TERAYON COMMUNICATION SYSTEMS - 10-Q - 20070110 - LEGAL_PROCEEDING
Item 1.
Legal
Proceedings
Beginning in April 2000, several plaintiffs filed class action
lawsuits in federal court against us and certain of our officers
and directors. Later that year, the cases were consolidated in
the United States District Court for the Northern District of
California (Court) as
In re Terayon Communication Systems,
Inc. Securities Litigation.
The Court then appointed lead
plaintiffs who filed an amended complaint. In 2001, the Court
granted in part and denied in part defendants’ motion to
dismiss, and plaintiffs filed a new complaint. In 2002, the
Court denied defendants’ motion to dismiss that complaint,
which, like the earlier complaints, alleged that the defendants
violated the federal securities laws by issuing materially false
and misleading statements and failing to disclose material
information regarding our technology. On February 24, 2003,
the Court certified a plaintiff class consisting of those who
purchased or otherwise acquired our securities between
November 15, 1999 and April 11, 2000. On
September 8, 2003, the Court heard defendants’ motion
to disqualify two of the lead plaintiffs and to modify the
definition of the plaintiff class. On September 10, 2003,
the Court issued an order vacating the hearing date for the
parties’ summary judgment motions, and, on
September 22, 2003, the Court issued another order staying
all discovery until further notice and vacating the trial date,
which had been scheduled for November 4, 2003. On
February 23, 2004, the Court issued an order disqualifying
two of the lead plaintiffs and ordered discovery, which was
conducted. In February 2006, we mediated the case with
plaintiffs’ counsel. As part of the mediation, we reached a
settlement of $15.0 million. After this mediation, our
insurance carriers agreed to tender their remaining limits of
coverage, and we contributed approximately $2.2 million to
the settlement. On March 17, 2006, we, along with
plaintiffs’ counsel, submitted the settlement to the Court
and the shareholder class for approval. The Court held a hearing
to review the settlement of the shareholder litigation on
September 25, 2006. To date, the Court has not approved the
settlement.
On October 16, 2000, a lawsuit was filed against us and the
individual defendants (Zaki Rakib, Selim Rakib and Raymond
Fritz) in the Superior Court of California, San Luis Obispo
County. This lawsuit was titled
Bertram v. Terayon
Communication Systems, Inc.
The factual allegations in the
Bertram complaint were similar to those in the federal class
action, but the Bertram complaint sought remedies under state
law. Defendants removed the Bertram case to the United States
District Court, Central District of California, which dismissed
the complaint. Plaintiffs appealed this order, and their appeal
was heard on April 16, 2004. On June 9, 2004, the
United States Court of Appeals for the Ninth Circuit affirmed
the order dismissing the Bertram case.
In 2002, two shareholders filed derivative cases purportedly on
behalf of us against certain of our current and former
directors, officers, and investors. (The defendants differed
somewhat in the two cases.) Since the cases were filed, the
investor defendants have been dismissed without prejudice, and
the lawsuits have been
consolidated as
Campbell v. Rakib
in the Superior
Court of California, County of Santa Clara. We are a
nominal defendant in these lawsuits, which allege claims
relating to essentially the same purportedly misleading
statements that are at issue in the securities class action
filed in April 2000. In that securities class action, we
disputed making any misleading statements. The derivative
complaints also allege claims relating to stock sales by certain
of the director and officer defendants. On September 15,
2006, we entered into a Stipulation of Settlement of Derivative
Claims. On September 18, 2006, the Superior Court of
California, County of Santa Clara approved the final
settlement of the derivative litigation entitled
In re
Terayon Communication Systems, Inc. Derivative Litigation
(Case No. CV 807650). In connection with the
settlement, we paid $1.0 million in attorney’s fees and
expenses to the derivative plaintiffs’ counsel and agreed
to adopt certain corporate governance practices.
On June 23, 2006, a putative class action lawsuit was filed
against us in the United States District Court for the Northern
District of California by I.B.L. Investments Ltd. purportedly on
behalf of all persons who purchased our common stock between
October 28, 2004 and March 1, 2006. Zaki Rakib, Jerry
D. Chase, Mark Richman and Edward Lopez are named as individual
defendants. The lawsuit focuses on our March 1, 2006
announcement of the restatement of financial statements for the
year ended December 31, 2004, and for the four quarters of
2004 and the first two quarters of 2005. On November 8,
2006, Adrian G. Mongeli was appointed lead plaintiff in the
case, replacing I.B.L. Investments Ltd. On January 8, 2007,
Mongeli filed an amended complaint, purportedly on behalf of all
persons who purchased our common stock between June 28,
2001 and March 1, 2006. The amended complaint adds
Ernst & Young, Ray Fritz, Carol Lustenader, Matthew
Miller, Shlomo Rakib, Doug Sabella, Christopher Schaepe, Mark
Slaven, Lewis Solomon, Howard W. Speaks, Arthur T. Taylor and
David Woodrow to the defendants named in the original complaint.
The amended complaint incorporates the prior allegations and
includes new allegations relating to the restatement of our
consolidated historical financial statements as reported in our
Form 10-K
filed on December 29, 2006. The plaintiffs are seeking
damages, interest, costs and any other relief deemed proper by
the court. An unfavorable ruling in this legal matter could
materially and adversely impact our results of operations.
On April 22, 2005, we filed a lawsuit in the Superior Court
of California, County of Santa Clara against Adam S. Tom
(Tom) and Edward A. Krause (Krause) and a company founded by Tom
and Krause, RGB Networks, Inc. (RGB). We sued Tom and Krause for
breach of contract and RGB for intentional interference with
contractual relations based on breaches of the Noncompetition
Agreements entered into between us and Tom and Krause,
respectively. On May 24, 2006, RGB, Tom, and Krause filed a
Notice of Motion and Motion For Leave To File a Cross-Complaint,
in which the defendants stated that they intended to file
counter-claims against us for misappropriation of trade secrets,
unfair competition, tortious interference with contractual
relations, and tortious interference with prospective economic
advantage. On July 6, 2006, the court granted the
defendants’ motion, and on July 20, defendants filed a
cross-complaint for misappropriation of trade secrets, unfair
competition, tortious interference with contractual relations,
and tortious interference with prospective economic advantage.
On August 21, 2006, we filed a demurrer to certain of those
claims. The court granted our demurrer as to RGB’s request
for declaratory judgment. On November 9, 2006, we filed our
answer to RGB’s complaint. Damages in this matter are not
capable of determination at this time and the case may be
lengthy and expensive to litigate.
On September 13, 2005, a case was filed by Hybrid Patents,
Inc. (Hybrid) against Charter Communications, Inc. (Charter) in
the United States District Court for the Eastern District of
Texas for patent infringement related to Charter’s use of
equipment (cable modems, CMTS and embedded multimedia terminal
adapters (eMTAs)) meeting the Data Over Cable System Interface
Specification (DOCSIS) standard and certain video equipment.
Hybrid has alleged that the use of such products violates its
patent rights. Charter has requested that we and others
supplying it with equipment indemnify Charter for these claims.
We and others have agreed to contribute to the payment of the
legal costs and expenses related to this case. On May 4,
2006, Charter filed a cross-complaint asserting its indemnity
rights against us and a number of companies that supplied
Charter with cable modems. To date, this cross-complaint has not
been dismissed. Trial is scheduled on Hybrid’s claims for
July 2, 2007. At this point, the outcome is uncertain and
we cannot assess damages. However, the case may be expensive to
defend and there may be substantial monetary exposure if Hybrid
is
successful in its claim against Charter and then elects to
pursue other cable operators that use the allegedly infringing
products.
On July 14, 2006, a case was filed by Hybrid against Time
Warner Cable (TWC), Cox Communications Inc. (Cox), Comcast
Corporation (Comcast), and Comcast of Dallas, LP (together, the
MSOs) in the United States District Court for the Eastern
District of Texas for patent infringement related to the
MSOs’ use of data transmission systems and certain video
equipment. Hybrid has alleged that the use of such products
violates its patent rights. No trial date is known yet. To date,
we have not been named as a party to the action. The MSOs have
requested that we and others supplying them with cable modems
and equipment indemnify the MSOs for these claims. We and others
have agreed to contribute to the payment of legal costs and
expenses related to this case. At this point, the outcome is
uncertain and we cannot assess damages. However, the case may be
expensive to defend and there may be substantial monetary
exposure if Hybrid is successful in its claim against the MSOs
and then elects to pursue other cable operators that use the
allegedly infringing products.
On September 16, 2005, a case was filed by Rembrandt
Technologies, LP (Rembrandt) against Comcast in the United
States District Court for the Eastern District of Texas alleging
patent infringement. In this matter, Rembrandt alleged that
products and services sold by Comcast infringe certain patents
related to cable modem, voice-over internet, and video
technology and applications. To date, we have not been named as
a party in the action, but we have received a subpoena for
documents and a deposition related to the products we sold to
Comcast. We continue to comply with this subpoena. Comcast has
made a request for indemnity related to the products that we and
others sold to them. We and others have agreed to contribute to
the payment of legal costs and expenses related to this case.
Trial is scheduled on Rembrandt’s claims for August 6,
2007. At this point, the outcome is uncertain and we cannot
assess damages. However, the case may be expensive to defend and
there may be substantial monetary exposure if Rembrandt is
successful in its claim against Comcast and then elects to
pursue other cable operators that use the allegedly infringing
products.
On June 1, 2006, a case was filed by Rembrandt against
Charter, Cox, CSC Holdings, Inc. (CSC), and Cablevision Systems
Corp. (Cablevision) in the United States District Court for the
Eastern District of Texas alleging patent infringement. In this
matter, Rembrandt alleged that products and services sold by
Charter infringe certain patents related to cable modem,
voice-over internet, and video technology and applications. To
date, we have not been named as a party in the action, but
Charter has made a request for indemnity related to the products
that we and others have sold to them. We have not received an
indemnity request from Cox, CSC and Cablevision but we expect
that such request will be forthcoming shortly. To date, we and
others have not agreed to contribute to the payment of legal
costs and expenses related to this case. Trial date of this
matter is not known at this time. At this point, the outcome is
uncertain and we cannot assess damages. However, the case may be
expensive to defend and there may be substantial monetary
exposure if Rembrandt is successful in its claim against Charter
and then elects to pursue other cable operators that use the
allegedly infringing products.
On June 1, 2006, a case was filed by Rembrandt against TWC
in the United States District Court for the Eastern District of
Texas alleging patent infringement. In this matter, Rembrandt
alleged that products and services sold by TWC infringe certain
patents related to cable modem, voice-over internet, and video
technology and applications. To date, we have not been named as
a party in the action, but TWC has made a request for indemnity
related to the products that we and others have sold to them. We
and others have agreed to contribute to the payment of legal
costs and expenses related to this case. Trial date of this
matter is not known at this time. At this point, the outcome is
uncertain and we cannot assess damages. However, the case may be
expensive to defend and there may be substantial monetary
exposure if Rembrandt is successful in its claim against TWC and
then elects to pursue other cable operators that use the
allegedly infringing products.
On September 13, 2006, a second case was filed by Rembrandt
against TWC in the United States District Court for the Eastern
District of Texas alleging patent infringement. In this matter,
Rembrandt alleged that products and services sold by TWC
infringe certain patents related to the DOCSIS standard. To
date, we have not been named as a party in the action, but TWC
has made a request for indemnity related to the products that we
and others have sold to them. We and others have agreed to
contribute to the payment of legal costs and expenses related to
this case. Trial date of this matter is not known at this time.
At this point, the outcome is uncertain and we cannot assess
damages. However, the case may be expensive to defend and there
may be
substantial monetary exposure if Rembrandt is successful in its
claim against TWC and then elects to pursue other cable
operators that use the allegedly infringing products.
We have received letters claiming that our technology infringes
the intellectual property rights of others. We have consulted
with our patent counsel and reviewed the allegations made by
such third parties. If these allegations were submitted to a
court, the court could find that our products infringe third
party intellectual property rights. If we are found to have
infringed third party rights, we could be subject to substantial
damages
and/or
an
injunction preventing us from conducting our business. In
addition, other third parties may assert infringement claims
against us in the future. A claim of infringement, whether
meritorious or not, could be time-consuming, result in costly
litigation, divert our management’s resources, cause
product shipment delays or require us to enter into royalty or
licensing arrangements. These royalty or licensing arrangements
may not be available on terms acceptable to us, if at all.
Furthermore, we have in the past agreed to, and may from time to
time in the future agree to, indemnify a customer of our
technology or products for claims against the customer by a
third party based on claims that its technology or products
infringe intellectual property rights of that third party. These
types of claims, meritorious or not, can result in costly and
time-consuming litigation, divert management’s attention
and other resources, require us to enter into royalty
arrangements, subject us to damages or injunctions restricting
the sale of our products, require us to indemnify our customers
for the use of the allegedly infringing products, require us to
refund payment of allegedly infringing products to its customers
or to forgo future payments, require us to redesign certain of
our products, or damage our reputation, any one of which could
materially and adversely affect our business, results of
operations and financial condition.
We may, in the future, take legal action to enforce our patents
and other intellectual property rights, to protect our trade
secrets, to determine the validity and scope of the proprietary
rights of others, or to defend against claims of infringement or
invalidity. Such litigation could result in substantial costs
and diversion of resources and could negatively affect our
business, results of operations and financial condition.
In December 2005, the Commission issued a formal order of
investigation in connection with our accounting review of a
series of contractual arrangements with Thomson Broadcast. These
matters were previously the subject of an informal Commission
inquiry. We have been cooperating fully with the Commission and
will continue to do so in order to bring the investigation to a
conclusion as promptly as possible.
We are currently a party to various other legal proceedings, in
addition to those noted above, and may become involved from time
to time in other legal proceedings in the future. While we
currently believe that the ultimate outcome of these
proceedings, individually and in the aggregate, will not have a
material adverse effect on our financial position or overall
results of operations, litigation is subject to inherent
uncertainties. Were an unfavorable ruling to occur in any of our
legal proceedings, there exists the possibility of a material
adverse impact on our financial condition and results of
operations for the period in which the ruling occurs. The
estimate of the potential impact on our financial position and
overall results of operations for any of the above legal
proceedings could change in the future.
Item 1A.
Risk
Factors
The reader should carefully consider, in connection with the
other information in this report, the factors discussed in
Part I, Item 1A — Risk Factors on
pages 20 through 42 of our Annual Report on
Form 10-
K for the year ended December 31, 2005 (2005
Form 10-K).
These factors could cause our actual results to differ
materially from those stated in forward-looking statements
contained in this document and elsewhere. In addition to the
factors included in the 2005
Form 10-K,
the reader should also consider the following risk factor:
Our
quarterly results of operations are subject to significant
fluctuations and do not necessarily predict future operating
results.
Our results of operations have varied significantly from
quarter-to-quarter
in the past and are likely to vary significantly in future
periods, which makes it difficult to predict our future
operating results. Accordingly, we believe that
quarter-to-quarter
comparisons are not meaningful and should not be relied on as
an indicator of our future performance. Even if we record
positive net income in a given quarter, we may continue to
record losses from operations and not be profitable on a
consistent basis, and may remain unprofitable in future periods.
We continue to be unable to generate sufficient cash flow from
operations to fund our expenses and may remain unable to
generate sufficient cash flow from operations in future periods.
See Risk Factor entitled “We may continue to experience
fluctuation in our operating results and face unpredictability
in our future revenues” on pages 24 and 25 of our
2005
Form 10-K
for a description of factors that may cause our quarterly
revenue and operating results to fluctuate significantly from
quarter-to-quarter.
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