Item 1. Description of Business
Overview
Eagle Broadband, Inc. (the "Company" or "Eagle"), is a leading provider of broadband, Internet protocol (IP) and satellite communications technology and services. The Company is focused on three core businesses: broadband bundled services, IP set-top boxes and satellite communications technology. The Company's product offerings include an exclusive "four-play" suite of IP-based broadband bundled services with high-speed Internet, cable TV, telephone and security monitoring, and a turnkey suite of financing, network design, operational and support services that enables municipalities, utilities, real estate developers, hotels, multi-tenant owners and service providers to deliver exceptional value, state-of-the-art entertainment and communications choices and single-bill convenience to their residential and business customers. Eagle offers the HDTV-ready Media Pro IP set-top box product line that enables hotel operators and service providers to maximize revenues by offering state-of-the-art in-room entertainment and video services. The Company also develops and markets the SatMAX satellite communications system that allows government, military, homeland security, aviation, maritime and enterprise customers to deliver reliable, non-line-of-sight, voice and data communications services via the Iridium satellite network from any location on Earth.
As of August 31, 2004, the Company's active subsidiaries were: Eagle Broadband Services, Inc. (EBS), operating as Eagle BDS; DSS Security, Inc. (DSS), operating as Eagle Security Services; and Eagle Managed Services. Additionally, Eagle has a number of inactive subsidiaries that had results in one or more of the periods included in the financial statements covered by this report. These inactive subsidiaries include: ClearWorks Communications, Inc. (COMM), formerly operated as BDS; ClearWorks.net, Inc. (.NET); ClearWorks Home Systems, Inc. (HSI), operated as Eagle Residential Structured Wiring; Eagle Wireless International, Inc. (EWI); Contact Wireless, Inc. (CWI), operated as Eagle Paging Services; United Computing Group, Inc. (UCG), operated as Eagle Technology Services; and Link Two Communications, Inc. (LINK II), operated as Eagle Messaging Services. Eagle has incorporated certain ongoing operations of the inactive subsidiaries into the active subsidiaries listed above including Atlantic Pacific Communications (APC) and Etoolz, Inc. (ETI). The consolidated financial statements include the accounts of the Company and its subsidiaries. All significant inter-company transactions and balances have been eliminated in consolidation.
Eagle designs and manufactures a wide range of broadband products and provides complete installation services for copper, fiber, and wireless to commercial and residential markets. Core products offered by Eagle target end users of broadband services and include Internet, telephone, cable television, and security monitoring services, which services we refer to as bundled digital services or BDS. Each subscriber provides the Company with the opportunity to create a recurring revenue stream as well as the opportunity to sell additional products, such as Eagle's set-top boxes to existing customers. Management's goal is to obtain near-term and long-term recurring revenue.
Eagle designs, markets and services its products under the Eagle name. Eagle provides service and support for its products, as well as consulting and research development on a contract basis. In addition, Eagle offers a line of IP set-top boxes and satellite communication products. In fiscal 2003 and 2002, Eagle marketed products that included transmitters, receivers, controllers, software and other equipment used in personal communications systems and radio and telephone systems. Most of Eagle's broad line of products, covering the messaging spectrum as well as specific personal communication systems, and specialized mobile radio products are certified by the Federal Communications Commission.
Eagle was incorporated in May 1993 and changed its name in February 2002 to Eagle Broadband, Inc., its current name. Eagle's principal place of business is located at 101 Courageous Drive, League City, Texas 77573. Its telephone number is (281) 538-6000 and its web site address is www.eaglebroadband.com .
Product and Service Categories
Eagle BDS Services
Eagle provides fiber-to-the-user IP-based bundled digital services for municipalities, utilities, real estate developers and service providers. These services include high-speed Internet connectivity, home security monitoring, telephone service, and cable-style TV service over fiber. Eagle's exclusive "four-play" suite of high-speed Internet, video/cable TV, voice and security monitoring bundled digital services, HDTV-ready IP set-top boxes, and turnkey suite of financing, network design, deployment and operational services enable municipalities, real-estate developers, hotels, multi-tenant owners and service providers to deliver state-of-the-art entertainment and communication choices and single-bill convenience to their residential and business customers.
The fiber optic networks that Eagle deploys into residential communities and businesses consist of two parts: (a) the headend facility and (b) the fiber optic cable installed into the home. Eagle also sells structured wiring and audio/video products to single and multi-family units. These products and services are being made available to both residential and commercial customers in select states and communities nationwide.
Eagle's BDS Services revenues are reported under the category "Broadband Services" on the Company's Consolidated Statements of Operations included as page of this report and also under the category "EBS/DSS" within Note 22 - Industry Segments.
Eagle Security Services
Eagle, through its subsidiary DSS Security, Inc., markets security-monitoring services. DSS Security's principal business activity is providing monthly security monitoring service to both commercial and residential customers. As of August 31, 2004, DSS Security provided services to over 7,000 customers.
Eagle's Security Services revenues are reported under the category "Broadband Services" on the Company's Consolidated Statements of Operations included as page of this report and also under the category "EBS/DSS" within Note 22 - Industry Segments.
Eagle Satellite-Based Voice and Data Communications Services
The SatMAX
The SatMAX represents innovative and proprietary non-line-of-sight communications technology that enables users of the Iridium(R) satellite network to establish reliable voice and data communications to and from any location where the user is unable to gain line of sight to an orbiting Iridium Satellite such as onboard in-flight aircraft, within buildings, under ground or from obstructed areas. The technology provides global communications that enhance user productivity, mobility, problem solving, field-to-headquarters collaboration and emergency backup/response for a wide range of mission-critical and everyday communications needs. By extending coverage indoors to areas not traditionally served by satellite networks, the SatMAX extends customers' usage area, while enhancing the utility and overall value for both new and existing Iridium aviation, government, military, homeland security and commercial/enterprise customers. The Company has received certification by both the Federal Communications Commission (FCC Certification Identifier # LOKJHJLBT05A00021) and Iridium Satellite LLC for the SatMAX.
IP Set-Top Box Products
Eagle markets broadband IP-media set-top-box products. These multimedia and Internet based products provide users the ability to interface their Internet connection, broadcast video, cable or DSL, or satellite video source directly to their television receiver. Eagle markets the set-top boxes to Internet service providers or ISP's, systems integrators and OEM customers who typically bundle set-top-boxes with their own products and/or services.
Eagle designs and markets a complete line of advanced Media Pro IP set-top box products. Either standalone or in conjunction with the company's EZ Media middleware software, the products enable hotel and casino owners, hospitals, apartment owners, municipalities, real estate developers and schools to deliver a full range of higher-quality standard and high definition entertainment and information services that can generate higher-margin revenues. Media Pro IP set-top boxes also enable incumbent and competitive telecommunications service providers to cost effectively deploy, high-demand, IP-based bundled broadband and video services to their customers.
The Media Pro line of IP set-top boxes delivers full computing and video functionality in a compact footprint with a very quiet, fan-less design that enables a wide range of on-demand IP-based applications including high-speed Internet access, streaming IP video, digital audio/music, video-on-demand, 3D gaming, video conferencing and more. In addition, Eagle's customizable EZ-Magic middleware software platform delivers stunning high definition streaming video, superior digital audio, easier navigation of hotel and community services (i.e., concierge, local restaurants and events, etc.), advanced content and system security for a wide variety of hardware platforms.
EZMagic Software
EZMagic is a software-based middleware platform capable of delivering Eagle's complete "four-play" of voice, video, data, and security services over a wide variety of standard hardware systems. EZMagic-HD expands Eagle Broadband's EZMagic middleware software platform to include a range of new multi-media capabilities. The capabilities made possible by EZMagic-HD enable hotel and casino owners, municipalities, real estate developers, schools and health care facilities to deliver enhanced high-demand multimedia services with the goal of improving the satisfaction of residents and guests, maximizing occupancy rates and improving brand loyalty.
EZMagic features include high definition streaming video, improved digital audio and Internet capabilities, easier navigation of hotel and community services (e.g., concierge, local restaurants and events, etc.), increased content and system security, and additional operating system support. EZMagic-HD is designed for a range of higher margin applications and services including (i) high-end hospitality systems requiring sophisticated secure video; (ii) data and gaming services; (iii) educational distance-learning systems to improve both teacher and student education; (iv) on-demand entertainment including concerts, movies, music videos, etc. with superior visual clarity; (v) Internet access, video programming and other patient services for health care facilities; and (vi) fiber-to-the-user IP-based entertainment terminals/media centers.
Eagle's Broadband IP set-top box products revenues are reported under the category "Products" on the Company's Consolidated Statements of Operations included as page of this report and also under the category "Eagle" within Note 22 - Industry Segments.
Eagle Managed Services
Eagle provides data, telephony and fiber optic installation, project management and support services from initial concept through engineering to completion and documentation. Atlantic Pacific installs fiber and cabling to commercial and industrial clients throughout the United States. Services include:
o Multi-site rollout installation
o Statement of work/request for quotation preparation
o Installation supervision
o Structured wiring design
o Comprehensive project management
o Copper wiring configuration
o Fiber optic acceptance testing
o Aerial and underground OSP
o Fiber optic and copper cable
o Field service and support
Eagle's Communications Services revenues are reported under the category "Structured Wiring" on the Company's Consolidated Statements of Operations included as page of this report and also under the category "APC/HSI" within Note 22 - Industry Segments.
Eagle Technology Services
Eagle, through its United Computing Group subsidiary, sold computer hardware and IT business integration and enterprise management solutions in fiscal 2003 and 2002 to companies with complex computing and communication systems and needs. In fiscal 2004 Eagle did not conduct any United Computing Group business.
Eagle's Technology Services product revenues are reported under the category "Products" while the services components are reported under the category "Other" on Eagle's Consolidated Statements of Operations included as page of this report and also under the category "UCG" within Note 22 - Industry Segments.
Eagle Consulting Services
Eagle routinely provides consulting services on a contract basis to support the sale of its main product lines. Examples of these consulting services include design and engineering support for fiber-to-the-user headend and optical network integration. Eagle also performs research and development on a contract basis.
Eagle's Consulting Services revenues are reported under the category "Other" on the Company's Consolidated Statements of Operations included as page of this report and also under the category "Other" within Note 22 - Industry Segments.
Eagle Service and Support
Eagle provides service and support to customers on an on-going basis including installation, project management of turnkey systems, training, and service or extended warranty contracts with Eagle. Eagle believes that it is essential to provide reliable service to customers in order to solidify customer relationships and be the vendor of choice when a customer seeks new services or system expansions.
This relationship is further developed as customers come to depend upon Eagle for installation, system optimization, warranty and post-warranty services.
Eagle has a warranty and maintenance program for both its hardware and software products and maintains customer service facilities. Eagle's standard warranty provides its customers with repair or replacement of any defective Eagle manufactured equipment. The warranty is valid on all products for the period of one year from the later of the date of shipment or the installation by an Eagle qualified technician.
Eagle's Service and Support Services revenues are reported under the category "Other" on the Company's Consolidated Statements of Operations included as page of this report and also under the category "Other" within Note 22 - Industry Segments.
Eagle Paging Services
Eagle, through its subsidiary Contact Wireless, Inc., marketed paging and mobile telephone solutions in fiscal 2003 and 2002. Contact Wireless provided customers with paging and mobile telephone products and related monthly services in San Antonio and Houston areas. The assets for Contact Wireless, Inc., were sold effective October 1, 2003, and there was no additional business activity in fiscal 2004.
Eagle's Paging Services revenues are reported under the category "Other" on the Company's Consolidated Statements of Operations included as page of this report and also under the category "Other" within Note 22 - Industry Segments.
Eagle Messaging Services
Eagle, through its subsidiary Link Two Communications, Inc., marketed messaging network services. At August 31, 2002, management estimated through recent sales of equipment and industry pricing of FCC licenses that an impairment charge of $27,100,000 was necessary to reflect the ongoing value of its assets and licenses. Eagle did not conduct any substantive business in fiscal 2004, other than sustaining the FCC licenses.
Eagle's Messaging Services revenues are reported under the category "Other" on the Company's Consolidated Statements of Operations included as page of this report and also under the category "Eagle" within Note 22 - Industry Segments.
Eagle Wireless International
Eagle provided messaging services to customers during fiscal 2002. Eagle's Wireless International Products and Services revenues are reported under the category "Products" on the Company's Consolidated Statements of Operations included as page of this report and also under the category "Eagle" within Note 22 - Industry Segments. Eagle did not conduct any Eagle Wireless business in fiscal 2004.
Customers
Broadband and IP set-top box products are sold to a broad range of customers. These include residential, commercial, enterprise, military, government and service provider customers.
Eagle BDS Services historically sold its products and services primarily in the Houston, San Antonio, Austin, Las Vegas and Phoenix metropolitan markets. Today, however, such products and services are marketed nationwide through direct marketing efforts and via Eagle's sales staff and service centers. Currently the Company primarily markets the BDS Services to municipalities, real estate developers, hospitality operators, public utility districts and service providers, with residential and commercial customers typically subscribing to one or more bundled digital services such as voice, video, data/Internet and security monitoring.
Eagle Managed Services sells its project management services on a nationwide basis to a wide range of customers including telecommunications, hospitality, industrial and petrochemical, oil/gas companies and government sectors.
Eagle markets the SatMAX global non-line-of-sight communications system to Fortune 1000 enterprises, commercial aviation, government, the military and homeland security customers.
The Company had two customers in fiscal year 2004 that accounted for 30% and 25% of consolidated revenues. In fiscal years 2003 and 2002 the Company did not have any customers that aggregated ten percent or more of consolidated revenues.
Marketing and Sales
The majority of the Company's products and services are marketed through its employees using direct sales, channel marketing and various types of direct marketing techniques.
Eagle Technology Services were previously marketed through direct sales staff and through various types of direct marketing. For the years ended August 31, 2004, 2003 and 2002, Eagle Technology Services represented 4%, 21% and 54% of consolidated revenues, respectively.
Eagle Managed Services were marketed through Eagle's direct sales staff. For the years ended August 31, 2004, 2003 and 2002, Eagle Managed Services represented 50%, 34% and 18% of consolidated revenues, respectively.
Eagle Messaging Services were previously marketed through Eagle's direct sales staff and publication advertising.
Eagle also markets the SatMAX global non-line-of-sight communications system directly to Fortune 1000 enterprises, commercial aviation, government, the military and homeland security customers.
Eagle Security Services are marketed through Eagle's direct sales staff.
Research and Development
Eagle believes that a strong commitment to research and development is essential to the continued growth of its business. One of the key components of Eagle's development strategy is the promotion of a close relationship between its development staff, internally with Eagle manufacturing and marketing personnel, and externally with Eagle customers. This strategy has allowed Eagle to develop and bring to market customer-driven products that meet real customer needs.
From 1999 to 2004, Eagle has focused a large portion of its new development resources on the development of the new broadband multimedia and Internet product line. In addition, Eagle has formed a number of strategic relationships with other large suppliers and manufacturers that will allow the latest in technology and techniques to be utilized in the Company's IP set-top-box product line. Eagle will continue to incur research and development expenses with respect to the IP set-top-box product line during the current fiscal year.
Eagle has extensive expertise in the technologies required to develop wireless communications systems and products including high power, high frequency RF design digital signal processing, real-time software, high-speed digital logic, wireless DSL products, radio frequency and data network design. Eagle believes that by having a research and development staff with expertise in these key areas, it is well positioned to develop enhancements for its existing products as well as the next generation of personal communication products. Investment in advanced computer-aided design tools for simulation and analysis has allowed Eagle to reduce the time for bringing new products to market. Research and development expenditures incurred by Eagle for the fiscal years ended August 31, 2004, 2003 and 2002 were $557,000, $411,000 and $404,000, respectively.
Manufacturing
Eagle currently subcontracts and/or provides limited manufacturing of its satellite-based communications and wireless products at its facilities in League City, Texas. Some subassemblies are manufactured for Eagle by subcontractors at various locations throughout the world. Eagle's manufacturing expertise resides in assembling subassemblies and final systems that are configured to its customers' specifications. The components and assemblies used in Eagle's products include electronic components such as resistors, capacitors, transistors, and semiconductors such as field programmable gate arrays, digital signal processors and microprocessors, and mechanical materials such as cabinets in which the systems are built. Substantially all of the components and parts used in Eagle's products are available from multiple sources. In those instances where components are purchased from a single source, the supplier is reviewed frequently for stability and performance. Additionally, as necessary, Eagle purchases sufficient quantities of components that have long-lead requirements in the world market. Eagle ensures that all products are tested, tuned and verified prior to shipment to the customer.
Eagle has determined that the most cost effective manufacturing method for its high volume multimedia and Internet product line is to utilize offshore contract production facilities supplemented with high volume United States based contract facilities. The high volume requirements of the Company's convergence set-top-box product line are well beyond the capabilities of the current facilities and would be cost prohibitive to construct. However, in the selection of a high volume international manufacturer, Eagle has selected Taiwanese company with established subsidiaries in the USA, Netherlands, China and Germany. With a strong research and development team, this company is not only able to produce a wide range of products, but also has been recognized as a pioneer in the field and is both ISO-9001 and ISO-9002 certified. The manufacturing facility for the IP set-top-box is located in Taiwan.
Competition
Eagle competes with many established companies in the set-top-box business including Scientific Atlanta, General Instrument, and many smaller companies. Most of these companies have greater resources available than Eagle. The markets that are currently developing for set-top box products are extremely large and rapidly growing. Eagle has studied these markets and is of the belief based on this research that it can effectively compete in these markets with its new IP set-top-box product line. However, there can be no assurance that these conclusions are correct and that the multimedia and Internet markets will continue to expand at their current rates and that Eagle can gain significant market share in the future.
Eagle BDS competes indirectly with many established companies and service providers that provide fiber and cable, structured wiring, broadband data/Internet, security monitoring, cable television and telephone services. Most of these companies have greater resources than Eagle BDS. Eagle has studied these markets, and is of the belief that the bundled digital services offered to its customers as a complete package with one source billing is a competitive advantage for Eagle BDS. Certain of Eagle's residential customers are subject to developer and homeowner association agreements that allow Eagle BDS to be the primary single-source provider of these services. However, there can be no assurance that these conclusions are correct and that the bundled digital services market will continue to expand at the current rates and that Eagle BDS can gain significant market share in the future.
Eagle Managed Services competes with many established companies in the fiber and cable, structured wiring and project management services areas. Most of these companies have greater resources available than Eagle Managed Services. Eagle has studied these markets and is of the belief that the offering of the collective services on a nationwide scale is a competitive advantage for Eagle Managed Services. The use of the sub-contractors located across the nation allows Eagle Managed Services to complete large projects in an efficient manner, which is a valuable tool. However, there can be no assurance that these conclusions are correct and that these services will continue to expand at their current rates and that Eagle Managed Services can gain significant market share in the future.
Proprietary Information
Eagle attempts to protect its proprietary technology through a combination of trade secrets, non-disclosure agreements, patent applications, copyright filings, technical measures, and common law remedies with respect to its proprietary technology. Eagle has not yet been issued any patents on its products, technology or processes against such patent applications. This protection may not preclude competitors from developing products with features similar to Eagle's products. The laws of some foreign countries in which Eagle sells or may sell its products do not protect Eagle's proprietary rights in the products to the same extent as do the laws of the United States. Although Eagle believes that its products and technology do not infringe on the proprietary rights of others, there can be no assurance that third parties will not assert infringement claims against Eagle in the future. If litigation resulted in Eagle's inability to use technology, Eagle might be required to expend substantial resources to develop alternative technology. There can be no assurance that Eagle could successfully develop alternative technology on commercially acceptable terms.
Regulation
Many of Eagle's products operate on radio frequencies. Radio frequency transmissions and emissions, and certain equipment used in connection therewith, are regulated in the United States and internationally. Regulatory approvals generally must be obtained by Eagle in connection with the manufacture and sale of its products and by customers to operate Eagle's products. There can be no assurance that appropriate regulatory approvals will continue to be obtained or that approvals required with respect to products being developed for the personal communications services market will be obtained. The enactment by federal, state, local or international governments of new laws or regulations or a change in the interpretation of existing regulations could affect the market for Eagle's products. Although recent deregulation of international telecommunications industries along with recent radio frequency spectrum allocations made by the FCC have increased the demand for Eagle's products by providing users of those products with opportunities to establish new messaging and other wireless personal communications services, there can be no assurance that the trend toward deregulation and current regulatory developments favorable to the promotion of new and expanded personal communications services will continue or that future regulatory changes will have a positive impact on Eagle.
Employees
As of November 1, 2004, Eagle employed approximately 85 persons and retained independent contractors as necessary. Eagle believes its employee relations to be good. Eagle enters into independent contractual relationships with various individuals, from time to time, as needed.
Risk factors that may affect Eagle's results of operations and financial condition.
Investing in our common stock involves a high degree of risk. You should carefully consider the risks described below before making an investment decision. If any of the following risks actually occur, our business could be harmed. The value of our stock could decline, and you may lose all or part of your investment. Further, this Form 10-K contains forward-looking statements and actual results may differ significantly from the results contemplated by such forward-looking statements.
We have a history of operating losses and may never achieve profitability.
From inception through August 31, 2004, we have incurred an accumulated net deficit in the amount of $157,106,000. For the fiscal year ended August 31, 2004, we incurred net losses in the amount of $39,005,000. We anticipate that we will incur losses from operations for the current fiscal year. We will need to generate significant revenues and control expenses to achieve profitability. Our future revenues may never exceed operating expenses, thereby making the continued viability of our company dependent upon raising additional capital.
As we have not generated positive cash flow from operations for the past three fiscal years, our ability to continue operations is dependent on our ability to either begin to generate positive cash flow from operations or our ability to raise capital from outside sources.
We have not generated positive cash flow from operations during the last three fiscal years and we currently rely on external sources of capital to fund operations. For the fiscal year ended August 31, 2004, we have suffered losses from operations of approximately $39,005,000. At August 31, 2004, we had approximately $2,602,000 in cash, cash equivalents and securities available for sale, and a working capital deficit of approximately $15,272,000. Our net cash used by operations for the fiscal year ended August 31, 2004, was approximately $3,493,000.
We believe our current cash position and expected cash flow from operations will be sufficient to fund operations during the current fiscal year. Thereafter, we will need to raise additional funding unless our operations generate sufficient cash flows to fund operations. Historically, we have relied upon best efforts third-party funding from individual accredited investors. Though we have been successful at raising additional capital on a best efforts basis in the past, we may not be successful in any future best efforts financing efforts. We do not have any significant credit facilities or firm financial commitments established as of the date hereof. If we are unable to either obtain financing from external sources or generate internal liquidity from operations, we may need to curtail operations or sell assets.
We have been named a defendant in several lawsuits, which if determined adversely, could harm our ability to fund operations.
Eagle Broadband and its subsidiaries have been named defendants in several lawsuits in which plaintiffs are seeking substantial damages, which may include any of the following lawsuits:
Enron Corp. vs. United Computing Group, Inc. In September 2003, Enron sued United Computing Group seeking to avoid and recover a transfer in the amount of approximately $1,500,000 under Section 547 and 550 of the Bankruptcy Code.
Cornell Capital Partners, LP. vs. Eagle Broadband, Inc. In July 2003, Cornell Capital sued Eagle Broadband alleging breach of contract, fraud and negligent misrepresentation. As of November 30, 2003, the principal balance of the debenture of approximately $1.2 million was repaid, although the suit remains outstanding. Cornell seeks damages against Eagle in the amount of approximately $1,000,000. We have filed a counter-claim against Cornell Capital seeking in excess of $2,000,000.
The Tail Wind Fund Ltd. vs. Link Two Communications, Inc., and Eagle Broadband, Inc. In its complaint, The Tail Wild Fund asserts breach of contract claims in the amount of approximately $25 million.
Palisades Master Fund L.P. vs. Eagle Broadband, Inc., In November 2004, Palisades sued Eagle claiming in excess of $3,100,000 in damages.
We intend to vigorously defend these and other lawsuits and claims against us. However, we cannot predict the outcome of these lawsuits, as well as other legal proceedings and claims with certainty. An adverse resolution of any one pending lawsuit could substantially harm our ability to fund operations.
Our revenues may decrease if recurring-revenue contracts and security monitoring contracts are cancelled.
For the fiscal years ended August 31, 2004 and 2003, approximately 44% and 24%, respectively, of our revenue was generated by recurring-revenue contracts with Eagle Broadband Services and our security monitoring contracts with DSS Security. Although to date we have not experienced any significant interruptions or problems in our broadband or security services, any defects or errors in our services or any failure to meet customers' expectations could result in the cancellation of services, the refund of customers' money, or the requirement that we provide additional services to a client at no charge. Any of these events, could reduce the revenues or the margins associated with this revenue segment.
We rely heavily on third party suppliers for the material components for our products, and supply shortages could cause delays in manufacturing and delivering products which could reduce our revenues.
We rely upon unaffiliated suppliers for the material components and parts used to assemble our products. Most parts and components purchased from suppliers are available from multiple sources. We have not experienced significant supply shortages in the past and we believe that we will be able to continue to obtain most required components and parts from a number of different suppliers. However, the lack of availability of certain components could require a major redesign of our products and could result in production and delivery delays, which could reduce our revenues and impair our ability to operate profitably.
Because our industry is rapidly evolving, if we are unable to adapt or adjust our products to new technologies, our ability to compete and operate profitably may be significantly impaired.
The design, development, and manufacturing of personal communication systems, specialized mobile radio products, and multimedia entertainment products are highly competitive and characterized by rapid technology changes. We compete with other existing products and will compete against other technologies. Development by others of new or improved products or technologies may make our products obsolete or less competitive. While we believe that our products are based on established state-of-the-art technology, our products may become obsolete in the near future or we may not be able to develop a commercial market for our products in response to future
technology advances and developments. The inability to develop new products or adapt our current products to new technologies will impair our ability to compete and to operate profitably.
Approximately 48% of our total assets are comprised of intangible assets including goodwill, contract rights, customer relationships and other intangible assets which are subject to review on a periodic basis to determine whether an impairment on these assets is required. An impairment would not only greatly diminish our assets, but would also require us to record a significant charge against our earnings.
We are required under generally accepted accounting principles to review our intangible assets for impairment when events or changes in circumstances indicate the carrying value may not be recoverable. Goodwill is required to be tested for impairment at least annually. At August 31, 2004, our intangible assets, including goodwill, were net $35,238,000 million. If management determines that impairment exists in future periods, we will be required to record a significant charge to earnings in our financial statements during the period in which any impairment of our goodwill is determined.
Our business relies on our use of proprietary technology. Asserting, defending and maintaining intellectual property rights are difficult and costly and the failure to do so could harm our ability to compete and to fund our operations.
We rely, to a significant extent, on trade secrets, confidentiality agreements and other contractual provisions to protect our proprietary technology. In the event we become involved in defending or pursuing intellectual property litigation, such action may increase our costs and divert management's time and attention from our business. In addition to costly litigation and diversion of management's time, any potential intellectual property litigation could force us to take specific actions, including:
o cease selling products that use the challenged intellectual property;
o obtain from the owner of the infringed intellectual property a license to sell or use the relevant technology, which license may not be available on reasonable terms or at all; or
o redesign those products that use infringing intellectual property.
We compete with many companies that are larger and better financed than us, and our growth and profitability are dependent on our ability to compete with these entities.
We face competition from many entities with significantly greater financial resources, well-established brand names, and larger customer bases. We may become subject to severe price competition for our products and services as companies seek to enter our industry or current competitors attempt to gain market share. We expect competition to intensify in the future and expect significant competition from traditional and new telecommunications companies including, local, long distance, cable modem, Internet, digital subscriber line, microwave, mobile and satellite data providers. If we are unable to make or keep our products competitively priced and attain a larger market share in the markets in which our products compete, our levels of sales and our ability to achieve profitability may suffer.
A system failure could delay or interrupt our ability to provide products or services and could increase our costs and reduce our revenues.
Our operations are dependant upon our ability to support a highly complex network infrastructure. Many of our customers are particularly dependent on an uninterrupted supply of services. Any damage or failure that causes interruptions in our operations could result in loss of these customers. To date, we have not experienced any significant interruptions or delays which have affected our ability to provide products and services to our clients. Because our headquarters and infrastructure are located in the Texas Gulf Coast area, there is a likelihood that our operations may be effected by hurricanes or tropical storms, tornados, or flooding. Although we maintain redundant systems in north Houston, Texas, which allow us to operate our networks on a temporary basis, the occurrence of a natural disaster, operational disruption or other unanticipated problem could cause interruptions in the services we provide and significantly impair our ability to generate revenue and achieve profitability.
Our stock price has fluctuated intensely in the past, and stockholders face the possibility of future fluctuations in the price of our common stock.
The market price of our common stock may experience fluctuations that are unrelated to our operating performance. From January 30, 2003, through November 1, 2004, the highest sales price of our common stock was $2.08 which occurred on January 20, 2004, and the lowest sales price was $0.12, which occurred on March 7, 2003. The market price of our common stock has been volatile in the last 12 months and may continue to be volatile.
Our industry is highly regulated, and new government regulation could hurt our ability to timely introduce new products and technologies.
Our telecommunication and cable products are regulated by federal, state, and local governments. We are generally required to obtain regulatory approvals in connection with providing telephone and television services. For example, the cable and satellite television industry is regulated by Congress and the Federal Communications Commission, and various legislative and regulatory proposals
under consideration from time to time may substantially affect the way we design our products. New laws or regulations may harm our ability to timely introduce new products and technologies, which could decrease our revenues by shortening the life-cycle of a product.
Item 2.
Item 2. Description of Property
Eagle's headquarters are located in League City, Texas, and include approximately 25,550 square feet of leased office, production, and storage space. The lease expires in June 2007. Eagle believes that its rental rents are at market prices. Eagle has insured its facilities in an amount that it believes is adequate and customary in the industry.
Item 3.
Item 3. Legal Proceedings
In July 2003, Eagle became a defendant in Cornell Capital Partners, L.P. vs. Eagle Broadband, Inc., et al., Civil Action No. 03-1860 (KSH), In the United States District Court for the District of New Jersey. The suit presents claims for breach of contract, state and federal securities fraud and negligent misrepresentation. Plaintiff has also alleged that Eagle has defaulted on a convertible debenture for failing to timely register the shares of common stock underlying the convertible debenture and is seeking to accelerate the maturity date of the debenture. In November 2003, the principal balance of the debenture was repaid, although the suit remains outstanding. Cornell claims damages in excess of $1,000,000. The Company denies the claims and intends to vigorously defend this lawsuit and the claims against it. Eagle has asserted counterclaims against Cornell for fraud and breach of contract in the amount of $2,000,000. The Company has not accrued any expenses against this lawsuit, as the outcome cannot be predicted at this time.
In December 2000, ClearWorks became a defendant in State Of Florida Department Of Environmental Protection vs. Reco Tricote, Inc. And Southeast Tire Recycling, Inc. A/K/A Clearwork.net, Inc.; In The Circuit Court Of The Tenth Judicial Circuit In And For Polk County, Florida. The Florida EPA sued ClearWorks.net presenting claims for recovery costs and penalties for a waste tire processing facility. The suit seeks recovery of costs and penalties in a sum in excess of $1,000,000, attorneys' fees and cost of court. ClearWorks denies the claims and intends to vigorously contest all claims in this case and to enforce its indemnification rights against the principals of Southeast Tire Recycling. The Company has not accrued any expenses against this lawsuit, as the outcome cannot be predicted at this time.
In September 2003, Enron sued United Computing Group, Inc., in Enron Corp. (Debtors/Plaintiff) vs. United Computing Group, Inc.; Case No. 01-16034 in the United States Bankruptcy Court for the Southern District of New York. The suit presents claims pursuant to sections 547 and 550 of the Bankruptcy Code to avoid and recover a transfer in the amount of approximately $1,500,000.00. Defendant has filed an answer, denies the claims and intends to vigorously defend this lawsuit and claims against it. The Company has not accrued any expenses against this lawsuit, as the outcome cannot be predicted at this time.
In fiscal 2004, The Tail Wind Fund Ltd. sued Link Two Communications, Inc., and Eagle Broadband, Inc., Civil Action 04-CV-05776, in the United States District Court for the Southern District of New York. Tail Wind claims breach of contract seeking $25 million. The Company intends to vigorously defend this claim. The Company has accrued $500,000 in expenses against this lawsuit, although the outcome cannot be predicted at this time.
In November 2004, Palisades Master Fund L.P. sued Eagle Broadband, Ind., and David Weisman, Civil Action 04603626, in New York County, New York Supreme Court. Palisades seeks an injunction setting a conversion price on certain convertible debt and warrants at $0.4456 per share of Eagle common stock and seeks damages in excess of $3.1 million. The Company intends to vigorously defend this claim. The Company has not accrued any expenses against the lawsuit, as the outcome cannot be predicted at this time.
Eagle is involved in lawsuits, claims, and proceedings, including those identified above, which arise in the ordinary course of business. In accordance with SFAS No. 5, "Accounting for Contingencies," Eagle makes a provision for a liability when it is both probable that a liability has been incurred and the amount of the loss can be reasonably estimated. Eagle believes it has adequate provisions for any such matters. Eagle reviews these provisions at least quarterly and adjusts these provisions to reflect the impacts of negotiations, settlements, rulings, advice of legal counsel, and other information and events pertaining to a particular case. Litigation is inherently unpredictable. However, Eagle believes that it has valid defenses with respect to legal matters pending against it. Nevertheless, it is possible that cash flows or results of operations could be materially affected in any particular period by the unfavorable resolution of one or more of these contingencies.
We intend to vigorously defend these and other lawsuits and claims against us. However, we cannot predict the outcome of these lawsuits, as well as other legal proceedings and claims with certainty. An adverse resolution of pending litigation could have a material adverse effect on our business, financial condition and results of operations. The Company is subject to legal proceedings and claims that arise in the ordinary course of business. The Company's management does not expect that the results in any of these legal proceedings will have adverse affect on the Company's financial condition or results of operations.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders
At a special shareholders meeting in July 2004, shareholders holding 84,908,456 shares of our common stock adopted the June 2004 Compensatory Stock Option Plan reserving 10,000,000 shares to be issued under such plan. Holders of 830,792 shares abstained from the vote, and holders of 14,181,648 shares voted against the adoption of the plan.
PART II
Item 5.
Item 5. Market for Common Equity and Related Shareholder Matters
Shares of Eagle common stock are listed on the American Stock Exchange under the symbol "EAG." On November 18, 2004, Eagle's common stock closed at $.62 per share. Eagle is authorized to issue 350,000,000 shares of common stock, 205,509,000 of which were issued and outstanding at November 18, 2004. At November 18, 2004, there were approximately 1,076 holders of record of Eagle common stock.
The table set forth below, for the periods indicated, lists the reported high and low sale prices per share of Eagle common stock on the American Stock Exchange.
Eagle Common Stock --------------------- High Low --------- --------- Fiscal 2004 Quarter ended November 30, 2003 $ 2.13 $ 0.42 Quarter ended February 28, 2004 2.08 1.10 Quarter ended May 31, 2004 1.59 0.77 Quarter ended August 31, 2004 1.15 0.71 Fiscal 2003 Quarter ended November 30, 2002 0.54 0.27 Quarter ended February 28, 2003 0.53 0.16 Quarter ended May 31, 2003 0.37 0.12 Quarter ended August 31, 2003 0.63 0.33
Eagle has never paid any cash dividends on its common stock and does not anticipate paying cash dividends within the next two years.
Recent Sales of Unregistered Securities
In June 2004, the Company issued approximately 10,475,766 shares of common stock to 44 accredited investors in connection with these investors converting convertible debt into shares of common stock. This convertible debt was originally issued in October and November of 2003.
In October 2004, the Company issued 25,000 shares of its common stock as a partial settlement of a debt obligation.
These transactions were completed pursuant to Regulation D of the Securities Act. With respect to the issuances, the Company determined that each purchaser was an "accredited investor" as defined in Rule 501(a) under the Securities Act.
Except as otherwise noted, all sales of the Company's securities were made by officers of the Company who received no commission or other remuneration for the solicitation of any person in connection with the respective sales of securities described above. The recipients of securities represented their intention to acquire the securities for investment only and not with a view to or for sale in connection with any distribution thereof and appropriate legends were affixed to the share certificates and other instruments issued in such transactions.
Item 6.
Item 6. Selected Financial Data
The data that follows should be read in conjunction with the Company's consolidated financial statements and the notes thereto included in Item 8 and "Management's Discussion and Analysis."
Item 7.
Item 7. Management's Discussion and Analysis
Overview
Eagle Broadband, Inc. (the "Company" or "Eagle"), is a leading provider of broadband, Internet protocol (IP) and satellite communications technology and services. The Company is focused on three core businesses: broadband bundled services, IP set-top boxes and satellite communications technology. The Company's product offerings include an exclusive "four-play" suite of IP-based broadband bundled services with high-speed Internet, cable TV, telephone and security monitoring, and a turnkey suite of financing, network design, operational and support services that enables municipalities, utilities, real estate developers, hotels, multi-tenant owners and service providers to deliver exceptional value, state-of-the-art entertainment and communications choices and single-bill convenience to their residential and business customers." Eagle offers the HDTV-ready Media Pro IP set-top box product line that enables hotel operators and service providers to maximize revenues by offering state-of-the-art in-room entertainment and video services. The Company also develops and markets the SatMAX satellite communications system that allows government, military, homeland security, aviation, maritime and enterprise customers to deliver reliable, non-line-of-sight, voice and data communications services via the Iridium satellite network from any location on Earth.
During the fiscal year ended August 31, 2004, Eagle's business strategy has focused on pursuing higher-margin business opportunities in its core business segments, specifically in the bundled digital services and related products. We expect this trend to continue in fiscal 2005 with our goal of growing sales of the SatMAX satellite voice and data communications products for military, government and commercial customers. Set forth below is a table presenting the revenue derived from our business segments in the last three years:
During the fiscal year ended August 31, 2004, Eagle recognized 44% of its revenues from sales of bundle digital services and 21% from sales of set-top boxes (part of product sales) as compared to 2003 sales of bundled digital services and set-top boxes representing 24% and 11% of revenues, respectively.
Results of Operations
Fiscal Year Ended August 31, 2004, Compared to Fiscal Year Ended August 31, 2003
The following table sets forth summarized consolidated financial information for the fiscal years ended August 31, 2004 and 2003:
Condensed Financial Information
For the fiscal year ended August 31, 2004, Eagle's business operations reflected emphasis and further expansion of its IP set-top box and BDS business segments including Eagle's broadband bundled digital services (Internet, video, voice and security) for residential and business customers. The Company's consolidated operations generated revenues of $12,490,000 with a corresponding gross profit of $103,000 for the fiscal year ended August 31, 2004. The overall increase of 8% in revenues for the fiscal year ended August 31, 2004, as compared to the fiscal year ended August 31, 2003, was primarily attributable to a $5,564,000 increase in the Company's sales of bundled digital services, IP set-top boxes and ancillary equipment product shipments; offset by decreases of $4,667,000 in structured wiring and other operations.
The Company incurred a net loss of $(39,005,000) for the fiscal year ended August 31, 2004. The loss was attributable primarily to $26,212,000 of non-cash charges and increased operating expenses.
The Company's net loss for the fiscal year ended August 31, 2004, included approximately $5,097,000 in depreciation and amortization expenses and $1,984,000 in expenses associated with a net increase in the Company's accounts receivable allowances. Additionally, the Company's expenses included $18,472,000 of non-cash charges and stock issued to pay for interest expense and for services rendered.
The Company is continuing the development and expansion of the Company's bundled digital services model for distribution on a nationwide basis of voice, video and data content; increased sales efforts in the telephone, cable, Internet, security services and wireless segments; securing of long-term relationships for content for the bundled digital services activities; and marketing/sales agreements with other companies for the sale of broadband products and services. On a nationwide basis, we are entering into business relationships with financial and technology companies to provide bundled digital services (digital content) to real estate developments, cities and municipalities that currently have or are in the process of completing construction of their own fiber infrastructure to the home.
The following table sets forth summarized sales information for the fiscal years ended August 31, 2004 and 2003:
Sales Information - -----------------
Net Sales. For the fiscal year ended August 31, 2004, net sales increased to $12,490,000 from $11,593,000 during the fiscal year ended August 31, 2003. The overall increase of 7.7% was attributable to a $1,389,000 increase in the Company's product sales of IP set-top boxes and an increase of $2,716,000 in the Company's BDS sales; offset by decreases of $3,014,000 in structured wiring operations and a $1,653,000 decrease in other sales. The $2,848,000 increase in the Company's product sales was primarily attributable to shipment of IP set-top boxes and related equipment to a major customer. The $2,716,000 increase in sales of the Company's broadband services was primarily attributable to contracts valued at $3,111,000 executed by the Company's security-monitoring subsidiary, DSS Security, Inc., against which the Company realized sales of $2,874,000 during the fiscal year ended August 31, 2004. Without giving effect to the security monitoring
contract transactions of $2,874,000, the Company's base broadband services sales decreased by approximately $158,000 in the fiscal year ended August 31, 2004, primarily attributable to the exit from the unprofitable Austin area BDS market discussed in prior periods and the decline in recurring security monitoring sales resulting from the sale of certain security monitoring contracts in the Company's portfolio to Sweetwater Capital, LLC. The $3,014,000 decrease in structured wiring sales corresponded to the Company's previously announced strategy to no longer pursue structured wiring and commercial cabling opportunities on a direct basis outside of the its BDS model. The $1,653,000 decrease in other sales was primarily attributable to the other sales components from various operating segments that were divested or phased out during fiscal 2004 including Contact Wireless, UCG, and Eagle Wireless.
The following table sets forth summarized cost of goods sold information for the fiscal years ended August 31, 2004 and 2003:
Cost of Goods Sold ------------------
Cost of Goods Sold. For the fiscal year ended August 31, 2004, cost of goods sold increased by 14.9% to $12,387,000 from $10,784,000 as compared to fiscal year ended August 31, 2003. The overall increase of $1,603,000 was primarily attributable to the shipment of IP set-top boxes and the purchase and resale of certain related equipment. The Company's overall gross profit percentage was 1% and 7% for the fiscal years ended August 31, 2004 and 2003, respectively. This substantial decrease in gross profit percentage is primarily attributable to a heavy sales mix of product shipments of IP set-top boxes and the dilutive effect of the purchase and resale of certain related equipment versus the prior fiscal year; the dilutive effect of the security monitoring transactions recorded in the fiscal year ended August 31, 2004, i.e., sales recorded of $2,873,000 with corresponding cost of sales of $1,901,000, the decision to no longer pursue structured wiring outside of its BDS model and an increase in depreciation expenses associated with the build-out of the Company's BDS infrastructure.
The following table sets forth summarized operating expense information for the fiscal years ended August 31, 2004 and 2003.
Operating Expenses ------------------
The following table breaks out other support costs information for the fiscal years ended August 31, 2004 and 2003:
Other Support Costs -------------------
Operating Expenses. For the fiscal year ended August 31, 2004, operating expenses decreased by 3% to $31,055,000 as compared to $31,884,000 for the fiscal year ended August 31, 2003. The primary fluctuations that occurred as evidenced by the two preceding tables immediately above are discussed below:
o A $7,044,000 increase in salaries and related costs. The increase was attributable to an expansion of executive and general management compensation expenses, increased Board of Director compensation expense, and compensation expense associated with stock option exercises and severance. In addition, compensation for certain officers and key employees under incentive clauses of their employment contracts (i) includes a non-cash expense of $4,493,000 incurred upon the modification of warrants for 4,200,000 common shares and (ii) reflects a guaranteed compensation of the modified warrants equivalent to $1.75 less the warrant strike price.
o An $833,000 decrease in depreciation and amortization, due principally to the prior year disposition of assets in subsidiaries that are no longer active.
o A $630,000 increase in other support costs, the components of which are set forth on the table included immediately above. Included in this increase was a $1,304,000 increase in property taxes recorded against the Company's BDS infrastructure, a $687,000 increase in professional and contract labor and a $466,000 increase in bad debt, offset by a $676,000 decrease in rent expense and a $597,000 decrease in telephone and utilities.
o A $159,000 increase in research and development expenses, primarily consisting of the Company's continued investment in HDTV-ready IP set-top boxes for hospitality and broadband customers and the SatMAX satellite voice and data communications products for military, government and commercial customers.
Net Loss For the fiscal year ended August 31, 2004, Eagle's net loss was $(39,005,000), compared to a net loss of $(36,501,000) during the fiscal year ended August 31, 2003.
Changes in Cash Flow. Eagle's operating activities used net cash of $(3,784,000) in the fiscal year ended August 31, 2004, compared to use of net cash of $(6,085,000) in the fiscal year ended August 31, 2003. The decrease in net cash used by operating activities was primarily attributable to fund an increase in the Company's net loss, net of non-cash charges, totaling $27,512,000 combined with $8,000,000 of cash provided by fluctuations in working capital requirements consisting of the combination of accounts receivable, inventory, prepaid expenses, accounts payable and accrued expenses. Eagle's investing activities used net cash of $1,216,000 in the fiscal year ended August 31, 2004, compared to $1,276,000 in the fiscal year ended August 31, 2003. The decrease was due primarily to a significant decline in investment activities and purchase of equipment associated with the prior years build out of Eagle's network and infrastructure for the delivery of broadband services. Eagle's financing activities provided cash of $5,936,000 in the fiscal year ended August 31, 2004, compared to $6,912,000 of cash provided in the fiscal year ended August 31, 2003. The decrease resulted from less borrowing activities during the fiscal year ended August 31, 2004.
Year Ended August 31, 2003, Compared to Year Ended August 31, 2002
Net Sales. For the year ended August 31, 2003, net sales declined to $11,593,000 from $29,817,000 during the year ended August 31, 2002. The overall decrease of 61% was primarily attributable to the Company's decision to no longer pursue direct sales of low-margin commodity computer products in the Company's subsidiary United Computing Group, Inc. Additionally, a decline in the sale of commercial and residential home cabling occurred as a result of a deferral of implementation of national contracts and the Company's decision to no longer pursue Atlantic Pacific/Home Systems structured wiring opportunities on a direct standalone model basis outside of its BDS model,
including home cabling projects in the Arizona, Houston, San Antonio and Austin, Texas, markets, partially offset by increased sales of broadband products and services.
Cost of Goods Sold. For the year ended August 31, 2003, cost of goods sold declined to $10,784,000 from $22,704,000 during the year ended August 31, 2002. The decrease was primarily attributable to the Company's decision to no longer pursue the direct sales of low-margin commodity computer products and commercial structured wiring in the markets referenced above. Eagle's overall gross profit percentage was 7% and 24% for the years ended August 31, 2003 and August 31, 2002. This decrease is primarily attributable to write-downs of inventory of $2.6 million in connection with impaired, slow moving and obsolete inventory.
Eagle's Structured Wiring cost of goods sold decreased to $1,774,000 from $2,121,000 for the period ending August 31, 2003 and 2002, respectively, on corresponding revenues for these same periods of $3,692,000 and $8,036,000; thereby resulting in a gross margin decline to $1,918,000 from $5,915,000 for the same periods. This gross margin decline is primarily attributable to the Company's decision to no longer pursue the direct sales of commercial structured wiring and inventory write-downs totaling $0.5 million.
Eagle's Broadband Services cost of goods sold increased to $903,000 from $763,000 for the period ending August 31, 2003 and 2002, respectively, on corresponding revenues for these same periods of $2,809,000 and $2,657,000; thereby resulting in a gross margin increase to $1,906,000 from $1,894,000 for the same periods. This gross margin increase is primarily attributable to the increase in revenues for this sector.
Eagle's Products cost of goods sold decreased to $5,400,000 from $15,250,000 for the period ending August 31, 2003 and 2002, respectively, on corresponding revenues for these same periods of $3,342,000 and $16,108,000; thereby resulting in a gross margin decline to a deficit $2,058,000 from $858,000 for the same periods. This gross margin decline is primarily attributable to the decline in revenues for this sector, resulting from Eagle's decision to no longer pursue direct sales of low-margin commodity computer products and inventory write-downs totaling $2.1 million .
Operating Expenses. For the year ended August 31, 2003, operating expenses decreased to $31,884,000 from $83,821,000 for the year ended August 31, 2002. The primary portions of the decrease are discussed below:
o A $57,054,000 decrease in non-cash impairment charges resulting from a $7,611,000 non-cash impairment charge for the year ended August 31, 2003, associated with the Company's decision to no longer pursue the direct sales of low-margin commodity products discussed above compared to a $64,665,000 non-cash impairment charges for the year ended August 31, 2002, for the impairment of licenses and equipment in Eagle's Link Two subsidiary and goodwill related to the Clearworks.net acquisition. At August 31, 2003, management determined that a $7,611,000 non-cash impairment charge was necessary for realigned, impaired and abandoned operations including direct sales of low-margin commodity products, residential and commercial structured wiring operations and the withdrawal from its Austin, Texas, area BDS development based on the lack of demand for BDS services resulting from a slower build out of the development than originally projected in conjunction with local market competition. Included in the impairment was the write down of goodwill associated with the Atlantic Pacific Comtel acquisition of $1,878,000.
o A $1,693,000 decrease in salaries and related costs as a result of overall staffing reductions across all business units, the majority of which occurred in Atlantic Pacific/Home Systems and United Computing Group operations.
o A $716,000 decrease in advertising and promotion, due primarily to extensive cost reductions measures implemented in fiscal 2003 as the Company placed more emphasis on directly marketing its products and services to its customers as well as entering into business relationships with financial and technology companies to provide BDS services to cities and municipalities and decreased attendance at conventions and tradeshows.
o A $1,244,000 decrease in depreciation and amortization, due principally to the disposal of certain assets from the Company's Austin area BDS operations.
o An $8,763,000 increase in other support costs, due to an increase in litigation settlement costs of $3,650,000, bad debt expense of $2,177,000 and various charges included in accrued expenses related to costs associated with reserves for early terminations of certain property leases totaling $171,000 and reserves for sales tax liabilities that resulted from a sales tax audit of the Company's United Computing Group operation for time periods that preceded the acquisition date of this operation totaling $553,000.
Net Loss. For the year ended August 31, 2003, Eagle's net loss was $36,501,000, compared to a net loss of $76,973,000 during the year ended August 31, 2002.
Liquidity and Capital Resources.
Current assets for the fiscal year ended August 31, 2004, totaled $5,093,000 (includes cash and cash equivalents of $2,051,000 and securities available for sale of $551,000) as compared to $8,109,000 reported for the year ended August 31, 2003. During the fiscal year
ended August 31, 2004, Eagle received net proceeds of $6,778,000 through the issuance of debt and through the sale of marketable securities held as short-term investments and has retired or reduced certain of its notes payable and accrued expenses.
The Company anticipates that it will incur significantly less capital expenditures for broadband fiber infrastructure as a result of an emphasis of the sale of its BDS services to municipalities, real estate developers, hotels, multi-tenant units and service providers that own or will build a their own fiber networks. Historically, the Company built out these networks, thereby incurring significant capital expenditures. The Company incurred approximately $729,000 in capital expenditures in fiscal 2004. The Company currently intends to continue its nationwide expansion into the delivery of bundled digital services using partnerships and joint marketing agreements funded through cash in amounts equal to or exceeding expenditures in fiscal 2004 as well as through equity securities.
The Company expects that certain of its liabilities listed on the balance sheet under the headings Accounts Payable, Accrued Liabilities and Notes Payable will be retired by issuing stock versus cash during the next 12 months. The Company has historically used stock for retirement of certain liabilities on a negotiated basis. The Company issued stock for retirement of certain liabilities aggregating $3,586,000, $13,878,000 and $13,341,000 for fiscal years 2002, 2003 and 2004, respectively. Eagle Broadband expects to continue its practice of retiring certain liabilities as may be negotiated through a combination of cash and the issuance of shares of Eagle common stock. The Company cannot quantify the amount of common stock expected to be issued to retire such debts at this time and as such will report these results on a quarterly basis. In fiscal 2004, the Company completed $5,936,000 in net financing activities. The Company's management believes it has sufficient capital to fund operations for the next twelve months based on: (i) the Company's reduced capital expenditure requirements for fiscal 2005, and (ii) the Company's current cash, cash equivalents and securities held for resale, including recent net financing proceeds and sale of marketable securities received during fiscal 2005.
Historically, we have financed operations through the sale of debt and equity securities. We do not have any significant credit facilities available with financial institutions or other third parties and historically, we have relied upon best efforts third-party funding from individual accredited investors. Though we have been successful at raising additional capital on a best efforts basis in the past, we can provide no assurance that we will be successful in any future best efforts financing efforts. If we are unable to either obtain financing from external sources or generate internal liquidity from operations in the future, we may need to curtail operations or sell assets.
Contractual Obligations
The Company's contractual obligations consist of long-term debt as set forth in Note 6 (Notes Payable) to the Company's financial statements and certain off-balance-sheet obligations for office space operating leases requiring future minimal commitments under non-cancelable leases. See Item 2 - Management's Discussion and Analysis under non-cancelable leases as described in Note 17 to the Company's financial statements under the heading Commitments and Contingent Liabilities.
CRITICAL ACCOUNTING POLICIES
The Company has identified the following policies as critical to its business and the understanding of its results of operations. The Company believes it is improbable that materially different amounts would be reported relating to the accounting policies described below if other acceptable approaches were adopted. However, the application of these accounting policies, as described below, involve the exercise of judgment and use of assumptions as to future uncertainties; therefore, actual results could differ from estimates generated from their use.
Impairment of Long-Lived Assets and Goodwill
Background
Goodwill and other intangibles of $35,238,000 net of prior impairments and amortization were recorded under the purchase method for the purchases of ClearWorks.net, Inc.; Atlantic Pacific, Inc.; DSS Security, Inc.; Contact Wireless, Inc.; and Comtel, Inc. The majority of the intangibles were from the ClearWorks acquisition. ClearWorks was in the business of selling telecommunications services to residential neighborhoods.
Impairment Assessment
Our long-lived assets predominantly include goodwill. Statement of Financial Accounting Standards No. 142 (SFAS 142), "Goodwill and Other Intangible Assets" ("SFAS 142") requires that goodwill and intangible assets be tested for impairment at the reporting unit level (operating segment or one level below an operating segment) on an annual basis and between annual tests in certain circumstances. Application of the goodwill impairment test requires judgment, including the identification of reporting units, assigning assets and
liabilities to reporting units, assigning goodwill and intangible assets to reporting units, and determining the fair value of each reporting unit. Significant judgments required to estimate the fair value of reporting units include estimating future cash flows, determining appropriate discount rates and other assumptions. Changes in these estimates and assumptions could materially affect the determination of fair value for each reporting unit.
Goodwill is primarily the Company rights to deliver bundled digital services such as Internet, telephone, cable television and security monitoring services to residential and business users. The Company obtained an independent appraisal as of August 31, 2004, to assess the fair value of the intangible assets. There were a number of significant and complex assumptions used in the calculation of the fair value of the intangible assets. If any of these assumptions prove to be incorrect, the Company could be required to record a material impairment to its intangible assets. The assumptions included significant market penetration in its current markets under contract and significant market penetration in markets where they are currently negotiating contracts.
The Company evaluates the carrying value of long-lived assets and identifiable intangible assets for potential impairment on an ongoing basis. An impairment loss would be deemed necessary when the estimated non-discounted future cash flows are less than the carrying net amount of the asset. If an asset were deemed to be impaired, the asset's recorded value would be reduced to fair market value. In determining the amount of the charge to be recorded, the following methods would be utilized to determine fair market value (i) quoted market prices in active markets, (ii) estimate based on prices of similar assets and (iii) estimate based on valuation techniques. The Company tested the fair value of its goodwill and intangibles as of August 31, 2004, and determined that these net assets totaling $35,238,000 were not impaired.
Revenue Recognition
The Company designs, manufactures, markets and services its products and services under its principal subsidiaries and operating business units including; Eagle Wireless International, Inc.; BroadbandMagic; ClearWorks Communications, Inc.; ClearWorks Home Systems, Inc.; Atlantic Pacific Communications, Inc.; Contact Wireless, Inc.; DSS Security, Inc.; Link Two Communications, Inc.; and United Computing Group, Inc., names.
Eagle adopted EITF 00-21, "Revenue Arrangements with Multiple Deliverables," in the fourth quarter of fiscal 2003. The impact of adopting EITF 00-21 did not have a material effect to Eagle's results of operations. Eagle's contracts that contain multiple elements as of August 31, 2004, or prior were immaterial. When elements such as hardware, software and consulting services are contained in a single arrangement, or in related arrangements with the same customer, Eagle allocates revenue to each element based on its relative fair value, provided that such element meets the criteria for treatment as a separate unit of accounting. The price charged when the element is sold separately generally determines fair value. In the absence of fair value for a delivered element, Eagle allocates revenue first to the fair value of the undelivered elements and allocates the residual revenue to the delivered elements. In the absence of fair value for an undelivered element, the arrangement is accounted for as a single unit of accounting, resulting in a delay of revenue recognition for the delivered elements until the undelivered elements are fulfilled. Eagle limits the amount of revenue recognition for delivered elements to the amount that is not contingent on the future delivery of products or services or subject to customer-specified return or refund privileges.
Deferred Revenues
Revenues that are billed in advance of services being completed are deferred until the conclusion of the period of the service for which the advance billing relates. Deferred revenues are included on the balance sheet as a current liability until the service is performed and then recognized in the period in which the service is completed. Eagle's deferred revenues primarily consist of billings in advance for cable, Internet, security and telephone services, which generally are for between one and three months of services. Eagle had deferred revenues of $96,000 and $230,000 as of August 31, 2004, and August 31, 2003, respectively.
Eagle Wireless International, Inc.
Eagle designs, manufactures and markets transmitters, receivers, controllers and software, along with other equipment used in commercial and personal communication systems, radio and telephone systems. Revenues from these products are recognized when the product is shipped. Eagle's Wireless International Product revenues are reported under the category "Products" on Eagle's Consolidated Statements of Operations included as page of this report and also under the category "Eagle" within Note 22 - Industry Segments.
BroadbandMagic
BroadbandMagic designs, manufactures and markets the IP set-top boxes. Products are sent principally to commercial customers for a pre-sale test period of ninety days. Upon the end of the pre-sale test period, the customer either returns the product or accepts the product, at which time Eagle recognizes the revenue. Eagle's Broadband Multimedia and Internet Products revenues are reported under the category "Products" on Eagle's Consolidated Statements of Operations included as page of this report and also under the category "Eagle" within Note 22 - Industry Segments. Revenue from software consists of software licensing. There is no post-contract customer support. Software revenue is allocated to the license using vendor specific objective evidence of fair value ("VSOE") or, in the absence of VSOE, the residual method. The price charged when the element is sold separately generally determines VSOE. In the absence of VSOE of a delivered element, Eagle allocates revenue to the fair value of the undelivered elements and the residual revenue to the delivered elements. Eagle recognizes revenue allocated to software licenses at the inception of the license.
Eagle Broadband, Inc.
Eagle Broadband, Inc., engages independent agents for sales principally in foreign countries and certain geographic regions in the United States. Under the terms of these one-year agreements the distributor or sales agents provide the companies with manufacturing business sales leads. The transactions from these distributors and agents are subject to Eagle's approval prior to sale. The distributorship or sales agent receives commissions based on the amount of the sales invoice from the companies to the customer. The sale is recognized at the time of shipment to the customer. These sales agents and distributors are not a significant portion of total sales in any of the periods presented. Eagle's Broadband, Inc., revenues are reported under the category "Products" on Eagle's Consolidated Statements of Operations included as page of this report and also under the category "Eagle" within Note 22 - Industry Segments.
Eagle BDS Services - dba ClearWorks Communications, Inc.
ClearWorks Communications, Inc., provides bundled digital services to business and residential customers, primarily in the Texas market. Revenue is derived from fees charged for the delivery of bundled digital services, which includes telephone, long distance, Internet, security monitoring and cable services. This subsidiary recognizes revenue and the related costs at the time the services are rendered. Installation fees are recognized upon completion and acceptance. Eagle's BDS Services revenues are reported under the category "Broadband Services" on Eagle's Consolidated Statements of Operations included as page of this report and also under the category "EBS/DSS" within Note 22 - - Industry Segments.
Eagle Residential Structured Wiring - dba ClearWorks Home Systems, Inc.
ClearWorks Home Systems, Inc., sells and installs structured wiring, audio and visual components to homes. This subsidiary recognizes revenue and the related costs at the time the services are performed. Revenue is derived from the billing of structured wiring to homes and the sale of audio and visual components to the homebuyers. Eagle's Residential Structured Wiring revenues are reported under the category "Structured Wiring" on Eagle's Consolidated Statements of Operations included as page of this report and also under the category "APC/HSI" within Note 22 - Industry Segments.
Eagle Communication Services - dba Atlantic Pacific Communications, Inc.
Atlantic Pacific Communications, Inc., provides project planning, installation, project management, testing and documentation of fiber and cable to commercial and industrial clients throughout the United States. The revenue from the fiber and cable installation and services is recognized upon percentage of completion of the project. Most projects are completed in less than one month, therefore, matching revenue and expense in the period incurred. Service, training and extended warranty contract revenues are recognized as services are completed. Eagle's Communications Services revenues are reported under the category "Structured Wiring" on Eagle's Consolidated Statements of Operations included as page of this report and also under the category "APC/HSI" within Note 22 - Industry Segments.
Etoolz, Inc.
Etoolz, Inc., provides research and development support for all Eagle companies and does not currently provide billable services to independent third parties.
Eagle Messaging Services - dba Link Two Communications, Inc.
Link Two Communications, Inc., provides customers with one- and two-way messaging systems. The revenue from the sale of these products is recognized at the time the services are provided. Eagle's Messaging Services revenues are reported under the category "Other" on Eagle's Consolidated Statements of Operations included as page of this report and also under the category "Eagle" within Note 22 - Industry Segments.
Eagle Paging Services - dba Contact Wireless, Inc.
Contact Wireless, Inc., provides customers with paging and mobile telephone products and related monthly services. Revenue from product sales is recorded at the time of shipment. Revenue for the mobile phone and paging service is billed monthly as the service is provided. Eagle's Paging Services revenues are reported under the category "Other" on Eagle's Consolidated Statements of Operations included as page of this report and also under the category "Other" within Note 22 - Industry Segments.
Eagle Security Services - dba DSS Security, Inc.
DSS Security, Inc., provides security monitoring services to residential and commercial customers, purchases and resells and bundles and sells contracts from its own portfolio to independent third-party companies. Security monitoring customers are billed three months in advance of service usage. The revenues are deferred at the time of billing and ratably recognized over the prepayment period as service is provided. Installation fees are recognized upon completion and acceptance. Revenues from the sale of security monitoring contracts, both purchased and owned, are recognized upon contract execution except for reserves, hold backs or retentions, which are deferred until the contract provisions are fulfilled. Eagle's Security Services revenues are reported under the category "Broadband Services" on Eagle's Consolidated Statements of Operations included as page of this report and also under the category "EBS/DSS" within Note 22 - - Industry Segments.
Eagle Technology Services - dba United Computing Group, Inc.
United Computing Group, Inc., provides business-to-business hardware and software network solutions and network monitoring services. The revenue from the hardware and software sales is recognized at the time of shipment. The monitoring services recognition policy is to record revenue on completion. Eagle's Technology Services product revenues are reported under the category "Products" while the services components are reported under the category "Other" on Eagle's Consolidated Statements of Operations included as page of this report and also under the category "UCG" within Note 22 - Industry Segments.
Receivables
For the fiscal year ended August 31, 2004, Eagle accounts receivable decreased to $1,470,000 from $1,704,000 at August 31, 2003. The majority of this decrease was due to the increase on an allowance for doubtful accounts of $2,000,000 from the sale of IP set-top boxes and ancillary equipment to a major customer in the third quarter of fiscal 2004, totaling $3,806,806, as discussed earlier herein.
The Company's accounts receivable aging as measured by days sales outstanding (DSO) totaled 29 days at August 31, 2004, and 75 days at August 31, 2003, on an adjusted basis after recording the write-off's and reserves. The primary decrease in DSO from 75 days at August 31, 2003, to 29 days at August 31, 2004, was attributable to an allowance on a major customer that the Company determined could be potentially impaired based on several factors: (i) current economic condition of the customer, (ii) management believes that the ultimate collectibility of this customer receivable cannot be determined at this time and, accordingly, has increased its allowance for doubtful accounts to reflect the collectibility issue of slow paying.
The Company's allowance for doubtful accounts totaled $2,396,000 and $412,000 for the years ended August 31, 2004 and 2003, respectively. These allowance for doubtful accounts amounts represented 61% and 20% of the gross accounts receivable balances for the years ended August 31, 2004 and 2003, respectively; while they likewise represented7% and 39% of the Company's greater than 90-day accounts for these same respective time periods.
The Company reviews its accounts receivable balances by customer for accounts greater than 90 days old and makes a determination regarding the collectibility of the accounts based on specific circumstances and the payment history that exists with such customers. The Company also takes into account its prior experience, the customer's ability to pay and an assessment of the current economic conditions in determining the net realizable value of its receivables. The Company also reviews its allowances for doubtful accounts in aggregate for adequacy following this assessment. Accordingly, the Company believes that its allowances for doubtful accounts fairly represent the underlying collectibility risks associated with its accounts receivable.
Earnings are charged with a provision for doubtful accounts based on collection experience and current review of the collectibility of accounts receivable. Accounts receivables deemed uncollectible are charged against the allowance for doubtful accounts.
Inventory
Inventories are valued at the lower of cost or market. The cost is determined by using the first-in first-out method. At August 31, 2004, Eagle's inventory totaled $403,000 as compared to $3,199,000 at August 31, 2003. The majority of this decrease was due to an impairment of slow moving, obsolete inventory. The significant impairment of $1,300,000 consisted of less marketable, obsolete set-top boxes which were replaced with a new design set-top box in the fiscal 2004. Management has incorporated "just in time" inventory practices to avoid future inventory obsolesce. Eagle is outsourcing most, if not all, production based on contract orders from customers.
Recent Accounting Pronouncements
In March 2004, the FASB issued a proposed Statement, "Share-Based Payment, an amendment of FASB Statements Nos. 123 and 95," that addresses the accounting for share-based payment transactions in which a Company receives employee services in exchange for either equity instruments of the Company or liabilities that are based on the fair value of the Company's equity instruments or that may be settled by the issuance of such equity instruments. The proposed statement would eliminate the ability to account for share-based compensation transactions using the intrinsic method that the Company currently uses and generally would require that such transactions be accounted for using a fair-value-based method and recognized as expense in the consolidated statement of operations. The effective date of the proposed standard is for periods beginning after June 15, 2005. It is expected that the final standard will be issued before December 31, 2004 and should it be finalized in its current form, it will have a significant impact on the consolidated statement of operations as the Company will be required to expense the fair value of stock option grants and stock purchases under employee stock purchase plan.
In April 2004, the Emerging Issues Task Force ("EITF") issued Statement No. 03-06 "Participating Securities and the Two-Class Method Under FASB Statement No. 128, Earnings Per Share" ("EITF 03-06"). EITF 03-06 addresses a number of questions regarding the computation of earnings per share by companies that have issued securities other than common stock that contractually entitle the holder to participate in dividends and earnings of the Company when, and if, it declares dividends on its common stock. The issue also provides further guidance in applying the two-class method of calculating earnings per share, clarifying what constitutes a participating security and how to apply the two-class method of computing earnings per share once it is determined that a security is participating, including how to allocate undistributed earnings to such a security. EITF 03-06 became effective during the quarter ended June 30, 2004, the adoption of which did not have an impact on the calculation of earnings per share of the Company.
In July 2004, the EITF issued a draft abstract for EITF Issue No. 04-08, "The Effect of Contingently Convertible Debt on Diluted Earnings per Share" ("EITF 04-08"). EITF 04-08 reflects the Task Force's tentative conclusion that contingently convertible debt should be included in diluted earnings per share computations regardless of whether the market price trigger has been met. If adopted, the consensus reached by the Task Force in this Issue will be effective for reporting periods ending after December 15, 2004. Prior period earnings per
share amounts presented for comparative purposes would be required to be restated to conform to this consensus and the Company would be required to include the shares issuable upon the conversion of the Notes in the diluted earnings per share computation for all periods during which the Notes are outstanding. Currently, there would be no effect of this proposed statement on our financial position and results of operations
In September 2004, the EITF delayed the effective date for the recognition and measurement guidance previously discussed under EITF Issue No. 03-01, "The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments" ("EITF 03-01") as included in paragraphs 10-20 of the proposed statement. The proposed statement will clarify the meaning of other-than-temporary impairment and its application to investments in debt and equity securities, in particular investments within the scope of FASB Statement No. 115, "Accounting for Certain Investments in Debt and Equity Securities," and investments accounted for under the cost method. Currently, there would be no effect of this proposed statement on its financial position and results of operations.
Item 8.
Item 8. Consolidated Financial Statements
The financial statements have been audited by Lopez, Blevins, Bork & Associates, LLP, for the fiscal years ended August 31, 2004 and 2003, and the related statements of operations, stockholders' equity, and cash flows for the years then ended, and the financial statements for the fiscal year ended August 31, 2002, and the related statements of operations, stockholders' equity, and cash flows for the year then ended have been audited by McManus & Co., P.C., independent certified public accountants, to the extent and for the periods set forth in their report appearing herein and are included in reliance upon such reports given upon the authority of said firms as experts in auditing and accounting.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
On August 23, 2004, the Board of Directors and the Audit Committee of the Board of Directors of Eagle Broadband (the "Company") dismissed its independent auditors, Malone & Bailey, PLLC, and engaged Lopez, Blevins, Bork & Associates, LLP, as the Company's registered public accounting firm for the fiscal year ending August 31, 2004. The Company filed a Current Report, dated August 30, 2004, on Form 8-K regarding this change in accountants.
There were no changes in or disagreements with accountants on accounting or financial disclosure during fiscal year 2004.
Item 9A.
Item 9A. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
The Company's Chief Executive Officer and Principal Accounting Officer have evaluated the effectiveness of the Company's disclosure controls and procedures (as such term is defined in Rules 13a-15(be) or Rule 15d-15(e) under the Securities Exchange Act of 1934, as amended (the "Exchange Act")) as of the end our fourth fiscal quarter of 2003. Based on such evaluation, such officers have concluded that the Company's disclosure controls and procedures are effective in alerting them on a timely basis to material information relating to the Company (including its consolidated subsidiaries) required to be included in the Company's periodic filings under the Exchange Act. Our Chief Accounting Officer, instead of our Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures as of August 31, 2004, and certifies to such effect pursuant to Section 302 and 906 of the Sarbanes-Oxley Act of 2002. Our prior Chief Financial Officer resigned in November 2004 and our current Chief Financial Officer was hired in November 2004. From August 31, 2004 to the date hereof, our Principal Accounting Officer has performed the function of our Chief Financial Officer.
Changes in Internal Controls
There has been no change in the Company's internal control over financial reporting identified in connection with our evaluation as of the end our fourth fiscal quarter ended August 31, 2004, that has materially affected, or is reasonably likely to materially affect, the Company's internal controls over financial reporting.
Item 9B.
Item 9B. Other Information
None.
PART III
Item 10.
Item 10. Directors and Executive Officers of the Registrant
The information required by this item is incorporated herein by reference from the information provided in the Company's Proxy Statement.
Item 11.
Item 11. Executive Compensation
The information required by this item is incorporated herein by reference from the information provided in the Company's Proxy Statement.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Equity Compensation Plan Information
The following table sets forth information, as of August 31, 2004, with respect to the Company's compensation plans under which common stock is authorized for issuance
Item 15.
Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K
(a) Financial Statements and Schedules:
The financial statements are set forth under Item 8 of this Annual Report on Form 10-K. Financial statement schedules have been omitted since they are either not required, not applicable, or the information is otherwise included.
(b) Reports on Form 8-K
The following reports were furnished on Form 8-K during the three months ended August 31, 2004:
A report on Form 8-K, announcing information under Items 5 and 7 of the report, was filed on June 17, 2004, with the Securities and Exchange Commission.
A report on Form 8-K, announcing information under Item 5 of the report, was filed on July 21, 2004, with the Securities and Exchange Commission.
A report on Form 8-K, announcing information under Items 4.01 and 9.01 of the report, was filed on August 24, 2004, with the Securities and Exchange Commission.
A report on Form 8-K/A, announcing information under Items 4.01 and 9.01 of the report, was filed on August 30, 2004, with the Securities and Exchange Commission.
(c) Exhibit Listing
SIGNATURES
In accordance with the Section 13 or 15(d) of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Eagle Broadband, Inc.
By:/s/ DAVID A. WEISMAN ----------------------------- David A. Weisman Chairman of the Board and Chief Executive Officer
In accordance with the Exchange Act, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
INDEPENDENT AUDITOR'S REPORT
To the Board of Directors Eagle Broadband, Inc. Houston, Texas
We have audited the accompanying consolidated balance sheet of Eagle Broadband, Inc. as of August 31, 2004 and 2003, and the related consolidated statements of operations, shareholders' equity, and cash flows for the years then ended. These financial statements are the responsibility of Eagle Broadband, Inc.'s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Eagle Broadband, Inc. as of August 31, 2004 and 2003, and the results of its operations and its cash flows for the year then ended, in conformity with accounting principles generally accepted in the United States of America.
/S/ Lopez, Blevins, Bork and Associates, LLP - -------------------------------------------- Lopez, Blevins, Bork and Associates, LLP Houston, Texas
November 15, 2004
INDEPENDENT ACCOUNTANT'S REPORT
TO THE BOARD OF DIRECTORS AND STOCKHOLDERS OF EAGLE BROADBAND, INC.:
We have audited the accompanying consolidated balance sheets of Eagle Broadband, Inc. and subsidiaries as of August 31, 2002, and the related consolidated statements of earnings, shareholders' equity, and cash flows for the year then ended. These financial statements are the responsibility of Eagle Broadband, Inc.'s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, based on our audits, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Eagle Broadband, Inc. and subsidiaries as of August 31, 2002, and the results of their earnings, shareholders' equity, and their cash flows for each of the year then ended are in conformity with generally accepted accounting principles.
/S/ McManus & Co., P.C. McManus & CO., P.C. CERTIFIED PUBLIC ACCOUNTANTS ROCKAWAY, NEW JERSEY
December 13, 2002
- -------------------------------------------------------------------------------- EAGLE BROADBAND, INC., AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (In thousands, except per share amounts) - --------------------------------------------------------------------------------
ASSETS August 31, 2004 2003 ---------- ---------- Current Assets Cash and Cash Equivalents $2,051 $824 Securities Available for Sale 551 1,714 Accounts Receivable, net 1,470 1,704 Inventories 403 3,199 Net investment in direct financing leases 291 - Prepaid Expenses 327 668 ---------- ---------- Total Current Assets 5,093 8,109 ---------- ----------
Property and Equipment Operating Equipment 36,415 36,422 Less: Accumulated Depreciation (7,837) (5,689) ---------- ---------- Total Property and Equipment 28,578 30,733 ---------- ----------
Other Assets: Deferred Costs --- 334 Net investment in direct financing leases 623 --- Goodwill, net 4,095 4,095 Contract rights, net 21,678 23,590 Customer relationships, net 5,431 5,912 Other Intangible assets, net 4,034 4,366 Other Assets 679 227 ---------- ---------- Total Other Assets 36,540 38,524 ---------- ----------
Total Assets $70,211 $ $77,366 ========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities: Accounts Payable $ $4,445 $ $5,461 Accrued Expenses 9,647 7,560 Notes Payable 5,920 5,779 Deferred revenue 96 230 ---------- ---------- Total Current Liabilities 20,108 19,030 ---------- ----------
Commitments and Contingent Liabilities
Shareholders' Equity: Preferred Stock - $.001 par value Authorized 5,000,000 shares Issued -0- shares --- --- Common Stock - $.001 par value Authorized 350,000,000 shares Issued and Outstanding at August 31, 2004 and 2003, 205,509,000 and 147,447,000, respectively 206 147 Additional Paid in Capital 208,051 177,017 Accumulated Deficit (157,106) (118,101) Accumulated Comprehensive Income (Loss) (1,048) (727) ---------- ---------- Total Shareholders' Equity 50,103 58,336 ---------- ----------
Total Liabilities and Shareholders' Equity $70,211 $77,366 ========== ==========
See accompanying notes to consolidated financial statements.
- -------------------------------------------------------------------------------- EAGLE BROADBAND, INC., AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (in thousands, except per share amounts) - --------------------------------------------------------------------------------
- -------------------------------------------------------------------------------- EAGLE BROADBAND, INC., AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (in thousands, except per share amounts) - --------------------------------------------------------------------------------
- -------------------------------------------------------------------------------- EAGLE BROADBAND, INC., AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands, except per share amounts) - --------------------------------------------------------------------------------
Eagle Broadband, Inc., and Subsidiaries Notes to the Consolidated Financial Statements August 31, 2004
NOTE 1 - Basis of Presentation and Significant Accounting Policies:
Eagle Broadband, Inc. (the "Company" or "Eagle"), incorporated as a Texas corporation on May 24, 2993, and commenced business in April of 1996. The Company is a leading provider of broadband, Internet protocol (IP) and satellite communications technology and services. The Company is focused on three core businesses: broadband bundled services, IP set-top boxes and satellite communications technology. The Company's product offerings include an exclusive "four-play" suite of IP-based broadband bundled services with high-speed Internet, cable TV, telephone and security monitoring, and a turnkey suite of financing, network design, operational and support services that enables municipalities, utilities, real estate developers, hotels, multi-tenant owners and service providers to deliver exceptional value, state-of-the-art entertainment and communications choices and single-bill convenience to their residential and business customers. Eagle offers the HDTV-ready Media Pro IP set-top box product line that enables hotel operators and service providers to maximize revenues by offering state-of-the-art in-room entertainment and video services. The Company also develops and markets the SatMAX satellite communications system that allows government, military, homeland security, aviation, maritime and enterprise customers to deliver reliable, non-line-of-sight, voice and data communications services via the Iridium satellite network from any location on Earth.
A) Consolidation
At August 31, 2004, 2003 and 2002, the Company's subsidiaries were: Atlantic Pacific Communications, Inc. (APC) - operated as Eagle Communication Services; Etoolz, Inc. (ETI); Eagle Wireless International, Inc. (EWI); ClearWorks.net, Inc. (.NET); ClearWorks Communications, Inc. (COMM) - operated as Eagle BDS Services; ClearWorks Home Systems, Inc. (HSI) - operated as Eagle Residential Structured Wiring; Contact Wireless, Inc. (CWI) - operating as Eagle Paging Services; DSS Security, Inc., (DSS) - operated as Eagle Security Services; United Computing Group, Inc. (UCG) - operated as Eagle Technology Services; and Link Two Communications, Inc. (LINK II) - operated as Eagle Messaging Services. The consolidated financial statements include the accounts of the Company and its subsidiaries. All significant inter-company transactions and balances have been eliminated in consolidation.
B) Cash and Cash Equivalents
The Company considers all highly liquid financial instruments with original maturities of three months or less to be cash equivalents. The Company maintains cash deposits in banks which from time to time exceed the amount of deposit insurance available. Management periodically assesses the financial condition of the institutions and believes that any potential credit loss is minimal.
The Company has $2,051,000 and $824,000 of cash and cash equivalents invested in interest bearing accounts at August 31, 2004, and August 31, 2003, respectively.
C) Property and Equipment
Property and equipment are carried at cost less accumulated depreciation. Depreciation is calculated by using the straight-line method for financial reporting and accelerated methods for income tax purposes. The recovery classifications for these assets are listed as follows:
Years -------------------------- Headend Facility and Fiber Infrastructure 20 Manufacturing Equipment 3-7 Furniture and Fixtures 2-7 Office Equipment 5 Leasehold Improvements Life of Lease Property and Equipment 5 Vehicles 5
Expenditures for maintenance and repairs are charged against income as incurred whereas major improvements are capitalized. Eagle has acquired all of its property and equipment with either cash or stock and has not capitalized any interest expenses in its capital assets.
Eagle Broadband, Inc., and Subsidiaries Notes to the Consolidated Financial Statements August 31, 2004
D) Inventories
Inventories are valued at the lower of cost or market. The cost is determined by using the FIFO method. Inventories consist of the following items, in thousands:
August 31, 2004 2003 ---------- ---------- Raw Materials $ 294 $ 1,826 Work in Process 108 1,237 Finished Goods 1 136 ---------- ---------- $ 403 $ 3,199 ========== ==========
E) Revenue Recognition
The Company designs, manufactures, markets and services its products and services under the Eagle Broadband, Inc.; BroadbandMagic; ClearWorks Communications, Inc.; ClearWorks Home Systems, Inc.; Eagle Wireless International, Inc., Atlantic Pacific Communications, Inc.; Link Two Communications, Inc.; United Computing Group, Inc.; Contact Wireless, Inc.; and DSS Security, Inc., names.
Eagle adopted EITF 00-21, "Revenue Arrangements with Multiple Deliverables," in the fourth quarter of fiscal 2003. The impact of adopting EITF 00-21 did not have a material effect to Eagle's results of operations. Eagle's contracts that contain multiple elements as of August 31, 2004, or prior were immaterial. When elements such as hardware, software and consulting services are contained in a single arrangement, or in related arrangements with the same customer, Eagle allocates revenue to each element based on its relative fair value, provided that such element meets the criteria for treatment as a separate unit of accounting. The price charged when the element is sold separately generally determines fair value. In the absence of fair value for a delivered element, Eagle allocates revenue first to the fair value of the undelivered elements and allocates the residual revenue to the delivered elements. In the absence of fair value for an undelivered element, the arrangement is accounted for as a single unit of accounting, resulting in a delay of revenue recognition for the delivered elements until the undelivered elements are fulfilled. Eagle limits the amount of revenue recognition for delivered elements to the amount that is not contingent on the future delivery of products or services or subject to customer-specified return or refund privileges.
Deferred Revenues
Revenues that are billed in advance of services being completed are deferred until the conclusion of the period of the service for which the advance billing relates. Deferred revenues are included on the balance sheet as a current liability until the service is performed and then recognized in the period in which the service is completed. Eagle's deferred revenues primarily consist of billings in advance for cable, Internet, security and telephone services, which generally are between one and three months of services. Eagle had deferred revenues of $353,000 and $230,000 as of August 31, 2004 and 2003, respectively.
Eagle Wireless International, Inc.
Eagle designs, manufactures and markets transmitters, receivers, controllers and software, along with other equipment used in commercial and personal communication systems, radio and telephone systems. Revenues from these products are recognized when the product is shipped. Eagle's Wireless International Product revenues are reported under the category "Products" on Eagle's Consolidated Statements of Operations included as page of this report and also under the category "Eagle" within Note 22 - Industry Segments.
BroadbandMagic
BroadbandMagic designs, manufactures and markets the IP set-top boxes. Products are sent principally to commercial customers for a pre-sale test period of ninety days. Upon the end of the pre-sale test period, the customer either returns the product or accepts the product, at which time Eagle recognizes the revenue. Eagle's Broadband Multimedia and Internet Products revenues are reported under the category "Products" on Eagle's Consolidated Statements of Operations included as page of this report and also under the category "Eagle" within Note 22 - Industry Segments. Revenue from software consists of software licensing. There is no post-contract customer support. Software revenue is allocated to the license using vendor specific objective evidence of fair value ("VSOE") or, in the absence of VSOE, the residual method. The price charged when the element is sold separately generally determines VSOE. In the absence of VSOE of a delivered element, Eagle allocates revenue to the fair value of the undelivered elements and the residual revenue to the delivered elements. Eagle recognizes revenue allocated to software licenses at the inception of the license.
Eagle Broadband, Inc., and Subsidiaries Notes to the Consolidated Financial Statements August 31, 2004
Eagle Broadband, Inc.
Eagle Broadband, Inc., engages independent agents for sales principally in foreign countries and certain geographic regions in the United States. Under the terms of these one-year agreements the distributor or sales agents provide the companies with manufacturing business sales leads. The transactions from these distributors and agents are subject to Eagle's approval prior to sale. The distributorship or sales agent receives commissions based on the amount of the sales invoice from the companies to the customer. The sale is recognized at the time of shipment to the customer. These sales agents and distributors are not a significant portion of total sales in any of the periods presented. Eagle's Broadband, Inc. revenues are reported under the category "Products" on Eagle's Consolidated Statements of Operations included as page of this report and also under the category "Eagle" within Note 22 - Industry Segments.
Eagle BDS Services - dba ClearWorks Communications, Inc.
ClearWorks Communications, Inc., provides Bundled Digital Services to business and residential customers, primarily in the Texas market. Revenue is derived from fees charged for the delivery of Bundled Digital Services, which includes telephone, long distance, Internet, security monitoring and cable services. This subsidiary recognizes revenue and the related costs at the time the services are rendered, Installation fees are recognized upon completion and acceptance. Eagle's BDS Services revenues are reported under the category "Broadband Services" on Eagle's Consolidated Statements of Operations included as page of this report and also under the category "EBS/DSS" within Note 22 - Industry Segments.
Eagle Residential Structured Wiring - dba ClearWorks Home Systems, Inc.
ClearWorks Home Systems, Inc., sells and installs structured wiring, audio and visual components to homes. This subsidiary recognizes revenue and the related costs at the time the services are performed. Revenue is derived from the billing of structured wiring to homes and the sale of audio and visual components to the homebuyers. Eagle's Residential Structured Wiring revenues are reported under the category "Structured Wiring" on Eagle's Consolidated Statements of Operations included as page of this report and also under the category "APC/HSI" within Note 22 - Industry Segments.
Eagle Communication Services - dba Atlantic Pacific Communications, Inc.
Atlantic Pacific Communications, Inc., provides project planning, installation, project management, testing and documentation of fiber and cable to commercial and industrial clients throughout the United States. The revenue from the fiber and cable installation and services is recognized upon percentage of completion of the project. Most projects are completed in less than one month, therefore, matching revenue and expense in the period incurred. Service, training and extended warranty contract revenues are recognized as services are completed. Eagle's Communications Services revenues are reported under the category "Structured Wiring" on Eagle's Consolidated Statements of Operations included as page of this report and also under the category "APC/HSI" within Note 22 - Industry Segments.
Etoolz, Inc.
Etoolz, Inc., provides research and development support for all Eagle companies and does not currently provide billable services to independent third parties.
Eagle Messaging Services - dba Link Two Communications, Inc.
Link Two Communications, Inc., provides customers with one- and two-way messaging systems. The revenue from the sale of these products is recognized at the time the services are provided. Eagle's Messaging Services revenues are reported under the category "Other" on Eagle's Consolidated Statements of Operations included as page of this report and also under the category "Eagle" within Note 22 - Industry Segments.
Eagle Paging Services - dba Contact Wireless, Inc.
Contact Wireless, Inc., provides customers with paging and mobile telephone products and related monthly services. Revenue from product sales is recorded at the time of shipment. Revenue for the mobile phone and paging service is billed monthly as the service is provided. Eagle's Paging Services revenues are reported under the category "Other" on Eagle's Consolidated Statements of Operations included as page of this report and also under the category "Other" within Note 22 - Industry Segments.
Eagle Security Services - dba DSS Security, Inc.
DSS Security, Inc., provides monthly security monitoring services to residential customers. The customers are billed three months in advance of service usage. The revenues are deferred at the time of billing and ratably recognized over the prepayment period as service is provided. Installation fees are recognized upon completion and acceptance. Eagle's Security Services revenues are reported under the category "Broadband Services" on Eagle's Consolidated Statements of Operations included as page of this report and also under the category "EBS/DSS" within Note 22 - Industry Segments.
Eagle Technology Services - dba United Computing Group, Inc.
United Computing Group, Inc., provides business-to-business hardware and software network solutions and network monitoring services. The revenue from the hardware and software sales is recognized at the time of shipment. The monitoring services
Eagle Broadband, Inc., and Subsidiaries Notes to the Consolidated Financial Statements August 31, 2004
recognition policy is to record revenue on completion. Eagle's Technology Services product revenues are reported under the category "Products" while the services components are reported under the category "Other" on Eagle's Consolidated Statements of Operations included as page of this report and also under the category "UCG" within Note 22 - Industry Segments.
F) Research and Development Costs
Research and development expenditures are generally charged to operations as incurred. For the years ended August 31, 2004, 2003 and 2002, the Company performed research and development activities for internal projects related to its SatMAX global non-line-of-sight communications system, IP set-top boxes as well as its multi-media entertainment centers. Research and development costs of $557,000, $411,000, and $404,000, were expensed for the years ended August 31, 2004, 2003, and 2002, respectively.
No research and development services were performed for outside parties for the year ended August 31, 2004, 2003 and 2002.
G) Income Taxes
The Company adopted the provisions of Statement of Financial Accounting Standards (SFAS) No. 109, "Accounting for Income Taxes", which requires a change from the deferral method to assets and liability method of accounting for income taxes. Timing differences exist between book income and tax income, which relate primarily to depreciation methods.
H) Net Earnings Per Common Share
Net earnings per common share are shown as both basic and diluted. Basic earnings per common share are computed by dividing net income less any preferred stock dividends (if applicable) by the weighted average number of shares of common stock outstanding. Diluted earnings per common share are computed by dividing net income less any preferred stock dividends (if applicable) by the weighted average number of shares of common stock outstanding plus any dilutive common stock equivalents. The components used for the computations are shown as follows, in thousands:
2004 2003 2002 ---------- ----------- ---------- Weighted Average Number of Common Shares Outstanding Including: Basic Common Stock Equivalents 185,046 95,465 64,004 Fully Diluted Common Stock Equivalents 185,046 95,465 64,158
I) Impairment of Long-Lived Assets and Goodwill
Our long-lived assets primarily include goodwill, contract rights and customer relationships. Statement of Financial Accounting Standards No. 142 "Goodwill and Other Intangible Assets" ("SFAS 142") requires that goodwill and intangible assets be tested for impairment at the reporting unit level (operating segment or one level below an operating segment) on an annual basis and between annual tests in certain circumstances. Application of the goodwill impairment test requires judgment, including the identification of reporting units, assigning assets and liabilities to reporting units, assigning goodwill and intangible assets to reporting units, and determining the fair value of each reporting unit. Significant judgments required to estimate the fair value of reporting units include estimating future cash flows, determining appropriate discount rates and other assumptions. Changes in these estimates and assumptions could materially affect the determination of fair value for each reporting unit.
The intangible assets primarily are the Company rights to deliver bundled digital services such as, Internet, telephone, cable television and security monitoring services to residential and business users. The Company assessed the fair value of the intangible assets. There were a number of significant and complex assumptions used in the calculation of the fair value of the intangible assets. If any of these assumptions prove to be incorrect, the Company could be required to record a material impairment to its intangible assets. The assumptions include significant market penetration in its current markets under contract and significant market penetration in markets where they are currently negotiating contracts.
The Company evaluates the carrying value of long-lived assets and identifiable intangible assets for potential impairment on an ongoing basis. An impairment loss would be deemed necessary when the estimated non-discounted future cash flows are less than the carrying net amount of the asset. If an asset were deemed to be impaired, the asset's recorded value would be reduced to fair market value. In determining the amount of the charge to be recorded, the following methods would be utilized to determine fair market value:
Eagle Broadband, Inc., and Subsidiaries Notes to the Consolidated Financial Statements August 31, 2004
1) Quoted market prices in active markets. 2) Estimate based on prices of similar assets 3) Estimate based on valuation techniques
At August 31, 2002, Eagle determined that an impairment of Link Two paging network equipment and nationwide licenses existed. Link Two Communications competes with many established companies in the nationwide one and two-way messaging services area. The paging industry has declined over the past year and the major paging companies have undergone significant beneficial financial restructurings. These companies are able to offer products and related services at more favorable rates than Link Two. Because the paging industry and related financial credit availability from banks for financing emerging nationwide networks has been declining over the last year, Link Two has been unable to obtain significant funding to expand and provide cost effective service to its customers. Accordingly, Link Two has had to curtail its development on a nationwide basis and restricted its operations to serve the Houston and Dallas, Texas, markets. The equipment servicing the nationwide network has been inactive and is being dismantled. The equipment servicing the nationwide network is inactive and has been impaired as well as the value of the related FCC licenses. At August 31, 2002, management estimated through recent sales of equipment and industry pricing of FCC licenses that an impairment charge of $27,100,000 was necessary to reflect the ongoing value of its assets and licenses.
At August 31, 2003, management determined that a $7,611,000 non-cash impairment charge was necessary against realigned operations and the discontinued sale of low margin commodity products, residential and commercial structured wiring operations and the withdrawal from its Austin area BDS development based on the lack of demand for BDS services resulting from a slower build out of the development than originally projected in conjunction with local market competition. Included in the impairment was the write down of goodwill associated with the Comtel acquisition of $1,878,000.
J) Intangible Assets
Goodwill represents the excess of the cost of companies acquired over the fair value of their net assets at the dates of acquisition and were being amortized using the straight-line method over twenty (20) years for Atlantic Pacific Communications, Inc., and twenty-five (25) years for Bundled Digital Services through June 30, 2001.
Contract rights and customer relationships relate to the Company rights to deliver bundled digital services such as Internet, telephone, cable television and security monitoring services to certain residential and business users that were acquired in the Clearworks.net, Inc. merger and are being amortized over the lives of the contracts which is fifteen (15) years.
Other intangible assets consist of licenses and permits and other acquired contracts, which are being amortized using the straight-line method over their estimated useful lives of 1 to twenty (20) years. Eagle's licenses include FCC licenses for designated narrowband personal communications services, radio frequencies or spectrum to service providers. Prior to the adoption of FAS 142, Eagle amortized these licenses using the straight line method over twenty years. At August 31, 2002, management estimated through recent sales of equipment and industry pricing of FCC licenses that an impairment charge of $27,100,000 was necessary to reflect the ongoing value of its assets and licenses; thereby leaving an unamortized balance of licenses on its books of $1,562,000. Eagle does not maintain that these licenses have an indefinite life, but rather has ceased amortizing the remaining balance of $1,562,000 as management believes that this balance represents the salvage value of such assets. Eagle, to date, has maintained all operational requirements to keep its licenses current, and periodically assesses both future operating requirements as well as the salvage of such assets.
During the fiscal year ended August 31, 2004, and subsequent to the issuance of the Company's financial statements as of August 31, 2003, it was determined that the allocation of the purchase price to net assets acquired in connection with its acquisition of ClearWorks.net, Inc., and certain other classifications of intangible assets had not been appropriately classified. Eagle also determined that goodwill was impaired at August 31, 2002, and recorded an impairment charge of $37,565,000,
Goodwill is carried at cost less accumulated amortization. Intangible assets were amortized on a straight-line basis over the economic lives of the respective assets, generally ten to twenty-five years. Prior to July 1, 2001, goodwill was amortized over 20 to 25 years. The Company's adoption of SFAS 142 eliminated the requirement to amortize goodwill subsequent to the fiscal year ending August 31, 2001. Under the provisions of SFAS 142, the Company is required to periodically assess the carrying value of goodwill associated with each of its distinct business units that comprise its business segments of the Company to determine if impairment in value has occurred. Impairment tests completed as of August 31, 2002 and August 31, 2001 concluded that the carrying amount of goodwill for each acquired business unit did not exceed its net realizable value based on the Company's estimate of expected future cash flows to be generated by its business units, except as described above in Note I. The Company updated its assessment as of August 31, 2003 and concluded that based on a valuation model incorporating expected future cash flows in consideration of historical cash flows and results to date, no impairment charge was necessary.
Eagle Broadband, Inc., and Subsidiaries Notes to the Consolidated Financial Statements August 31, 2004
Goodwill and other intangibles of $35,238,000 net of prior impairments and amortization were recorded under the purchase method for the purchases of ClearWorks.net, Inc., Atlantic Pacific, Inc., DSS Security, Inc., Contact Wireless, Inc., and Comtel, Inc. The majority of the intangibles were from the ClearWorks acquisition. ClearWorks was in the business of selling telecommunications services to residential neighborhoods. In fiscal 2003, Eagle realized it had failed to successfully achieve profits using the ClearWorks model of installing fiber optic cable to neighborhoods under the speculative attempt to capture enough individual homeowners in each neighborhood via individual selling methods to pay for the cable infrastructure. In early 2003, Eagle modified its strategy to deliver the ClearWorks developed bundled digital services approach including Internet, telephone, cable television and security monitoring services to residential and business users by targeting municipalities, homebuilders and residential real estate developers that finance and install the fiber optic cable backbone in every lot and offer Eagle exclusive rights to deliver digital bundled services to homeowners, using pre-selling promotions and other low cost mass marketing techniques.
Eagle assessed the fair value of the intangible assets as of August 31, 2004, and concluded that the goodwill and other intangible assets valuations remain at an amount greater than the current carrying and other intangible assets value.
There were a number of significant and complex assumptions used in the calculation of the fair value of the goodwill. If any of these assumptions prove to be incorrect, Eagle could be required to record a material impairment to its goodwill. The assumptions include significant market penetration in its current markets under contract and significant market penetration in markets where they are currently negotiating contracts.
K) Advertising Costs
Advertising costs are expensed when incurred. For the year ended August 31, 2004, 2003, and 2002, the Company expensed $29,000, $247,000 and $963,000, respectively.
L) Deferred Syndication Costs
Deferred syndication costs consist of those expenditures incurred that are directly attributable to fundraising and the collection thereto. Upon successful collection of the funds, all expenses incurred will be reclassified to additional paid in capital and treated as syndication costs; netted against the funds raised.
M) Use of Estimates
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent asset and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
N) Marketable Securities
Eagle holds minority equity investments in companies having operations or technology in areas within Eagle's strategic focus. Eagle applies the equity method of accounting for minority investments when Eagle has the ability to exert significant influence over the operating and financial policies of an investment. In the absence of such ability, Eagle accounts for these minority investments under the cost method. Certain investments carry restrictions on immediate disposition. Investments in public companies (excluding those accounted for under the equity method) with restrictions of less than one year are classified as available-for-sale and are adjusted to their fair market value with unrealized gains and losses, net of tax, recorded as a component of accumulated other comprehensive income. Upon disposition of these investments, the specific identification method is used to determine the cost basis in computing realized gains or losses, which are reported in other income and expense. Declines in value that are judged to be other than temporary are reported in other income and expense.
The Company has Securities Available for Sale that include shares of common stock and bonds. These investments have a fair market value of $551,000 and of $1,714,006 and are included in the Balance Sheet category "Securities Available for Sale" as of August 31, 2004 and 2003. (See Note 10.)
O) Other Comprehensive Income
In 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 130, "Other Comprehensive Income," effective for fiscal years beginning after December 15, 1997. This statement considers the presentation of unrealized holding gains and losses attributable to debt and equity securities classified as available-for-sale. As stated, any
Eagle Broadband, Inc., and Subsidiaries Notes to the Consolidated Financial Statements August 31, 2004
unrealized holding gains or losses affiliated to these securities are carried below net income under the caption "Other Comprehensive Income." For the fiscal year ended August 31, 2004, 2003, and 2002 other comprehensive loss was ($321, 000), ($71,000) and ($279,000), respectively.
P) Reclassification
The Company has reclassified certain assets costs and expenses for the years ended August 31, 2004, 2003 and 2002, to facilitate comparisons.
Q) Supporting Costs in Selling, General and Administrative Expenses
Other support costs for the twelve months ended August 31, 2004, 2003, and 2002 are as follows, in thousands: -
R) Recent Pronouncements
In July 2002, the FASB issued Statement of Financial Accounting Standards No. 146 ("SFAS 146"), "Accounting for Costs Associated with Exit or Disposal Activities," which nullifies EITF Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)." SFAS 146 requires that costs associated with an exit or disposal activity be recognized only when the liability is incurred (that is, when it meets the definition of a liability in the FASB's conceptual framework). SFAS 146 also establishes fair value as the objective for initial measurement of liabilities related to exit or disposal activities. SFAS 146 is effective for exit or disposal activities that are initiated after December 31, 2002. The Company adopted SFAS in the first quarter of fiscal 2003.
In January 2003, FASB issued Interpretation No. 46 (FIN 46), an interpretation of Accounting Research Bulletin No. 51, which requires the Company to consolidate variable interest entities for which it is deemed to be the primary beneficiary and disclose information about variable interest entities in which it has a significant variable interest. FIN 46 became effective immediately for variable interest entities formed after January 31, 2003 and effective for periods ending after December 15, 2003, for any variable interest entities formed prior to February 1, 2003. The Company does not believe that this Interpretation will have a material impact on its consolidated financial statements.
In April 2002, the FASB issued Statement of Financial Accounting Standards No. 145 ("SFAS 145"), "Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections," which requires that the extinguishment of debt not be considered an extraordinary item under APB Opinion No. 30 ("APB 30"), "Reporting the Results of Operations-Reporting the Effects of Disposal of a Segment of Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions," unless the debt extinguishment meets the "unusual in nature and infrequent of occurrence" criteria in APB 30. SFAS 145 is effective for fiscal years beginning after May 15, 2002, and, upon adoption, companies must
Eagle Broadband, Inc., and Subsidiaries Notes to the Consolidated Financial Statements August 31, 2004
reclassify prior period items that do not meet the extraordinary item classification criteria in APB 30. The Company adopted SFAS 145 and related rules as of August 31, 2002. The adoption of SFAS 145 had no effect on the Company's financial position or results of operations.
In March 2004, the FASB issued a proposed Statement, "Share-Based Payment, an amendment of FASB Statements Nos. 123 and 95," that addresses the accounting for share-based payment transactions in which a Company receives employee services in exchange for either equity instruments of the Company or liabilities that are based on the fair value of the Company's equity instruments or that may be settled by the issuance of such equity instruments. The proposed statement would eliminate the ability to account for share-based compensation transactions using the intrinsic method that the Company currently uses and generally would require that such transactions be accounted for using a fair-value-based method and recognized as expense in the consolidated statement of operations. The effective date of the proposed standard is for periods beginning after June 15, 2005. It is expected that the final standard will be issued before December 31, 2004 and should it be finalized in its current form, it will have a significant impact on the consolidated statement of operations as the Company will be required to expense the fair value of stock option grants and stock purchases under employee stock purchase plan.
In April 2004, the Emerging Issues Task Force ("EITF") issued Statement No. 03-06 "Participating Securities and the Two-Class Method Under FASB Statement No. 128, Earnings Per Share" ("EITF 03-06"). EITF 03-06 addresses a number of questions regarding the computation of earnings per share by companies that have issued securities other than common stock that contractually entitle the holder to participate in dividends and earnings of the Company when, and if, it declares dividends on its common stock. The issue also provides further guidance in applying the two-class method of calculating earnings per share, clarifying what constitutes a participating security and how to apply the two-class method of computing earnings per share once it is determined that a security is participating, including how to allocate undistributed earnings to such a security. EITF 03-06 became effective during the quarter ended June 30, 2004, the adoption of which did not have an impact on the calculation of earnings per share of the Company.
In July 2004, the EITF issued a draft abstract for EITF Issue No. 04-08, "The Effect of Contingently Convertible Debt on Diluted Earnings per Share" ("EITF 04-08"). EITF 04-08 reflects the Task Force's tentative conclusion that contingently convertible debt should be included in diluted earnings per share computations regardless of whether the market price trigger has been met. If adopted, the consensus reached by the Task Force in this Issue will be effective for reporting periods ending after December 15, 2004. Prior period earnings per share amounts presented for comparative purposes would be required to be restated to conform to this consensus and the Company would be required to include the shares issuable upon the conversion of the Notes in the diluted earnings per share computation for all periods during which the Notes are outstanding. . Currently, there would be no effect of this proposed statement on our financial position and results of operations
In September 2004, the EITF delayed the effective date for the recognition and measurement guidance previously discussed under EITF Issue No. 03-01, "The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments" ("EITF 03-01") as included in paragraphs 10-20 of the proposed statement. The proposed statement will clarify the meaning of other-than-temporary impairment and its application to investments in debt and equity securities, in particular investments within the scope of FASB Statement No. 115, "Accounting for Certain Investments in Debt and Equity Securities," and investments accounted for under the cost method. Currently, there would be no effect of this proposed statement on its financial position and results of operations.
S) Product Warranties
The Company warrants its products against defects in design, materials and workmanship generally for six months to a year. Other warranties from our vendors which are incorporated in our products are passed on to the customer at the completion of the sale. Provision for estimated warranty costs is made in the period in which such costs become probable. Historically, Eagle has not incurred any material warranty costs and, accordingly, Eagle has not accrued for these costs at August 31, 2004 and 2003. Eagle provides for the estimated cost of product warranties at the time it recognizes revenue. Eagle engages in product quality programs and processes, including actively monitoring and evaluating the quality of its component suppliers; however, ongoing product failure rates, material usage and service delivery costs incurred in correcting a product failure, as well as specific product class failures outside of Eagle's baseline experience, affect the estimated warranty obligation. If actual product failure rates, material usage or service delivery costs differ from estimates, revisions to the estimated warranty liability would be required.
T) Beneficial Conversion Values:
Beneficial conversion values are calculated at the difference between the conversion price and the fair value of the common stock into which the debt is convertible, multiplied by the number of shares into which the debt is convertible. The beneficial conversion value is charged to interest expense because the debt is convertible at the date of issuance. The value is limited to the total proceeds received.
Eagle Broadband, Inc., and Subsidiaries Notes to the Consolidated Financial Statements August 31, 2004
NOTE 2 - Related Party Transactions:
Sale of Assets:
During the fiscal year ended August 31, 2004, the Company completed a transaction with an effective date of October 1, 2003, with Eagle RF International, Inc. (dba ERF), to sell certain assets of its subsidiary Contact Wireless, Inc. Eagle RF International, Inc., is a private company engaged in providing products and services to the wireless industry. ERF has a board member who is also a member of the Company's board of directors, namely H. Dean Cubley. The assets sold related to the Contract Wireless paging network business and included a switch center lease and tower lease, network equipment, network contracts, paging licenses, accounts receivable, inventory, furniture and fixtures. The Company had downsized this subsidiary during the course of fiscal 2003 and during the three months ended February 29, 2004, elected to exit this business segment. The Company has recorded approximately $329,000 in revenues with a corresponding segment loss of approximately $387,000 from this business segment in fiscal 2003 and recorded approximately $80,000 in revenues with a corresponding loss of $25,000 in the first quarter of fiscal 2004. The Company had no competing offers with respect to the sale of assets and/or sale of the business and the Company's board of directors determined that the offer from ERF represented fair value. The Company terminated its remaining employees associated with this subsidiary and ERF entered into new employment arrangements with certain of these employees. Additionally, ERF assumed certain liabilities and subleased certain property from the Company in Houston and San Antonio. In conjunction with this transaction, the Company recorded a loss of $642,000 on the sale of assets and certain other costs incurred in the exit from this line of business.
Compensation
Eagle renewed a professional service agreement effective April 1, 2004, with the son of a director. The agreement states that consulting services provided will include support in the areas of management information systems, investor relations, and corporate finance and accounting. Compensation includes monthly salary of $10,000 and quarterly issuance of stock options to purchase common stock of Eagle Broadband.
In addition, compensation for certain officers and key employees under incentive clauses of their employment contracts (i) includes a non-cash expense of $4,493,000 incurred upon the modification of warrants for 4,200,000 common shares and (ii) reflects a guaranteed compensation of the modified warrants equivalent to $1.75 less the warrant strike price.
NOTE 3 - Accounts Receivable:
Accounts receivable consist of the following, in thousands:
August 31, --------------------------------- 2004 2003 ------------ ------------ Accounts Receivable $ 3,866 $ 2,116 Allowance for Doubtful Accounts (2,396) (412) ------------ ------------ Accounts Receivable, Net $ 1,470 $ 1,704 ============ ============
Eagle Broadband, Inc., and Subsidiaries Notes to the Consolidated Financial Statements August 31, 2004
NOTE 4 - Property, Plant & Equipment and Intangible Assets:
Components of property, plant & equipment are as follows, in thousands:
August 31, -------------------------------- 2004 2003 ------------ ------------- Automobile $ 143 $ 143 Headend facility and fiber infrastructure 27,146 26,688 Furniture and fixtures 516 565 Leasehold improvements 133 122 Office equipment 7,454 979 Property, manufacturing and equipment $ 1,023 $ 7,925 ------------ ------------- Total Property, Plant and Equipment 36,415 36,422 Less accumulated depreciation $ (7,837) $ (5,689) ------------ ------------- Net property, plant and equipment $ 28,578 $ 30,733 ============ =============
Eagle expenses repairs and maintenance against income as incurred whereas major improvements are capitalized. Eagle defines major improvements as those assets acquired that extend the life of the underlying base asset while defining other improvements that do not extend the life as repairs and maintenance. Eagle expensed repairs and maintenance of $43,000, $47,000 and $63,000 for the three years ended August 31, 2004, 2003 and 2002, respectively, whereas it did not have any capitalized major improvements for the same time periods.
Eagle's headend facility and fiber infrastructure consist primarily of digital computing and telecommunications equipment that comprise Eagle's main headend facility at it headquarters, wireless headend equipment, a digital headend facility and a fiber backbone in the master planned communities in which it operates and a fiber ring connecting the various master planned communities in the Houston area. These fiber and headend infrastructures are similar to those that would exist in a major telecommunications or cable television provider that offers digital services for Internet, cable TV, telephone and security monitoring services. Eagle determined that a twenty-year straight line depreciation method is appropriate for its Headend Facility and Fiber Infrastructure based on industry standards for these asset types.
Components of intangible assets are as follows, in thousands:
August 31, ---------------------------- 2004 2003 ---------- ----------- Goodwill $ 5,596 $ 5,596 Accumulated Amortization (1,501) (1,501) ---------- ----------- $ 4,095 $ 4,095 ---------- ----------- Contract Rights $28,691 $28,691 Accumulated Amortization (7,013) (5,101) ---------- ----------- $21,678 $ 23,590 ---------- ----------- Customer Relationships $ 7,189 $ 7,189 Accumulated Amortization (1,758) (1,277) ---------- ----------- $ 5,431 $ 5,912 ---------- ----------- Other Intangible Assets $ 6,839 $ 6,839 Accumulated Amortization (2,805) (2,473) ---------- ----------- $ 4,034 $ 4,366 ---------- -----------
NOTE 5 - Business Combinations:
Effective January 1, 2002, the Company acquired DSS Security, Inc., and Contact Wireless in a business combination accounted for as a purchase. DSS Security, Inc., provides security monitoring to business and residential customers. Contact Wireless sells and services mobile phones and one- and two-way messaging devices. The Company paid cash of $450,000 and issued a short-term note payable of $130,000 for the assets of Contact Wireless for a total purchase price of $580,000. Additionally, the Company acquired DSS Security, Inc., for $2,002,147. In this transaction, the Company issued 2,002,147 shares of its common stock with a guaranteed value of $1 per share. The Company allocated $51,595 to the fair value of the property and equipment and
Eagle Broadband, Inc., and Subsidiaries Notes to the Consolidated Financial Statements August 31, 2004
$1,950,552 in goodwill. The allocation of the purchase price is based on the fair value of the assets acquired based on management's estimates and existing contracts. At August 31, 2003 and 2002, the Company has accruals for $573,000 and $921,000; respectively for the portion of the purchase that represents the difference between purchase price and market value of the Company's common stock on the date of purchase.
NOTE 6 - Notes Payable:
The following table lists the Company's note obligations as of August 31, 2004 and 2003, in thousands:
NOTE 7 - Capital Lease Obligations:
The Company historically has leased equipment from various companies under capital leases. The assets and liabilities under the capital lease are recorded at the lower of the present value of the minimum lease payments or the fair value of the asset. The assets are depreciated over the estimated useful life with the value and depreciation being included as a component of Property and Equipment under operating equipment. As of August 31, 2004, there was no equipment under capital lease.
NOTE 8 - Lines of Credit:
On July 16, 2002, the Company entered into a $20,000,000 line of credit with Cornell Capital Partners, LP (CCP). The Company has not drawn on the line of credit and currently has no plans to do so. One of the issues in the litigation between CCP and the Company (see Legal Proceedings below) is whether the Company owes CCP a commitment fee for this line of credit. Cornell contends that the Company owes $395,000 of stock; the Company denies the liability.
NOTE 9 - Convertible Debentures:
During October 2002, the Company entered into a $3,000,000 convertible debenture agreement with Cornell Capital Partners, LP (CCP). During the three month period ended November 30, 2003, the principal balance of the debenture was repaid, although a lawsuit remains outstanding - see Legal Proceedings. On July 16, 2002, the Company entered into a $20,000,000 line of credit with Cornell Capital Partners, LP (CCP). The Company has not drawn on the line of credit and currently has no plans to do so. One of the issues in the litigation between CCP and the Company (see Legal Proceedings below) is whether the Company owes CCP a commitment fee for this line of credit. Cornell contends that the Company owes $395,000 of stock; the Company denies the liability. The Company is currently negotiating to settle this contested liability and the cancellation of the line of credit.
During 2001, the Company acquired ClearWorks.net, Inc., and as a result, ClearWorks is a wholly owned subsidiary of Eagle. Link Two Communications, Inc., is a subsidiary of ClearWorks. Link Two entered an agreement with The Tail Wind Fund Ltd., under which Tail Wind purchased from Link Two a 2% convertible note in the initial amount of $5,000,000. As a result of the acquisition, Eagle the parent of Link Two, has guaranteed the Link Two notes issued to Tail Wind and allowed Tail Wind to convert the above mentioned debt into Eagle common stock and warrants at various rates. During fiscal 2002 Eagle made payments of $500,000 in cash and converted $2,500,000 into common stock. During fiscal 2003, Tail Wind converted $405,169 into common stock and during fiscal 2004 Eagle made the final payment of $1,594,831 in cash.
Between November 25, 2002, and June 9, 2003, the Company sold approximately $6.5 million of convertible debt securities to 45 accredited investors. The securities consisted of $25,000, 12% five-year bonds. The bonds are due and payable upon maturity at the end of the five-year period. Interest on the bonds is payable at the rate of 12% per annum, and is payable semiannually. The bondholder may require the Company to convert the bond (including any unpaid interest) into shares of the Company's common stock at any time
Eagle Broadband, Inc., and Subsidiaries Notes to the Consolidated Financial Statements August 31, 2004
during the first year but not thereafter. The conversion rates vary from $0.16 to $0.34 per share. The Company may redeem the bonds at any time after the first year.
Between October 30, 2003, and November 5, 2003, the Company sold approximately $4.1 million of convertible debt securities to 36 accredited investors. The securities consisted of $25,000, 12% five-year bonds. The bonds are due and payable upon maturity at the end of the five-year period. Interest on the bonds is payable at the rate of 12% per annum, and is payable semiannually. The bondholder may require the Company to convert the bond (including any unpaid interest) into shares of the Company's common stock at any time during the first year but not thereafter. The conversion rates vary from $0.50 to $0.75 per share. The Company may redeem the bonds at any time after the first year.
Eagle Broadband, Inc. ("Eagle" or "Company") entered into a Securities Purchase Agreement dated June 2, 2004, (the "Agreement") with four accredited investors (collectively, the "Investors"), pursuant to which Eagle agreed to sell, and the Investors agreed to purchase, debentures in the principle amount of $4,888,400 bearing interest at the rate of 8% per annum, maturing in June 2007 ("Debentures"), convertible into an aggregate of 5,360,088 shares of Eagle common stock, par value $.001 per share (the "Common Stock"), together with five-year warrants to purchase an aggregate of 1,340,022 shares of Common Stock at an exercise price of $1.265 per share (the " Warrants") ( the funding of the Debentures and issuance of the Warrants referred to as the "Financing").
The Debentures are convertible immediately. Subject to certain exceptions, in the event that on or before the date on which the Debentures are converted, Eagle issues or sells, or is deemed to have issued or sold in accordance with the terms of the Debentures, any shares of Common Stock for consideration per share less than the conversion price of the Debentures as then in effect (a "Dilutive Issuance"), then the conversion price of the Debentures will be adjusted to equal the consideration per share of Common Stock issued or sold or deemed to have been issued and sold in such Dilutive Issuance.
All of the Warrants are exercisable immediately. Subject to certain exceptions, in the event that on or before the date on which the Warrants are exercised, Eagle issues or sells, or is deemed to have issued or sold in accordance with the terms of the Warrants, a Dilutive Issuance, then the exercise price of the Warrants will be adjusted to equal the consideration per share of Common Stock issued or sold or deemed to have been issued and sold in such Dilutive Issuance.
Eagle also granted the Investors a right to participate in subsequent private offerings of its equity or equity equivalent securities undertaken by Eagle for the purpose of raising capital (each, a "Subsequent Placement"). The Investors' right of participation is subject to certain additional limitations and expires 6 months from the effective date of the registration statement filed to register the resale of the shares of Common Stock underlying the Debentures and Warrants ("Shares").
Eagle has agreed to file a registration statement with the Securities and Exchange Commission within 40 days after the closing of the Financing in order to register the resale of the Shares. If Eagle fails to meet this deadline, if the registration statement is not declared effective prior to the 90th day after the closing date, if Eagle fails to respond to comments made by the SEC within 10 days, if the registration statement ceases to remain effective, or certain other events occur, Eagle has agreed to pay the Investors 2.0% of the aggregate purchase price for each month of such event.
NOTE 10 - Securities Held for Resale:
As discussed in Note 1, the Company adopted the provisions of SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities" and SFAS No. 130, "Accounting for Other Comprehensive Income." At August 31, 2004 and 2003, all of the Company's marketable equity securities are classified as available-for-sale; they were acquired with the intent to dispose of them within the next year.
At August 31, 2004, securities available for sale include 580,000 shares of Burst.com with a cost basis of $127,832 and a fair market value of $551,000.
At August 31, 2003, securities available for sale include 1,480,000 shares of common stock of Burst.com, 146,085,264 shares of Celerity Systems common stock and $350,000 Celerity Systems Bonds. These common stock and bond investments have an aggregate cost basis of $1,075,000 and an aggregate fair market value of $1,714,006.
NOTE 11 - Income Taxes:
As discussed in note 1, the Company adopted the provisions of Statement of Financial Accounting Standards (SFAS) No. 109, "Accounting for Income Taxes". Implementation of SFAS 109 did not have a material cumulative effect on prior periods nor did it result in a change to the current year's provision.
Eagle Broadband, Inc., and Subsidiaries Notes to the Consolidated Financial Statements August 31, 2004
The effective tax rate for the Company is reconcilable to statutory tax rates as follows:
August 31, ----------------------------------- 2004 2003 2002 (%) (%) (%) -------- ------- -------- U. S. Federal Statutory Tax Rate 34 34 34 U.S. Valuation Difference (34) (34) (34) Effective U. S. Tax Rate 0 0 0 Foreign Tax Valuation 0 0 0 Effective Tax Rate 0 0 0
Income tax expense (benefit) attributable to income from continuing operations differed from the amounts computed by apply the U.S. Federal income tax rate of 34% to pretax income from continuing operations as a result of the following (in thousands):
The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at August 31, 2004 and 2003, are presented below (in thousands) and include the balances of the merged company ClearWorks.net.
August 31, -------------------------------- 2004 2003 ------------ ------------ Deferred Tax Assets: Net Operating Loss Carry Forwards $ 63,606 $ 50,344 Less Valuation Allowance (63,606) (50,344) ------------ ------------ Net Deferred Tax Assets $ - $ - ============ ============
The valuation allowance for deferred tax assets of August 31, 2004, 2003 and 2002, was $63,606,000, $50,344,000 and $25,162,000, respectively. At August 31, 2003 and 2002, the Company has net operating loss carry-forwards of $110,507,000 and $74,006,000, respectively, which are available to offset future federal taxable income, if any, with expirations from 2020 to 2022.
NOTE 12 - Issuance of Common Stock:
During the fiscal year ended August 31, 2004, the Company issued shares of common stock. The following table summarizes the shares of common stock issued, in thousands.
Eagle Broadband, Inc., and Subsidiaries Notes to the Consolidated Financial Statements August 31, 2004
NOTE 13 - Preferred Stock, Stock Options and Warrants:
The warrants outstanding are segregated into two categories (issued and outstanding and exercisable):
Warrants Issued & Outstanding Warrants Exercisable Class of Expiration August 31, August 31, Warrants Date 2004 2003 2004 2003 - -------- ---------- ----------------------- ----------------------- 0.41 Sep-08 3,800,000 3,800,000 1,550,000 1,550,000 0.48 Oct-06 25,000 25,000 25,000 25,000 0.60 Sep-06 400,000 400,000 - - 0.61 Jan-05 25,000 25,000 25,000 25,000 0.69 Oct-04 25,000 25,000 25,000 25,000 0.75 Sep-08 500,000 500,000 - - 0.97 Jul-07 25,000 - - - 1.04 Apr-05 50,000 50,000 50,000 50,000 1.23 Apr-07 25,000 - - - 1.31 Jan-07 25,000 - 25,000 - 7.50 Apr-08 800,000 800,000 800,000 800,000 ESOP Various 346,002 * 406,131 346,002 406,131 ----------------------- ----------------------- 6,046,002 **6,031,131 2,846,002 2,881,131 ======================= =======================
*Denotes warrants which would have an anti-dilutive effect if currently used to calculate earnings per share for the years ended August 31, 2004 and 2003. **Denotes 12,700,000 warrants for shares that have been excluded from this table that are subject to issuance to certain employees under incentive clauses of employment contracts expiring 5 years from the date of issuance. The warrants vest based on accumulated revenue targets ranging from $50 million to $500 million and on market performance of Eagle's common stock at market capitalization between $450 million and $1 billion. The warrants are to purchase fully paid and non-assessable shares of the common stock, par value $0.001 per share at purchase prices ranging from $0.41 to $1.50 per share. The Company has determined that the probability of the achievement of such targets is remote as of the date of the issuance of the Company's financial statements and thus has not included them in the outstanding warrant table above. The shares of common stock underlying these warrants were not registered for resale under the Securities Act of 1933. As of August 31, 2004, none of these warrants have been exercised.
NOTE 14 - Capitalization Activities:
Between November 25, 2002 and June 9, 2003, the Company sold approximately $6.5 million of convertible debt securities to 45 accredited investors. The securities consisted of $25,000, 12% five-year bonds. The bonds are due and payable upon maturity at the end of the five-year period. Interest on the bonds is payable at the rate of 12% per annum, and is payable semiannually. The bondholder may require the Company to convert the bond (including any unpaid interest) into shares of the Company's common stock at any time during the first year but not thereafter. The conversion rates vary from $0.16 to $0.34 per share. The Company may redeem the bonds at any time after the first year.
Between October 30, 2003 and November 5, 2003, the Company sold approximately $4.1 million of convertible debt securities to 36 accredited investors. The securities consisted of $25,000, 12% five-year bonds. The bonds are due and payable upon maturity at the end of the five-year period. Interest on the bonds is payable at the rate of 12% per annum, and is payable semiannually. The bondholder may require the Company to convert the bond (including any unpaid interest) into shares of the Company's common stock at any time during the first year but not thereafter. The conversion rates vary from $0.50 to $0.75 per share. The Company may redeem the bonds at any time after the first year.
Eagle Broadband, Inc. ("Eagle" or "Company") entered into a Securities Purchase Agreement dated June 2, 2004, (the "Agreement") with four accredited investors (collectively, the "Investors"), pursuant to which Eagle agreed to sell, and the Investors agreed to purchase, debentures in the principle amount of $4,888,400 bearing interest at the rate of 8% per annum, maturing in June 2007 ("Debentures"), convertible into an aggregate of 5,360,088 shares of Eagle common stock, par value $.001 per share (the "Common Stock"), together with five-year warrants to purchase an aggregate of 1,340,022 shares of Common Stock at an exercise price of $1.265 per share (the " Warrants") ( the funding of the Debentures and issuance of the Warrants referred to as the "Financing").
Eagle Broadband, Inc., and Subsidiaries Notes to the Consolidated Financial Statements August 31, 2004
NOTE 15 - Risk Factors:
For the years ended August 31, 2004, 2003, and 2002, substantially all of the Company's business activities have remained within the United States and have been extended to the wireless infrastructure, fiber, cabling, computer services and broadband industries. Approximately, 83% of the Company's revenues and receivables have been created solely in the state of Texas, 0% have been created in the international market, and the approximate 17% remainder have been created relatively evenly over the rest of the nation during the year ended August 31, 2004. Approximately, 74% of the Company's revenues and receivables have been created solely in the state of Texas, 0% have been created in the international market, and the approximate 26% remainder have been created relatively evenly over the rest of the nation during the year ended August 31, 2003. Whereas, approximately 84% of the Company's revenues and receivables have been created solely in the state of Texas, 0% has been created in the international market, and the approximate 16% remainder has been created relatively evenly over the rest of the nation for the year ended August 31, 2002. Through the normal course of business, the Company generally does not require its customers to post any collateral.
NOTE 16 - Foreign Operations:
Although the Company is based in the United States, its product is sold on the international market. Presently, international sales total approximately 0%, 0% and 0% at August 31, 2004, 2003, and 2002, respectively.
NOTE 17 - Commitments and Contingent Liabilities:
Leases
For the years ending August 31, 2004 and 2003, rental expenses of approximately $507,000 and $1,183,000, respectively, were incurred.
The Company renewed its primary office lease space in League City, Texas, for $24,983 per month with South Shore Harbor Development, Ltd. The renewal lease commenced on June 1, 2004, and expires on May 31, 2009. The Lessor agreed to grant the Company a one-time option to terminate the lease at 36 months by paying an unamortized leasing commission of $35,000 and a penalty of 1.5 months rent of $37,000 for a combined total of $72,000.
Period Ending August 31, Amount ---------------- ---------------- 2005 $ 299,801 2006 299,801 2007 306,180 2008 325,316 2009 243,987 ---------------- Total $ 1,475,085 ================
Legal Proceedings
In July 2003, Eagle became a defendant in Cornell Capital Partners, L.P. vs. Eagle Broadband, Inc., et al., Civil Action No. 03-1860 (KSH), In the United States District Court for the District of New Jersey. The suit presents claims for breach of contract, state and federal securities fraud and negligent misrepresentation. Plaintiff has also alleged that Eagle has defaulted on a convertible debenture for failing to timely register the shares of common stock underlying the convertible debenture and is seeking to accelerate the maturity date of the debenture. In November 2003, the principal balance of the debenture was repaid, although the suit remains outstanding. Cornell claims damages in excess of $1,000,000. The Company denies the claims and intends to vigorously defend this lawsuit and the claims against it. Eagle has asserted counterclaims against Cornell for fraud and breach of contract in the amount of $2,000,000. The Company has not accrued any expenses against this lawsuit, as the outcome cannot be predicted at this time.
In December 2000, ClearWorks became a defendant in State Of Florida Department Of Environmental Protection vs. Reco Tricote, Inc. And Southeast Tire Recycling, Inc. A/K/A Clearwork.net, Inc.; In the Circuit Court of The Tenth Judicial Circuit In And For Polk County, Florida. The Florida EPA sued ClearWorks.net presenting claims for recovery costs and penalties for a waste tire processing facility. The suit seeks recovery of costs and penalties in a sum in excess of $1,000,000, attorneys' fees and cost of court. ClearWorks denies the claims and intends to vigorously contest all claims in this case and to enforce its indemnification rights against the principals of Southeast Tire Recycling. The Company has not accrued any expenses against this lawsuit, as the outcome cannot be predicted at this time.
Eagle Broadband, Inc., and Subsidiaries Notes to the Consolidated Financial Statements August 31, 2004
In September 2003, Enron sued United Computing Group, Inc. in Enron Corp. (Debtors/Plaintiff) vs. United Computing Group, Inc.; Case No. 01-16034 in the United States Bankruptcy Court for the Southern District of New York. The suit presents claims pursuant to sections 547 and 550 of the Bankruptcy Code to avoid and recover a transfer in the amount of approximately $1,500,000. Defendant has filed an answer, denies the claims and intends to vigorously defend this lawsuit and claims against it. The Company has not accrued any expenses against this lawsuit, as the outcome cannot be predicted at this time.
In fiscal 2004, The Tail Wind Fund Ltd. sued Link Two Communications and Eagle, Civil Action 04-CV-05776, in the United States District Court for the Southern District of New York. Tail Wind claims breach of contract seeking $25 million. The Company intends to vigorously defend this claim. The Company has accrued $500,000 in expenses against this lawsuit, although the outcome cannot be predicted at this time.
In November 2004, Palisades Master Fund L.P. sued Eagle Broadband, Ind., and David Weisman, Civil Action 04603626, in New York County, New York Supreme Court. Palisades seeks an injunction setting a conversion price on certain convertible debt and warrants at $0.4456 per share of Eagle common stock and seeks damages in excess of $3.1 million. The Company intends to vigorously defend this claim. The Company has not accrued any expenses against the lawsuit, as the outcome cannot be predicted at this time.
Eagle is involved in lawsuits, claims, and proceedings, including those identified above, which arise in the ordinary course of business. In accordance with SFAS No. 5, "Accounting for Contingencies," Eagle makes a provision for a liability when it is both probable that a liability has been incurred and the amount of the loss can be reasonably estimated. Eagle believes it has adequate provisions for any such matters. Eagle reviews these provisions at least quarterly and adjusts these provisions to reflect the impacts of negotiations, settlements, rulings, advice of legal counsel, and other information and events pertaining to a particular case. Litigation is inherently unpredictable. However, Eagle believes that it has valid defenses with respect to legal matters pending against it. Nevertheless, it is possible that cash flows or results of operations could be materially affected in any particular period by the unfavorable resolution of one or more of these contingencies.
We intend to vigorously defend these and other lawsuits and claims against us. However, we cannot predict the outcome of these lawsuits, as well as other legal proceedings and claims with certainty. An adverse resolution of pending litigation could have a material adverse effect on our business, financial condition and results of operations. The Company is subject to legal proceedings and claims that arise in the ordinary course of business. The Company's management does not expect that the results in any of these legal proceedings will have adverse affect on the Company's financial condition or results of operations.
NOTE 18 - Earnings Per Share:
The following table sets forth the computation of basic and diluted earnings per share, in thousands except per-share amount:
For the year ended August 31, 2004, anti-dilutive securities existed. (see Note 13)
Eagle Broadband, Inc., and Subsidiaries Notes to the Consolidated Financial Statements August 31, 2004
NOTE 19 - Employee Stock Option Plan:
In July 1996, the Board of Directors and majority stockholders adopted a stock option plan under which 400,000 shares of the Company's common stock have been reserved for issuance. Since that time, the Board of Directors have amended the July 1996, employee stock option plan under which 1,000,000 shares of Common Stock have been reserved for issuance. Under this plan, as of August 31, 2004, a total of 346,002 options have been issued to various employees.
The Company has elected to follow APB 25, "Accounting for Stock Issued to Employees." Accordingly, since employee stock options are granted at market price on the date of grant, no compensation expense is recognized. However, SFAS 123 requires presentation of pro forma net income and earnings per share as if the Company had accounted for its employee stock options granted under the fair value method of that statement. The weighted average fair value of the individual options issued and granted during 2003 is estimated as $0.58 on the date of grant. Management estimates the average fair value for options granted during 2003, to be comparable to those granted in 2002. The impact on net loss is minimal; therefore, the pro forma disclosure requirements prescribed by SFAS 123 are not significant to the Company. The fair values were determined using a Black-Scholes option-pricing model with the following assumptions:
August 31, ---------------------- 2004 2003 --------- -------- U. S. Federal Statutory Tax Rate 0.00% 0.00% U.S. Valuation Difference 0.91% 0.91% Effective U. S. Tax Rate 4.00% 4.00% Foreign Tax Valuation 4.00% 7.00% Effective Tax Rate 5 years 5 years
The pro forma effect on net loss as if the fair value of stock-based compensation had been recognized as compensation expense on a straight-line basis over the vesting period of the stock option or purchase right was as follows for the years ended August 31, 2004, 2003 and 2002:
Option activity was as follows for the years ended August 31, 2004, 2003 and 2002:
Eagle Broadband, Inc., and Subsidiaries Notes to the Consolidated Financial Statements August 31, 2004
Information about options outstanding was as follows at August 31, 2004:
NOTE 20 - Retirement Plans:
During October 1997, the Company initiated a 401(k) plan for its employees which is funded through the contributions of its participants. Prior to March 2003, the Company matched the participant's contribution up to 3% of their salary. Subsequent to March 2003, the plan was amended and the Company match became elective. For the year ended August 31, 2004 and 2003, employee contributions were approximately $109,000 and $279,000, respectively. The Company matched approximately $0 and $67,850, respectively, for those same periods.
NOTE 21 - Major Customer:
The Company had gross revenues of $12,490,000 and $11,593,000 for the year ended August 31, 2004 and 2003, respectively.
The fiscal year ended August 31, 2004, included $3,103,937 or 25% of the fiscal year total sales from Sweetwater Security Capital, LLC, that were executed with the Company's security-monitoring service subsidiary, DSS Security, Inc. Also during this period, Eagle Broadband Inc, had sales of $3,806,806 or 30% sales to a major customer for shipment of IP set-top boxes and related equipment. There were no other customers individually that represented greater than 10% of the revenues in the fiscal year ended August 31, 2003.
NOTE 22 - Industry Segments:
The Company has seven business units have separate management teams and infrastructures that offer different products and services. The business units have been aggregated into five reportable segments (as described below) since the long-term financial performance of these reportable segments is affected by similar economic conditions.
Eagle Broadband, Inc., (Eagle) is a supplier of broadband and telecommunications equipment with related software and broadband products. (Including Eagle Wireless International, Inc.; BroadbandMagic; and Etoolz, Inc., for this summary).
Atlantic Pacific Communications, Inc., (APC) specializes in providing professional data and voice cable and fiber optic installations through project management services on a nationwide basis for multiple site-cabling installations for end users and re-sellers.
ClearWorks Communications, Inc., (EBS) provides solutions to consumers by implementing technology both within the residential community and home. This is accomplished through the installation of fiber optic backbones to deliver voice, video and data solutions directly to consumers.
ClearWorks Home Systems, Inc., (HSI) specializes in providing fiber optic and copper based structured wiring solutions and audio and visual equipment to single-family and multi-family dwelling units.
United Computing Group, Inc., (UCG) is an accelerator company and computer hardware and software reseller. UCG / INT maintain a national market presence.
Link Two Communications, Inc., (Link II) is in the development and delivery of one- and two-way messaging systems.
DSS Security, Inc., (DSS) is a security monitoring company.
ClearWorks.net, Inc., (.NET) is inactive with exception of debt related expenses.
Contact Wireless, Inc., is a paging, cellular, and mobile services provider and reseller.
Eagle Broadband, Inc., and Subsidiaries Notes to the Consolidated Financial Statements August 31, 2004
The accounting policies of the reportable segments are the same as those described in Note 1. The Company evaluates the performance of its operating segments based on income before net interest expense, income taxes, depreciation and amortization expense, accounting changes and non-recurring items.
NOTE 23 - Quarterly Financial Data.
NOTE 24 - Supplemental Non-Cash Disclosures:
During the fiscal year ended August 31, 2004, the Company issued $3,000,000 of convertible debt which was retired through the issuance of 2,000,000 shares of Series A Preferred Stock which was concurrently converted to 29,500,000 shares of the Company's common stock. Additionally, the Company received proceeds of $3,912,000 from the sale of convertible bonds.
Eagle Broadband, Inc., and Subsidiaries Notes to the Consolidated Financial Statements August 31, 2004
The beneficial conversion values associated with these financings aggregating $6,912,000 are calculated at the difference between the conversion price and the fair value of the common stock into which the debt is convertible, multiplied by the number of shares into which the debt is convertible. Since the beneficial conversion value exceeded the $6,912,000 raised on these convertible instruments, the value charged to interest expense during the quarter was limited to $6,912,000 raised on these convertible instruments, the value charged to interest expense during the fiscal year ended August 31, 2004, was limited to $6,912,000. This non-cash charge comprises $6,912,000 of the $8,325,000 interest expense on the Company's Statement of Operations as is shown as an adjustment to reconcile net loss to net cash on the Company's Statement of Cash Flows.
In addition, compensation for certain officers and key employees under incentive clauses of their employment contracts (i) includes a non-cash expense of $4,493,000 incurred upon the modification of warrants for 4,200,000 common shares and (ii) reflects a guaranteed compensation of the modified warrants equivalent to $1.75 less the warrant strike price.
NOTE 25 - Exit Activities:
During the fiscal year ended August 31, 2003, we implemented cost reductions in various operating segments. In the aggregate, the Company reduced its overall personnel by 114 headcount or a 50% reduction for the fiscal year ended August 31, 2003 as compared to the fiscal year ended August 31, 2002. The predominate reduction in headcount related to the Company's Atlantic Pacific / Homes Systems structured wiring and commercial cabling segment with headcount reductions of nine, six and 57 personnel in the first three quarters of fiscal 2003; aggregating an overall headcount reduction of 72 or 71% of this segments workforce. Additionally, the Company reduced its United Computing Group computer hardware sales segment by 18, nine, and two personnel in the first three quarters of fiscal 2003; aggregating an overall reduction of 29 or 59% of this segments workforce. These two operating segments accounted for 101 of the 114 headcount reductions affected in fiscal 2003. Specifically, certain components of these operating segments, i.e., home systems structured wiring, commercial cabling and computer hardware sales, were not expected to provide significant long-term revenues and profitability, and therefore were reduced. Following the series of cost reduction activities implemented during the first three quarters of fiscal 2003, Eagle's management assessed the viability of continued financial investment in these unprofitable segments in the fourth quarter of fiscal 2003 and into early first quarter of fiscal 2004 and made further reductions. In conjunction with the appointment of , Mr. Weisman as our new Chief Executive Officer, in early October 2003, the Company completed the final consolidation of the United Computing Group segment into other Eagle operations while further reducing the Atlantic Pacific / Home Systems operations to an outsource commercial cabling and structured wiring operation that project manages affiliate contractors.
Additionally, in conjunction with the appointment of Mr. Weisman as Chief Executive Officer,, the Company made certain decisions during the preparation of its Form 10-K in our first quarter of fiscal 2004 that affected the value of certain assets as of August 31, 2003. These decisions included:
o A revised collection assessment of certain accounts receivables from these and other down-sized Eagle business segments.
o The decision to no longer pursue new commercial structured cabling opportunities on a direct basis versus the outsource model; thereby resulting in the impairment of goodwill from its Atlantic Pacific operations.
o The decision to no longer pursue Home Systems structured wiring opportunities on a direct standalone model basis outside its BDS model; thereby resulting in the impairment of its Home Systems inventory.
o The decision to withdraw from certain unprofitable BDS projects, namely its Austin area BDS developments; thereby impairing certain assets including property, plant and equipment.
o The decision to settle numerous existing and threatened legal proceedings versus continuing the timing consuming and costly process of defending such proceedings; thereby resulting in the accrual of numerous reserves for such settlements.
o The decisions to consolidate its operating segments into its corporate lease space; thereby resulting in reserves for property lease settlements.
o The decision to negotiate the settlement of certain sales tax liabilities that resulted from a sales tax audit of United Computing Group operations for periods that preceded the acquisition date of this subsidiary.
Accordingly, Eagle incurred certain asset impairments and operating charges in the fourth quarter associated with these decisions. These asset impairment charges, allowances, write-off's and reserves included the following:
o Accounts receivable write-off's and reserves aggregating $2,177,000; of which $1,348,000 was attributable to the decisions affecting the Company's Atlantic Pacific / Home Systems operations, $15,000 attributable to the decisions affecting its United Computing Group operations and $814,000 attributable to the Company's Eagle, EBS and Other segment operations.
Eagle Broadband, Inc., and Subsidiaries Notes to the Consolidated Financial Statements August 31, 2004
o Inventory impairment charges of $2,627,000; of which $501,000 was attributable to the decisions affecting the Company's Atlantic Pacific / Home Systems operations and $74,000 attributable to the decisions affecting its United Computing Group operations. Additionally, the Company recorded an impairment charge of $1,125,000 for slow-moving and obsolete inventory in its Eagle operations. This charge primarily resulted from a major client's decision to upgrade from a 400 MHz chip to a 500 MHz chip for the Company's IP set top box.
o Litigation settlement costs and reserves of $3,650,000 against certain of the legal proceedings previously discussed in Item 3. Legal Proceedings. Additionally, the Company recorded charges aggregating $2,274,000 to settle threatened and existing legal proceeding associated with prior financing transactions, including the Kaufman litigation.
o Lease settlement costs and reserves of $171,000 were attributable to the decision to consolidate various operating segments into its corporate lease space; thereby resulting in reserves for early exit of such leases.
o Impairment, write-down's and restructuring costs aggregating $7,611,000; of which $1,878,000 was attributable to an impairment of goodwill in the Company's Atlantic Pacific operations following the Company's decision to no longer pursue commercial cabling opportunities on a direct basis versus an outsource model. These costs were also comprised of $3,412,000 in impairment of property and equipment following the Company's decision to withdraw from certain unprofitable BDS projects, namely in the Austin area, and $323,000 of impairment of property and equipment from the Company's Atlantic Pacific / Home Systems operations following the decision to no longer pursue structured wiring opportunities on a direct standalone basis outside of its BDS model. Additionally, the aggregate total included a $553,000 charge for certain sales tax liabilities that resulted from an audit of the Company's United Computing Group operations for time periods that preceded the acquisition date of this operation.
Eagle incurred approximately $96,000 for severance and accrued vacation related to employees terminated in fiscal 2003. Eagle does not expect to incur any additional future period costs associated with such restructuring activities other than those accrued for and recorded in the fourth quarter of fiscal 2003.
An analysis of accrued costs and amounts charged against the provision are as follows:
Beginning Ending Balance Period Costs Balance 8/31/2003 (Additional) Payments 8/31/2004 ---------- -------- ----------- --------- Accrued Exit Expenses: Severance $- $- $- $- Terminated Lease Costs 171,000 - - $171,000 --------- -------- ---------- --------- $171,000 $- $- $171,000 ========= ======== ========== =========
For the year ended August 31, 2003, the Company incurred exit costs of $267,000 which are principally severance and lease termination costs. The total expected exit costs for severance and terminated leases are $96,000 and $171,000, respectively. These costs are included in the consolidated statement of income under the categories of salaries and related costs and other support costs.
These period and accumulated costs are included in the segment reporting as follows:
Eagle Broadband, Inc., and Subsidiaries Notes to the Consolidated Financial Statements August 31, 2004
SCHEDULE II
VALUATION AND QUALIFYING ACCOUNTS
Years ended August 31, 2004, 2003, and 2002 (amounts in thousands)
Additions Balance at Charged to Balance at Beginning of Expenses/ End of Description Period Revenues Deductions Period - -------------------------- --------- --------- ---------- ---------- Allowance for Doubtful Accounts: 2004 $ 412 $ 2,643 $ (659) $ 2,396 2003 242 2,177 (2,007) 412 2002 480 125 (363) 242