Moxi: Jazzy Product, Sizzling Start, Lots of Trouble

Out to start a home-entertainment revolution, Steve Perlman's startup is burning through cash. Abrupt change at the top

When Steve Perlman unveiled his new company, Moxi Digital Inc., on Jan. 7 at the Consumer Electronics Show (CES) in Las Vegas, he came close to matching Siegfried & Roy in the wow department. After two years in stealth mode, Perlman predicted that Moxi and its television set-top box would soon revolutionize home entertainment, combining TV, video, music, and the Internet in a single, powerful device. The press and analysts lapped it up, voting Moxi "Best of CES." Time magazine gushed over Moxi and its first customer, satellite-TV provider EchoStar Communications Corp. (DISH ), saying: "Can world domination be far behind?"

The gilded launch, however, masked a company that is struggling. Today, just seven weeks after its splashy debut, Perlman is no longer CEO. On Feb. 20, Moxi executives said that Perlman will step down to "have more time for creative projects." The CEO duties will immediately be handed to Rita Brogley, a Moxi vice-president who had headed sales, marketing, and business development.

The sudden change in command comes after BusinessWeek learned that Moxi is running low on cash. The startup could be out of money within a few months unless it raises more funds, is acquired, or cuts costs, say two Moxi insiders. Moxi has been in contact with early investors AOL Time Warner (AOL ), Vulcan Ventures, and EchoStar about their buying the startup, say the insiders. At one point, AOL made a tentative offer of around $100 million, according to an insider and someone close to the AOL negotiators. That's far below the $267 million valuation Moxi received when it got $67 million in funding 15 months ago--one of the 20 largest first-round financings in U.S. history. Talks between Moxi and AOL ended in mid-February, say the sources. Neither company would comment on them.

It's unclear what Brogley will do to improve Moxi's fortunes. She was unavailable for comment on Feb. 20, but in a written statement she said she will pursue a "variety of financing opportunities, including strategic relationships." Perlman will stay on as vice-chairman and will continue as the company's visionary. He could not be reached for comment on Feb. 20 but spoke to BusinessWeek over the past two weeks as issues were raised about the company's cash, its spending, and its prospects.

Moxi's woes are a sign of the times for T-shirt entrepreneurs. It has always been difficult for an inventor such as Perlman to turn a grand idea into a going business. Entrepreneurs need scads of money. Rocket-science technology must work as promised--and come at an affordable price. And all the while, a fledgling company risks being crushed in its infancy by large, well-heeled competitors. Turning dreams into dollars is even more challenging nowadays because funding is scarce. Venture capitalists invested $32.1 billion in startups last year, down 65% from a year ago, according to researcher VentureOne Corp.

To make matters worse for Moxi, it's trying to drum up customers during tough economic times, when the digital entertainment industry is loath to bet on unproven technologies. While Moxi's machine is praised by analysts, only EchoStar has publicly committed to testing the system. Even Time Warner Cable, a subsidiary of lead investor AOL, has not announced any arrangement with the startup. One cable-industry executive says his company won't make a deal because the hardware is too expensive and demand is uncertain. "It's a company with very talented people. In many ways, it's moving in the right direction, but it's ahead of its time," says the cable executive. "Someone will either pick it up for cheap, or it will go out of business." In the days before the management change, Perlman denied the company is in danger of going out of business.

Adding to the company's headaches are problems with expenses. Moxi pays rent at more than twice the market rate on an office building in downtown Palo Alto, Calif., that Moxi vacated in mid-2001 and that is partly owned by Perlman. The cash crunch also has sparked management turmoil, including the December departure of Chief Operating Officer Bill Keating, who pressed Perlman to cut expenses and lower the rent, say two company insiders. Meanwhile, Perlman acknowledges the company is still at least a year away from a broad rollout of its product and from generating significant revenues. "Moxi has a tremendous product with incredible value, but it's going to be all for nothing," laments a Moxi executive.

Perlman insists Moxi is nowhere near a cash crisis. He told BusinessWeek on Feb. 11 that he could fund the company himself for a year--though it is now unclear whether he's still willing to do so after the management change. Perlman has plenty of money: In 1997, he sold his previous company, WebTV Networks Inc., which provides Net access from TVs, to Microsoft Corp. for $425 million. As for the lease, Perlman says he hasn't benefited unfairly at Moxi's expense. And while the empty building's lease was signed just three months ago, the terms were set two years ago at the market rate then, says Perlman. Moxi is renegotiating the lease. Perlman says spending is under control. "We're consistently operating under budget," he says. "The burn rate came down nine months ago."

Moxi's struggle carries ramifications for the budding digital home-entertainment market. Sony Corp. (SNE ) and Microsoft (MSFT )are developing their own versions of a digital home-entertainment hub. The Moxi Media Center, designed to replace TV set-top boxes, is slightly larger than a VCR. The unit receives satellite or cable-TV signals and contains a personal video recorder to pause or store live television, a DVD and music CD player, an Internet connection, and a hard drive that can store thousands of songs. It can be attached to a computer network so entertainment and data can be received on any TV or PC in the house. If Moxi succeeds, it will push the market rapidly towards its vision of a one-stop entertainment hub in the home. "We think they could be the leading home-entertainment platform" in two years, says Richard F. Doherty, director at tech researcher Envisioneering Group.

Transforming the home entertainment experience has long been Perlman's dream. A native of West Hartford, Conn., he gained renown as one of Silicon Valley's innovators thanks to his work at Apple Computer Inc. (AAPL ), where he was one of the architects of the Macintosh Quicktime technology for handling audio and video. He also carved out new ground at WebTV, the first successful effort to wed TV and the Internet. "Steve has always had a passion for consumer electronics," says former Apple CEO John Sculley.

At the same time, Perlman gets frustrated when his ideas aren't lauded by others. As an engineer for Apple in the late 1980s, he often would blow up at product managers more concerned about incremental upgrades than his innovations. When Perlman left Apple, he penned an essay for Sculley and other executives on the reasons he was leaving, describing a "Salieri Syndrome"--referring to Mozart's jealous rival. He argued that less skilled people were undermining the company's true innovators. Later, as the chief technologist at upstart online-video game outfit Catapult Entertainment Inc., he was forced out by the top executives after he clashed with them over the company's direction. Perlman says he has butted heads with people he believes are stifling his creativity. "To me, the future is crystal-clear," he says. "I've been given a gift and a curse."

At Moxi, Perlman faced the inventor's dilemma. Like others passionate about their technology, he wanted to run his own show. But colleagues gave him mixed marks as a manager. Although he could spin a terrific vision, Perlman didn't readily accept advice from executives around him, say colleagues from WebTV and Moxi. And those who didn't agree with his way of doing things could provoke Perlman. "Steve was right about 80% of the time and wrong about 20%," says a former WebTV exec. "But if you harped on the 20%, he would shut you out."

When Perlman launched Moxi in January, 2000, he gave himself control over the startup. He funded it with about $10 million through most of its first year and was the majority owner. He controlled the board, with Moxi execs outnumbering outside directors 3 to 2. Despite the personality conflicts in Perlman's past, his reputation as an innovator attracted a lineup of all-star investors, including AOL Time Warner, Cisco (CSCO ), EchoStar, and Paul Allen's Vulcan Ventures. "We were less looking at Perlman as a CEO and more as a proven innovator," says board member Paul Bosco, an executive at Cisco Systems Inc. Bosco wouldn't comment on the problems at Moxi. Board member Kevin Fong, a venture capitalist at Mayfield, and other investors also declined to comment for this story.

Founded during the tail end of the dot-com boom, Moxi spared no expense in its early days. Some of this can be attributed to the high cost of competing for talent in Silicon Valley: large salaries, expensive flat-screen monitors for engineers, free dinner for staffers working late. But the company continued to burn through cash in 2001--when money was running tight, say two insiders and an investor. Early last year, the company spent nearly $2 million on the intellectual property of Geocast Network Systems Inc., a data-distribution company. Then, in the fall, it spent hundreds of thousands of dollars acquiring semiconductor assets from BroadLogic Network Technologies Inc. Both moves troubled some insiders, who say the added expertise and technology weren't critical to Moxi's product. In a written response to questions, Perlman says: "The acquisitions Moxi has made were, and continue to be, strategic to the company and have accrued to the company's valuation more than their cost."

Equally troubling to some employees have been the company's real estate expenses. In the summer of 2000, Moxi moved into a four-story, downtown Palo Alto building that Perlman had just co-purchased for nearly $21.5 million, according to a local real estate database. No written lease had been signed, but Moxi paid the owners rent. When Moxi began to outgrow the University Avenue building in early 2001, it signed a lease for another building several blocks away on Bryant Street. By the middle of 2001, Moxi had moved almost entirely to Bryant Street but continued to pay rent on the vacant building partly owned by Perlman. When Moxi signed a lease for Perlman's building in November, 2001, it was for $11.50 per square foot--the going rate when the company moved in, according to a Moxi insider. That was far above the market rate for Palo Alto in late 2001, which was $4.39 a square foot, according to a study by real estate agent BT Commercial. "That doesn't sit well with investors--who thought we were in this as partners, not a situation where he benefits personally while the company suffers," says one Moxi investor.

Perlman insists the deal is ethical. The terms for the University Avenue building are tied to those of the Bryant Street building, says Perlman. That was set up so he would not have a conflict of interest between his role as a landlord and his responsibilities to Moxi.

Even if Moxi can make it through its cash crunch, it will have to stretch to live up to its promises. For starters, Perlman told the press in January that the entertainment hub would cost $450 to produce. Analysts and Moxi insiders now say it will probably cost between $575 and $700, not including Moxi's undisclosed software license fee. So it's a less appealing prospect for the cable and satellite companies that would foot the bill. Says Mike Paxton, an analyst at Cahners In-Stat Group: "That's a very expensive set-top box." Perlman is sticking to his cost estimate, but he acknowledges that his price doesn't include the optical drive for the DVD player or the Moxi software license.

Perlman may have overstated the company's ties to EchoStar, too. In January, Perlman told BusinessWeek that EchoStar had made "a huge commitment" as its first customer and, after trials, would be releasing the product "later in the year." EchoStar, however, says that while it agreed to lend its support, it has not signed any contract as a customer. The satellite provider also has no deployment plans beyond some limited customer trials. Perlman defends the portrayal of the relationship. The fact that the companies participated in each other's press conferences at last month's show and that Moxi showed its machine in the EchoStar booth, demonstrates "the strength of [their] relationship and the level of commitment," says Perlman. EchoStar spokesman Marc Lumpkin does say the Moxi machine is impressive: "It has a lot of dynamic features we think our customers want."

That thought counts for something. But will Moxi be around long enough to deliver on its promise?

By Ben Elgin in Palo Alto, Calif., with Linda Himelstein and Cliff Edwards in San Mateo, Calif.

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