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SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
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FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 1998
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission file number 0-27886
WORLDTALK COMMUNICATIONS CORPORATION
(Exact name of Registrant as specified in its charter)
Delaware 77-0303581
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification Number)
5155 Old Ironsides Drive
Santa Clara, California 95054
(Address of principal executive offices)
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(408) 567-1500
(Registrant's telephone number, including area code)
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Securities registered pursuant to Section 12(b) of the Act:
None
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Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.01 Par Value
(Title of Class)
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Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Sections 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the Registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
The number of outstanding shares of the Registrant's Common Stock, par value
$0.01 per share, on August 10, 1998 was 10,593,055 shares.
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<TABLE>
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FORM 10-Q
WORLDTALK COMMUNICATIONS CORPORATION
INDEX
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Page
PART I FINANCIAL INFORMATION Number
<S> <C> <C>
ITEM 1: Financial Statements
Condensed Consolidated Balance Sheets as of June 30, 1998 and December 31, 1997.................. 3
Condensed Consolidated Statements of Operations for the three and six month periods
ended June 30, 1998 and 1997.................................................................. 4
Consolidated Statements of Cash Flows for the six month periods ended
June 30, 1998 and 1997........................................................................ 5
Notes to Condensed Consolidated Financial Statements............................................. 6
ITEM 2: Management's Discussion and Analysis of Financial Condition and Results of Operations............ 7
PART II OTHER INFORMATION
ITEM 1: Legal Proceedings................................................................................ 15
ITEM 4: Submission of Matters to a Vote of Security Holders.............................................. 15
ITEM 5. Change in Management............................................................................. 15
ITEM 6: Exhibits and Reports on Form 8-K................................................................. 15
Signature........................................................................................ 16
Exhibits......................................................................................... 17
</TABLE>
2
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PART I: FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
WORLDTALK CORPORATION AND SUBSIDIARY
<TABLE>
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except per share data)
(Unaudited)
<CAPTION>
ASSETS
June 30, December 31,
1998 1997
-------- --------
<S> <C> <C>
Current assets:
Cash and cash equivalents ............................................................ $ 8,038 $ 4,662
Short-term investments ............................................................... 996 6,415
Accounts receivable, net of allowance for doubtful
accounts of $121 and $121, respectively ............................................ 3,638 3,039
Prepaid expenses ..................................................................... 706 935
-------- --------
Total current assets ......................................................... 13,378 15,051
Property and equipment, net ............................................................ 1,383 1,658
Other assets ........................................................................... 494 556
-------- --------
$ 15,255 $ 17,265
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable ..................................................................... $ 800 $ 760
Short-term debt ...................................................................... 243 243
Capital lease obligations ............................................................ 296 471
Accrued expenses ..................................................................... 3,195 3,041
Deferred revenue ..................................................................... 2,792 4,094
-------- --------
Total liabilities ............................................................ 7,326 8,609
======== ========
Commitments and contingencies
Stockholders' equity:
Common stock, $.01 par value; 25,000 shares authorized,
10,582 and 10,487 shares issued and outstanding in 1998
and 1997, respectively .............................................................. 106 105
Additional paid-in capital ........................................................... 32,572 32,301
Deferred compensation ................................................................ (68) (89)
Accumulated deficit .................................................................. (24,681) (23,661)
-------- --------
Total stockholders' equity ................................................... 7,929 8,656
-------- --------
$ 15,255 $ 17,265
======== ========
<FN>
See accompanying notes to condensed consolidated financial statements.
</FN>
</TABLE>
3
<PAGE>
<TABLE>
WORLDTALK CORPORATION AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
(Unaudited)
<CAPTION>
Three Months ended June 30, Six Months ended June 30,
--------------------------- -------------------------
1998 1997 1998 1997
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Revenues:
Software licenses ................................................ $ 3,018 $ 1,056 $ 5,617 $ 2,420
Maintenance, installation and training ........................... 1,093 1,204 2,101 2,501
-------- -------- -------- --------
Total revenues ........................................... 4,111 2,260 7,718 4,921
-------- -------- -------- --------
Cost of revenues:
Software licenses ................................................ 198 217 392 499
Maintenance, installation and training ........................... 660 800 1,308 1,651
-------- -------- -------- --------
Total cost of revenues ................................... 858 1,017 1,700 2,150
-------- -------- -------- --------
Gross profit .................................................. 3,253 1,243 6,018 2,771
-------- -------- -------- --------
Operating expenses:
Product development .............................................. 1,023 1,167 2,072 2,254
Sales and marketing .............................................. 1,892 2,190 3,652 3,986
General and administrative ....................................... 697 657 1,367 1,256
-------- -------- -------- --------
Total operating expenses ................................. 3,612 4,014 7,091 7,496
-------- -------- -------- --------
Operating loss ..................................................... (359) (2,771) (1,073) (4,725)
Interest income, net ............................................... 102 135 223 255
-------- -------- -------- --------
Loss before income taxes ................................. (257) (2,636) (850) (4,470)
Income taxes ....................................................... 85 -- 170 64
-------- -------- -------- --------
Net loss ................................................. $ (342) $ (2,636) $ (1,020) $ (4,534)
======== ======== ======== ========
Basic and diluted net loss per share ............................... $ (0.03) $ (0.25) $ (0.10) $ (0.44)
======== ======== ======== ========
Shares used in computing basic and diluted net loss
per share .......................................................... 10,570 10,375 10,541 10,359
======== ======== ======== ========
<FN>
See accompanying notes to condensed consolidated financial statements.
</FN>
</TABLE>
4
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<TABLE>
WORLDTALK CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
<CAPTION>
Period ended June 30,
-------------------------------
1998 1997
------- -------
<S> <C> <C>
Cash flows from operating activities:
Net loss ........................................................................... $(1,020) $(4,534)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization .................................................... 391 421
Amortization of deferred compensation ............................................ 21 21
Changes in operating assets and liabilities:
Accounts receivable ............................................................ (599) 2,213
Prepaid expenses ............................................................... 229 (186)
Accounts payable ............................................................... 40 (424)
Accrued expenses ............................................................... 154 (489)
Deferred revenue ............................................................... (1,302) 100
Other liabilities .............................................................. -- (100)
------- -------
Net cash used in operating activities ....................................... (2,086) (2,978)
------- -------
Cash flows from investing activities:
Purchase of property and equipment ................................................. (116) (464)
Purchase of short-term investments ................................................. -- (1,495)
Sales and maturities of short-term investments ..................................... 5,419 2,518
Other assets ....................................................................... 62 101
------- -------
Net cash provided by investing activities ................................... 5,365 660
------- -------
Cash flows from financing activities:
Net proceeds from issuance of common stock ......................................... 272 308
Repayment of shareholder receivable ................................................ -- 233
Principal payments under capital lease obligations ................................. (175) (177)
------- -------
Net cash provided by financing activities ................................... 97 364
------- -------
Change in cash and cash equivalents .................................................. 3,376 (1,954)
Cash and cash equivalents at beginning of period ..................................... 4,662 7,012
------- -------
Cash and cash equivalents at end of period ........................................... $ 8,038 $ 5,058
======= =======
Supplemental disclosures:
Cash paid for interest: ............................................................ $ 27 $ 59
======= =======
<FN>
See accompanying notes to condensed consolidated financial statements.
</FN>
</TABLE>
5
<PAGE>
WORLDTALK CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Period ended June 30, 1998 and 1997
(In thousands, except per share data)
(Unaudited)
Basis of Presentation
The accompanying unaudited condensed consolidated balance sheets of
Worldtalk Corporation and its subsidiary ("Worldtalk" or the "Company") as of
June 30, 1998 and December 31, 1997 and the related unaudited condensed
consolidated statements of operations and cash flow for the three and six month
periods ended June 30, 1998 and 1997 have been prepared on substantially the
same basis as are the annual consolidated financial statements. The December
1997 balance sheet was derived from audited financial statements, but does not
include all disclosures required by generally accepted accounting principles.
The results of operation for the three and six month periods ended June 30, 1998
are not necessarily indicative of results to be expected for the entire year.
For software arrangements entered into after December 31, 1997, the Company
recognizes revenue in accordance with Statement of Position (SOP) 97-2, Software
Revenue Recognition, which supersedes SOP 91-1. SOP 97-2 requires the Company to
recognize revenue earned on software arrangements involving multiple elements to
be allocated to each element based on the relative fair values of the elements.
The fair value of an element must be based on evidence that is specific to the
vendor. If a vendor does not have evidence of the fair value for all elements in
a multiple-element, all revenue from the arrangement is deferred until such
evidence exists or until all elements are delivered. Accordingly, revenues from
software licenses are generally recognized upon shipment of software and
delivery of a permanent key, and that the revenue is collectible and the Company
is not obligated to provide significant customization for the software.
Earnings per Share
Basic EPS is computed using the weighted average number of common shares
outstanding during the period. Diluted earnings per share is computed using the
weighted average number of potentially dilutive common equivalent shares
outstanding for the period, if any. For the periods ending June 30, 1998 and
1997, common stock options approximately totaling 1,933,000 and 1,613,000
respectively, were omitted from the computation, as their impact would be
antidilutive.
Comprehensive Income
Comprehensive income as defined by Statement of Financial Accounting
Standards No. 130, "Reporting Comprehensive Income," is net income plus direct
adjustment to stockholders' equity. There are no material differences between
the net loss and the total comprehensive loss.
Legal Proceedings
The Company is engaged in certain legal actions arising in the ordinary
course of business. The Company believes that it has adequate legal defenses and
that the ultimate outcome of these actions will not have a material effect on
the Company's financial position and results of operation.
New Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board issued SFAS No 133
"Accounting for Derivative Instruments and Hedging Activities". SFAS No 133
establishes accounting and reporting standards for derivative instruments,
including certain derivative instruments embedded in other contracts,
(collectively referred to as derivatives) and for hedging activities. It
requires that an entity recognize all derivatives as either assets or
liabilities in the statement of financial position and measure those instruments
at fair value. If certain conditions are met, a derivative may be specifically
designated and accounted for as (a) a hedge of the exposure to changes in the
fair value of a recognized asset or liability or an unrecognized firm
commitment, (b) a hedge of the exposure to variable cash flows of a forecasted
transaction, or (c) a hedge of the foreign currency exposure of a net investment
in a foreign operation, an unrecognized firm commitment, an available-for-sale
security, or a foreign-currency-denominated forecasted transaction. For a
derivative not designated as a hedging instrument, changes in the fair value of
the derivative are recognized in earnings in the period of change. This
statement will be effective for all annual and interim periods beginning after
June 15, 1999 and management does not believe the adoption of SFAS No. 133 will
have a material effect on the financial position of the Company.
In March 1998, the American Institute of Certified Public Accountants issued
SOP No. 98-1, Accounting for the Costs of Computer Software Developed or
Obtained for Internal Use. SOP No. 98-1 requires that certain costs related to
the development or purchase of internal-use software be capitalized and
amortized over the estimated useful life of the software. SOP 98-1 is effective
for financial statements issued for fiscal years beginning after December 15,
1998. The Company does not expect the adoption of SOP No. 98-1 to have a
material impact on its results of operations.
6
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PART I: FINANCIAL INFORMATION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
- --------------------------------------------------------------------------------
Overview
This discussion and analysis of financial condition and results of
operations contains descriptions of the Company's expectations regarding future
trends affecting its business. These forward-looking statements and other
forward-looking statements made elsewhere in this document are made in reliance
upon the safe harbor provisions of the Securities Litigation Reform Act of 1995.
The discussion in this report contains forward-looking statements that involve
risks and uncertainties. The Company's actual results may differ materially from
the results discussed in the forward-looking statements. Factors that could
cause or contribute to such differences include, but are not limited to, those
discussed below and in "Additional Factors That May Affect Future Results".
The Company is an Internet security company focused on providing e-mail
security and policy management solutions that enable organizations to safely and
efficiently use the Internet for global business communication. The Company's
products include WorldSecure Server, an e-mail firewall and security policy
manager, WorldSecure Client, a desktop e-mail encryption product, NetTalk, a
Windows NT-based e-mail and directory server, and NetJunction, a UNIX-based
directory and messaging switch. During 1996, Worldtalk initiated a major product
development program to leverage the Company's technology base and expertise in
UNIX-based e-mail connectivity backbones and directory services to develop new
Windows NT-based Internet e-mail security and connectivity products. These
products, WorldSecure Server and NetTalk, were released in 1997. During 1997,
the Company experienced a more rapid decline in its UNIX-based NetJunction
product than had been anticipated at the end of 1996. The Company believes that
this was caused by a combination of factors. These included a more rapid market
shift from UNIX-based systems to Windows NT-based systems and the desire of
organizations to utilize Internet standards-based technology to build corporate
intranets in place of private, proprietary network backbones. The Company's
results started improving in the fourth quarter of 1997 and have continued to
improve in the first and second quarters of 1998 as a result of increased
revenue from the new Windows NT-based products and the implementation of
effective cost control measures.
The Company has experienced a significant shift in product mix from almost
100% of software license revenue coming from UNIX-based NetJunction products in
1996 to 81% of software license revenue coming from Windows NT-based e-mail
security and connectivity products in second quarter of 1998. A significant
portion of the revenue reported from these products during the first and second
quarters of 1998 came from shipments of products pursuant to minimum
non-refundable commitment terms with two large resellers, which do not directly
reflect sales to end-users. The realization of revenue in excess of the
non-refundable prepaid amount noted above will depend on the success of these
resellers in the marketplace, one of which is the Company's Japanese
distributor. The Company believes that achievement of profitability will depend
on increased market acceptance of its new Windows NT-based e-mail security and
policy management products. Further revenue from these new Windows NT-based
products will depend increasingly on the success of third-party reseller
channels. In this regard, the Company entered into product distribution
relationships in 1997 with The Peapod Group (Peapod) based in the United
Kingdom, ASCII Something Good Corporation (ASCII) based in Japan, Security
Dynamics Technologies (SDTI) worldwide, and various other resellers in the
United States and in foreign markets. A key element of the Company's future
revenue growth will be the ability of the Company's resellers to sell the
Company's products in volume. There can be no assurance that the Company's
resellers will be successful in marketing these products or that the Company's
new windows NT-based products will achieve broad market acceptance.
7
<PAGE>
The financial results for the first and second quarters of 1998 include
software license revenue from the Company's Japanese distributor. As of August
12, 1998, the Japanese distributor is in arrears for the payment associated with
the first quarter license revenue which was payable during the second quarter of
1998. In addition, as of August 12, 1998, the Japanese distributor is also in
arrears for the payment associated with the second quarter license revenue which
was payable during the early part of the third quarter of 1998. The Company
believes that collection is probable as the Company has received continued
assurances of payment for the overdue amount from the Japanese distributor and
its partners. However, the Company has not yet received payment. If the Company
is unable to collect the amounts due for the first and second quarters software
license revenue or minimum payments for future quarters, the financial results
would be materially impacted.
The Company is currently concentrating its development, sales and marketing
efforts on the Windows NT-based security products. The Company also plans to
continue maintaining and supporting its NetJunction product line and believes
that there may be a continuing revenue stream from this activity for a limited
time in the future. Although the Company believes that these products may
continue to be viable in the marketplace, the Company plans to utilize its
resources to exploit the Internet security market. There can be no assurance
that the Company will continue to recognize revenue from NetJunction or that the
Company's Internet Security products will achieve broad market acceptance.
The Company's Windows NT-based Internet security and policy management
products will also place the Company into competition with a new set of vendors,
many of whom have significantly greater resources than the Company. Accordingly,
the Company intends to invest significantly in its business. As a result, there
can be no assurance that the Company will be profitable on a quarterly or annual
basis or that the Company will be able to successfully compete with vendors that
have greater resources than the Company. The Company's future operating results
may fluctuate due to factors such as the demand for the Company's products; size
and timing of customer orders; success of the Company's resellers; the
introduction of new products and product enhancements by the Company or its
competitors; the budgeting cycles of customers; acceptance by the market of the
Company's products; changes in United States government policy on encryption
software; changes in the proportion of revenue attributable to license and
service fees; changes in the level of operating expenses; the ability of the
Company to develop new distribution channels; and competitive conditions in the
industry.
The Company believes that its products are or will be compliant with
customer requirements for operations through the year 2000 and beyond. Many
customers require such certification and warranties before purchasing products.
Failure of the Company's products to function through the year 2000 could cause
material liabilities to the Company to correct such defects.
The Company has an active program to make all of its computer facilities
year 2000 compliant by the middle of 1999. The Company's product development
computer environment is currently year 2000 compliant to the best of the
Company's knowledge. The Company's desktop productivity (word processing,
spreadsheets...) computer environment is anticipated to become year 2000
compliant with an upgrade to the Windows 98 operating system and associated
announced Office 2000 suite of products. The Company's financial systems
currently store data in a four-digit format while the application itself is not
year 2000 compliant. The Company's telecommunications systems will become year
2000 compliant with existing upgrades from the Company's current vendor. The
risks to the Company associated with the year 2000 compliant software include
the potential partial loss of customer information and voicemail functionality.
The company's contingency plan to address the above would primarily consist of
switching to alternative vendors for standard office productivity and
telecommunications software. The anticipated cost to become year 2000 compliant
is under $100,000.
8
<PAGE>
Results of Operations
The following table sets forth certain consolidated statements of operations
data for the periods indicated as a percentage of total revenues:
Three Months Six Months Ended
Ended June 30, June 30,
--------------- ----------------
1998 1997 1998 1997
----- ----- ----- -----
Revenue:
Software licenses .................... 73.4% 46.7% 72.8% 49.2%
Maintenance, installation
and training ........................ 26.6 53.3 27.2 50.8
----- ----- ----- -----
Total revenue ................ 100.0 100.0 100.0 100.0
----- ----- ----- -----
Cost of revenue:
Software licenses .................... 4.8 9.6 5.1 10.1
Maintenance, installation and
training ............................ 16.1 35.4 16.9 33.6
----- ----- ----- -----
Total cost of revenue ........ 20.9 45.0 22.0 43.7
----- ----- ----- -----
Gross margin ........................... 79.1 55.0 78.0 56.3
----- ----- ----- -----
Operating expenses:
Product development .................. 24.9 51.6 26.8 45.8
Sales and marketing .................. 46.0 96.9 47.3 81.0
General and administrative ........... 17.0 29.1 17.8 25.5
----- ----- ----- -----
Total operating expense ...... 87.9 177.6 91.9 152.3
----- ----- ----- -----
Operating loss ............... (8.8) (122.6) (13.9) (96.0)
Other income (expense), net ............ 2.5 6.0 2.9 5.2
----- ----- ----- -----
Loss before income taxes ............... (6.3) (116.6) (11.0) (90.8)
Income taxes ........................... 2.0 -- 2.2 1.3
----- ----- ----- -----
Net loss ..................... (8.3)% (116.6)% (13.2)% (92.1)%
===== ===== ===== =====
9
<PAGE>
Revenues
The Company's total revenues are derived primarily from license fees for its
software and charges for services, including maintenance, customization
consulting, installation and training. License fees relate to both the initial
licenses of its software products, as well as subsequent purchases to expand
capacity or add functionality. Maintenance, installation and training revenues
relate to support contracts, installation and training services. Revenues from
software licenses are generally recognized upon shipment of software and
delivery of a permanent key, and that the revenue is collectible and the Company
is not obligated to provide significant customization for the software. Revenues
from maintenance contracts are recognized over the contract term, which
generally is one year, while installation and training revenues are recognized
when the services are performed. The Company also reported revenue from
shipments pursuant to minimum non-refundable commitment terms with two large
resellers, which do not directly reflect sales to end-users. During the
remaining quarters of 1998, the Company expects to report additional revenue
from the recognition of the balance of a non-refundable prepaid purchase
commitment from one reseller based on product sell-through and guaranteed
quarterly minimum commitments from the Japanese distributor.
The Company's total revenues for the three and six months ended June
30, 1998 were $4.1 million and $7.7 million, respectively, an increase of $1.9
million or 82% and $2.8 million or 57% when compared to the same periods last
year and a increase of $504,000 or 14% when compared with the immediately
preceding quarter ended March 31, 1998.
Software license revenues for the three and six months ended June 30,
1998 were $3.0 million and $5.6 million, respectively, an increase of $2.0
million or 186% and $3.2 million or 132% when compared to the same periods last
year and an increase of $419,000 or 16% when compared to the immediately
preceding quarter. The increase in software license revenue for the first three
and six months of 1998, when compared to the same period last year, was
primarily attributable to increased sales of the Windows NT-based e-mail
security products, WorldSecure and NetTalk.
Maintenance, installation and training revenues for the three and six
months ended June 30, 1998 were $1.1 million and $2.1 million, respectively, a
decrease of $111,000 or 9% and $400,000 or 16% when compared to the same periods
last year and an increase of $85,000 or 8% when compared to the immediately
preceding quarter. The decreases in maintenance, installation and training
revenues from the comparable periods last year were attributable to the shift in
product sales. The increase in maintenance, installation and training revenues
from the immediately preceding quarter was attributable to the increased
WorldSecure and NetTalk software license revenue, since maintenance and
installation revenues are derived primarily from the Company's software license
installations.
Cost of Revenues
The Company's total costs of revenues for the three and six months ended
June 30, 1998 were $858,000 and $1.7 million, respectively, as compared to $1.0
million and $2.2 million for the same periods in 1997 and $842,000 for the
immediately preceding quarter ended March 31, 1998, representing decreases of
16% and 21% from the same periods last year and an increase of 2% from the
quarter ended March 31, 1998.
Cost of product revenues, consisting of the costs of royalties paid to
third-party vendors, product media and duplication, packaging materials, and
shipping expenses, were $198,000 and $392,000 for the three and six months ended
June 30, 1998, as compared to $217,000 and $499,000 for the same periods last
year and $194,000 for the quarter ended March 31, 1998, representing a decrease
of 9%, a decrease of 21% and an increase of 2%, respectively. The decrease in
cost of product revenues, when compared to the same period last year, was
primarily due to reductions in the cost of certain fixed price royalty
arrangements with third-party vendors and other amortized costs. Amortized costs
include manuals, disk duplications and packaging materials, which do not
fluctuate in direct proportion to license revenues.
10
<PAGE>
Maintenance, installation and training costs, consisting principally of
personnel-related costs for consulting, training and technical support, were
$660,000 and $1.3 million for the three and six months ended June 30, 1998, as
compared to $800,000 and $1.7 million for the same periods last year and
$648,000 for the immediately preceding quarter ended March 31, 1998,
representing decreases of 18% and 21%, and an increase of 2%, respectively. The
decreases from the same periods last year were due to the Company's reduction of
headcount early in the second half of 1997, and the Company's continued efforts
to control costs in the first half of 1998. The Company expects that
maintenance, installation and training costs will decline as a percentage of
revenue in the future, as the Company increases sales of Windows NT-based e-mail
security and policy management products that require less maintenance,
installation and training.
Product Development
Product development expenses consisting primarily of personnel-related
costs, including salaries and benefits of personnel, as well as equipment and
facility costs. Product development expenses were incurred for the research,
design and development of new products, enhancements of existing products, and
quality assurance activities. Costs related to research, design and development
of products are charged to product development expenses as incurred. Product
development expenses for the three and six months ended June 30, 1998 were $1.0
million and $2.1 million as compared to $1.2 million and $2.3 million for the
same periods last year and $1.0 million for the immediately preceding quarter,
representing decreases of 12%, 8% and 2%, respectively. Product development
expenses represented 25% and 52% of total revenues for the second quarter of
1998 and the second quarter of 1997, respectively. The decrease in absolute
dollars in product development for the first three and six months of 1998, when
compared to the same periods in 1997, was due to decreased staffing and
associated support costs of software engineers and consultants during the second
half of 1997. The decreases in product development expenses as a percentage of
total revenues were attributable to increasing revenues for the respective
periods and the fact that product development expenses do not fluctuate in
direct proportion to total revenues. The Company believes that continued
commitment to product development is required for the Company's products to
obtain a competitive advantage. The Company intends to continue to allocate
resources to product research and development. Consequently, such expenses may
increase in absolute dollar amounts in the future.
Sales and Marketing
Sales and marketing expenses consist primarily of salaries, benefits,
and commissions of sales and marketing personnel, trade show expenses, and
promotional expenses. Sales and marketing expenses for the three and six months
ended June 30, 1998 were $1.9 million and $3.7 million, as compared to $2.2
million and $4.0 million for the same periods in 1997 and $1.8 million for the
quarter ended March 31, 1998, representing decreases of 14% and 8% and an
increase of 8%, respectively. Sales and marketing expenses represented 46% and
97% of total revenues for the second quarters of 1998 and 1997, respectively.
The decrease in sales and marketing expenses as a percentage of total revenues
was attributable to increasing revenues for the respective periods and the fact
that certain sales and marketing expenses do not fluctuate in direct proportion
to total revenues. In the future, the Company expects to continue hiring
additional sales and marketing personnel, increase promotion and advertising
efforts and expand internationally through a combination of distributors, VARs
and direct sales personnel. Consequently, such expenses may increase in both
dollar amounts and as a percentage of total revenues in the future.
General and Administrative
General and administrative expenses primarily consist of personnel costs for
finance and accounting, human resources and executive management of the Company.
General and administrative expenses for the three and six months ended June 30,
1998 were $697,000 and $1.4 million as compared to $657,000 and $1.3 million for
the same periods in 1997 and $670,000 for the immediately preceding quarter
ended March 31, 1998, representing increases of 6%, 9% and 4%, respectively.
General and administrative
11
<PAGE>
expenses represented 17% and 29% of total revenues for the second quarters of
1998 and 1997, respectively. The increase in absolute dollars for the first
quarter and first half of 1998, when compared to the same periods in 1997, were
attributable primarily to increased staffing and associated expenses necessary
to manage and support the Company's business. The decrease in general and
administrative expenses as a percentage of total revenues was attributable to
increasing revenue for the respective periods and the fact that general and
administrative expenses do not fluctuate in direct proportion to total revenues.
The Company believes that general and administrative expenses will continue to
increase in absolute dollar amounts in the future, as the Company expands its
staffing to handle increased infrastructure requirements.
Net Interest Income
Net interest income consists of interest income and expense and other
miscellaneous income and expense items. Net interest income for the three and
six months ended June 30, 1998 was $102,000 and $223,000, as compared to
$135,000 and $255,000 for the same periods last year and $121,000 for the
immediately preceding quarter, respectively. The fluctuations in net interest
were primarily attributable to fluctuations in the Company's cash and cash
equivalent and short-term investments balances, coupled with interest rate
fluctuations during the comparable periods.
Liquidity and Capital Resources
At June 30, 1998, the Company had cash, cash equivalents and short term
investments of $9.0 million and working capital of $6.1 million. The Company had
a $2.0 million bank line of credit, which expired on January 9, 1998. As of
August 10, 1998 the Company had not yet renewed this line of credit agreement.
As of June 30, 1998, the Company had an outstanding loan agreement in the amount
of $243,000 with the bank.
Net cash used in operating activities amounted to $2.1 million for the six
months ended June 30, 1998, which was comprised principally of the Company's net
loss of $1.0 million, a decrease in deferred revenue of $1.3 million and an
increase in accounts receivable of $599,000, offset by an increase in accounts
payable, accrued expenses, and other liabilities of $194,000, a decrease in
prepaid expenses of $229,000 and depreciation and amortization of $412,000.
Net cash provided from investing activities amounted to $5.4 million for the
six months ended June 30, 1998, which included maturities of short-term
investments of $5.4 million and a decrease in other assets of $62,000, offset by
$116,000 for purchases of property and equipment. The Company currently has no
significant capital commitments for the remainder of fiscal 1998.
Net cash provided by financing activities amounted to $97,000 for the six
months ended June 30, 1998 which included net proceeds from the issuance of
common stock of $272,000, offset by principal payments under capital lease
obligations of $175,000.
The Company may, in the future, pursue acquisitions of complementary
companies or technologies, or divest certain products and related services, to
further strategic corporate objectives. Such transactions could result in a
significant use of or an increase in cash and earnings per share dilution or
increase caused by reduced or increased interest income and/or the issuance of
additional stock. Additionally, costs associated with the acquisition or
divestiture of companies, products and related services or technologies could
materially impact future operating results. Further, such acquisitions could
result in the immediate write-off of research and development in process and
expenses relating to integration costs. Such costs could result in significant
losses or gains in one or more fiscal quarters.
The Company believes that its cash balances and credit facilities will be
sufficient to meet its anticipated cash needs to fund operating losses, working
capital requirements, capital expenditures and business expansion for at least
the next twelve months. Thereafter, if cash generated from operations is
insufficient to satisfy the Company's liquidity requirements, the Company may
seek to sell additional
12
<PAGE>
equity or convertible debt securities or obtain additional credit facilities.
The sale of additional equity or convertible debt securities could result in
additional dilution to the Company's stockholders and may not be available on
terms favorable to the Company if at all.
Additional Factors That May Affect Future Results
The Company was founded in February 1992 and has incurred operating losses
in each of its fiscal years since inception and had an accumulated deficit of
$24.7 million as of June 30, 1998. The Company's prospects must be considered in
light of the risks, expenses and difficulties frequently encountered by
companies in the early stage of development, particularly companies in new and
rapidly evolving markets. There can be no assurance that the Company will be
successful in addressing such risks.
The Company's quarterly and annual operating results have in the past, and
may in the future, vary significantly depending on many factors. Historically, a
substantial portion of the Company's revenues has been recognized in the last
two weeks of the third month of the quarter as a result of many customers'
purchasing practices. The inability of the Company to recognize expected
revenues during the last month of the quarter could result in substantial
fluctuations in operating results from period to period. In addition,
significant revenue was reported during the first and second quarters of 1998
from non-refundable minimum commitments from two large resellers which do not
directly reflect sales to end-users. The realization of revenue in excess of the
non-refundable prepaid amount noted above will depend on the success of these
resellers in the marketplace, one of which is the Japanese distributor. The
Company believes that achievement of profitability will depend on increased
market acceptance of its new Windows NT-based e-mail security and policy
management products. Failure of the Company's resellers to successfully market
the Company's products would cause a material adverse effect on the Company's
anticipated future revenue, and there can be no assurance that the Company's
resellers will be successful in marketing the Company's products. Further, there
can be no assurance that the Company's products will achieve broad market
acceptance. Additional factors that may affect operating results include the
timing of customers' decision-making processes, the timing of research,
development and marketing expenses in relation to product releases, the timing
of product introductions by the Company and its competitors, market acceptance
of new versions of the Company's products, product mix and general economic
factors. Any unfavorable changes in these or other factors could have a material
adverse effect on the Company's business, financial condition and results of
operations.
The Company's success depends on the performance of management and key
personnel. There have been several executive level changes during 1997 and
during the first six months of 1998. A key element in the Company's future
success is the ability of the Company's management team to implement the
Company's business strategy.
The Company's success is also dependent upon market acceptance of its
products in preference to competing products and products that may be developed
by others. There can be no assurance that the Company will be successful in
developing and marketing product enhancements or new products that respond to
technological change, evolving industry standards and changing customer
requirements or that such new products will achieve a sufficient level of market
acceptance to result in profitable operations. In addition, the introduction or
announcement of new product offerings by the Company or its competitors could
cause customers to defer or cancel purchases of existing Company products.
Failure of the Company to develop and introduce new products and product
enhancements in a timely and cost-effective manner or to anticipate and respond
adequately to changing market conditions, as well as any significant delay in
product development or introduction, could cause customers to delay or decide
against purchases of the Company's product, which could have a material adverse
effect on the Company's business, financial condition and results of operations.
The Company's future operating results are significantly dependent upon
market acceptance of its new Windows NT-based e-mail security and policy
management products. The Company has devoted substantial resources to the
introduction of these new products and the development of new sales channels.
13
<PAGE>
The Company has experienced revenue growth in part of the sales of the new
products. However, there can be no assurance that the Company will be successful
in this regard in the future.
There are a number of factors that must be addressed for the Company's
products to achieve broad market acceptance. These factors include performance,
functionality, interoperability, price and the customer's assessment of the
Company's technical, managerial, service and support expertise and capability.
Failure to succeed with respect to any of these factors could result in the
Company failing to achieve broad market acceptance of its products, which could
have a material adverse effect on the Company's future revenue growth.
The financial results for the first and second quarters of 1998 include
software license revenue from the Company's Japanese distributor. As of August
12, 1998, the Japanese distributor is in arrears for the payment associated with
the first and second quarter license revenue. See "Overview" in Part I, Item 2
"Management's Discussion and Analysis of Financial Condition and Results of
Operations." If the Company is unable to collect the amounts due for the first
and second quarters software license revenue or payments for future quarters,
the financial results would be materially impacted. The Company's agreement with
the Japanese distributor calls for additional minimum license payments in future
quarters of 1998 as well as in 1999. If the Japanese distributor continues to be
in arrears for its payments associated with revenue recognized in the first and
second quarters of 1998 or with its payment obligations in general, this could
impact the company's ability to recognize future license revenues in the Japan
marketplace associated with its Japanese distributor. The inability to recognize
these revenues in the second half of 1998 could decreased revenues and increased
losses until a new Japanese distributor is found, if one could be found at all.
International license sales accounted for 42% of the Company's total sales
for the three months ended June 30, 1998 compared to 8% for the same period in
1997. It is not certain that revenues from the licensing and support of the
Company's products in international markets will continue to grow. International
sales involve a number of risks, including the impact of possible recessionary
environments in economies outside of the United States, longer receivables
collection periods, unexpected changes in regulatory requirements, reduced
protection for intellectual property rights in some countries, tariffs and other
trade barriers. Exports of the Company's WorldSecure products require export
licenses from the United States Department of Commerce, Bureau of Export
Administration. These licenses contain certain restrictions as well as
administrative requirements which must be assumed by the Company. Export of
"strong encryption" products requires that the Company comply with certain key
recovery requirements imposed by the United States government. There is no
assurance that the Company will be successful in obtaining additional licenses.
Failure to do so would adversely affect international sales of the Company's
WorldSecure products. Additionally, United States government policy relative to
encryption software is subject to change and any change resulting in increased
restrictions could adversely affect sales of the Company's WorldSecure products.
Recently Network Associates, a competitor, announced that it would allow its
Swiss subsidiary to begin selling an international version of a strong
encryption program, which it maintains does not require a Department of Commerce
approved export license. To the extent that Network Associates is successful
with this position, other companies, including Worldtalk, would be at a
competitive disadvantage in foreign markets for some period of time, possibly
resulting in lower than anticipated sales. There can be no assurance that the
Company will be able to sustain or increase revenue derived from international
licensing and service. Any failure to expand sales in foreign markets, and the
risks of doing business in those markets, could have a material adverse effect
on the Company's business, financial condition and results of operations.
14
<PAGE>
- --------------------------------------------------------------------------------
PART II: OTHER INFORMATION
- --------------------------------------------------------------------------------
Item 1. Legal Proceedings
The Company is engaged in certain legal actions arising in the ordinary
course of business. The Company believes that it has adequate legal defenses and
that ultimate outcome of these actions will not have a material effect on the
Company's financial position and results of operation.
Item 4. Submission of Matters to a Vote of Security Holders
On June 12, 1998, the Company held an Annual Meeting of Stockholders (the
"Meeting") at which the following matters were submitted for approval by the
stockholders: (i) election of two directors of the Company, with each to serve
until his term expires and his successor has been elected and qualified or until
such director's earlier resignation, death or removal; (ii) ratification of the
selection of KPMG Peat Marwick LLP as the Company's independent accountants for
the fiscal year ending December 31, 1998; and (iii) amendment of the Company's
1996 Equity Incentive Plan to increase the number of shares reserved for
issuance thereunder by 1,000,000 shares. A total of 9,596,022 shares were
represented at the Meeting, in person or by proxy, equal to approximately 91% of
the outstanding shares of the Company's Common Stock.
Each nominee to the Board of Directors was elected by the vote set forth below:
Nominee Votes For Votes Withheld
------- --------- --------------
David J. Cowan 9,563,277 32,745
Wade Woodson 9,563,277 32,745
The selection of KPMG Peat Marwick LLP as the Company's independent
accountants was approved by the following vote: 9,594,837 shares voted in favor,
785 shares voted against, 400 shares abstained. The amendment to the Company's
1996 Equity Incentive Plan was approved by the following vote: 6,741,936 shares
voted in favor, 395,139 shares voted against, 1,107 shares abstained and
2,457,840 broker non-votes.
Item 5. Change in Management
Todd Hagen, Vice President, Finance and Administration, Chief Financial
Officer and Secretary of Worldtalk joined the company on May 26, 1998.
Sathvik Krishnamurthy, Vice President of Engineering of Worldtalk has
resigned as of April 30, 1998.
Item 6. Exhibits and Reports on Form 8-K
(a) The following exhibits are being filed as part of this report on Form 10-Q:
11.1 Statement re: Computation of Net Income (Loss) per Share
27.1 Financial Data Schedule
(b) Report on Form 8-K
None
15
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, Registrant has duly caused this report to be signed on its
behalf by the undersigned thereunto duly authorized.
Date: August 14, 1998
WORLDTALK COMMUNICATIONS
CORPORATION
By: /s/ TODD HAGEN
-------------------------------------
Todd Hagen
Vice President and Chief Financial
Officer
(Duly Authorized Officer and Principal
Financial Officer)
16
<TABLE>
WORLDTALK COMMUNICATIONS CORPORATION EXHIBIT 11.1
Computation of Net Loss Per Share
(in thousands, except per share amounts)
- -----------------------------------------------------------------------------------------------------------------------------------
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
1998 1997 1998 1997
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Net loss $ (342) $ (2,636) $ (1,020) $ (4,534)
Weighted average common shares outstanding 10,570 10,375 10,541 10,359
Number of common shares and common share equivalents used
in computing basic and diluted net loss 10,570 10,375 10,541 10,359
======== ======== ======== ========
Basic and diluted net loss per share $ (0.03) $ (0.25) $ (0.10) $ (0.44)
======== ======== ======== ========
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> JUN-30-1998
<CASH> 8,038
<SECURITIES> 996
<RECEIVABLES> 3,638
<ALLOWANCES> 121
<INVENTORY> 0
<CURRENT-ASSETS> 13,378
<PP&E> 1,383
<DEPRECIATION> 391
<TOTAL-ASSETS> 15,255
<CURRENT-LIABILITIES> 7,326
<BONDS> 0
0
0
<COMMON> 106
<OTHER-SE> 7,929
<TOTAL-LIABILITY-AND-EQUITY> 15,255
<SALES> 7,718
<TOTAL-REVENUES> 7,718
<CGS> 1,700
<TOTAL-COSTS> 1,700
<OTHER-EXPENSES> 7,091
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 223
<INCOME-PRETAX> (850)
<INCOME-TAX> 170
<INCOME-CONTINUING> (1,020)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (1,020)
<EPS-PRIMARY> (0.10)
<EPS-DILUTED> (0.10)
</TABLE>
