 million in the three months ended September 30, 2001 from $10.9 million in
the three months ended September 30, 2000 and gross profit in that segment
increased to $8.4 million in the three months ended September 30, 2001 from $5.5
million in the three months ended September 30, 2000. The increase in this
segment was primarily due to $2.8 million in revenue and $1.2 million in gross
profits from sales of our Mobile Max product line and a $6.4 million increase in
revenue and $3.4 million increase in gross profit from sales of our
PacketCluster software suite and associated hardware. Mobile Max and
PacketCluster were obtained in connection with acquisitions made late in the
third quarter and in the fourth quarter of last year.
Revenue in the vertical markets segment increased to $74.2 million in the
nine months ended September 30, 2001 from $23.8 million in the nine months ended
September 30, 2000 and gross profit in that segment increased to $32.1 million
in the nine months ended September 30, 2001 from $11.4 million in the nine
months ended September 30, 2000. The increase between periods was primarily due
to $10.2 million in revenue and $3.1 million in gross profits from sales of our
Mobile Max product line and a $20.3 million increase in revenue and $11.5
million increase in gross profit from sales of our PacketCluster software suite
and associated hardware. The remaining increase was primarily due to sales to
our financial services customers and offerings to large enterprise customers.
36
European Operations. Our European operations segment consists of Sila and
generates revenue from subscribers, engineering services and from the sale of
software and related services. Sila was formed in May 2000. As Sila's revenues
are currently derived primarily from the financial services sector, it saw a
modest reduction in revenues from 2000 to 2001 due to the overall pullback in
the market for global equities.
Corporate & Other. Revenue in the Corporate & Other segment relates solely to
sales pursuant to our inventory reduction plan which provided for bulk sales of
inventory at prices below our cost. Negative gross profit in this segment was a
result both of the cost associated with the aforementioned revenue and inventory
obsolescence write downs of $1.9 million and $12.5 million in the first and
third quarters of 2001 respectively.
LIQUIDITY AND CAPITAL RESOURCES
Since our inception, we have financed our operations primarily through
private and public placements of our equity securities and debt. Through
September 30, 2001, we have raised aggregate net proceeds of approximately $1.5
billion including the issuance of $310.5 million of 6% convertible subordinated
notes of which $290.5 million were outstanding at September 30, 2001. As of
September 30, 2001, we had approximately $594.4 million in cash and short-term
investments (including restricted cash of $10.3 million) and working capital of
approximately $550.2 million.
Net cash used in operating activities was $156.6 million and $27.3 million
for the nine months ended September 30, 2001 and 2000, respectively. The
principal use of cash in each of these periods was to fund our losses from
operations.
Net cash used in investing activities was $112.3 million and $389.3
million for the nine months ended September 30, 2001 and 2000, respectively. For
the nine months ended September 30, 2001, we used $35.0 million for the purchase
of property and equipment primarily relating to the expansion of our network
operating centers and business systems. $37.0 million for investments in
companies under Aether Capital and $42.1 million for payments to satisfy
commitments on 2000 acquisitions. Cash used by investing activities for the nine
months ended September 30, 2000 was primarily for investments in companies of
$114.0 million and acquisitions of $252.8 million. Most of the remainder was due
to capital expenditures.
Net cash provided by (used in) financing activities was approximately
($5.9) million and $1,380.9 million for the nine months ended September 30,
2001 and 2000 respectively. For the nine months ended September 30, 2000, cash
provided by financing activities was primarily attributable to proceeds received
from our secondary offering of common stock and convertible subordinated notes.
37
While not a measure under generally accepted accounting principles,
EBITDA is a standard measure of financial performance in our industry. EBITDA
means earnings before interest, taxes, depreciation and amortization, option
and warrant expense, impairment charges, realized losses and cumulative effect
of change in accounting principle. EBITDA should not be considered in isolation
or as an alternative to net income (loss), income (loss) from operations, cash
flows from operating activities, or any other measure of performance under
generally accepted accounting principles. Cash expenditures for various
long-term assets, interest expense and income taxes have been, and will be,
incurred which are not reflected in the EBITDA presentations. EBITDA losses
increased to $55.5 million in the three months ended September 30, 2001 from
$28.9 million in the three months ended September 30, 2000. EBITA losses
increased to $157.3 for the nine months ended September 30, 2001 from $64.2 in
the nine months ended September 30, 2000. The increase between periods was due
to increases in operating expenses as a result of acquisitions and our
continued growth. EBITDA, exclusive of the inventory write down, has improved
sequentially over the past two quarters. This is a result of reduction in G&A,
S&M, and R&D expenses.
We expect to continue to use cash to fund operations as we continue to
develop our products and markets. The time at which our operating revenues will
exceed operating expenses, if ever, depends on a wide variety of factors
including general business trends, development of our markets, the progress of
and changes in our research and development activities and the effect of
potential future acquisitions. Given our current cash resources and our ability
to control some of the factors that will affect when operating revenues may
exceed operating expenses, we believe we have substantial flexibility to
continue operations and still have funds available for our operating and capital
requirements for at least the next twelve months.
For the remainder of fiscal year 2001, we expect to have expenditures totaling
approximately, $31.1 million relating to purchase commitments, commitments
related to 2000 acquisitions and funding to Sila.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this Amendment to be signed on its behalf by the
undersigned thereunto duly authorized.
Dated: November 16, 2001
Aether Systems, Inc.
By: /s/ David C. Reymann
--------------------
David C. Reymann
Chief Financial Officer
(Principal Financial and Accounting
Officer)
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