================================================================================
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
----------------
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 September 30, 1999
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)
----------------
(408) 567-1500
(Registrant's telephone number, including area code)
----------------
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 November 11, 1999 was 14,519,246 shares.
================================================================================
<PAGE>
- --------------------------------------------------------------------------------
FORM 10-Q
WORLDTALK COMMUNICATIONS CORPORATION
INDEX
- --------------------------------------------------------------------------------
Page
PART I FINANCIAL INFORMATION Number
ITEM 1: Financial Statements
Condensed Consolidated Balance Sheets as of September 30, 1999 and
December 31, 1998 ................................................. 3
Condensed Consolidated Statements of Operations for the three and
nine-month periods ended September 30, 1999 and 1998 .............. 4
Consolidated Statements of Cash Flows for the nine-month
periods ended September 30, 1999 and 1998 ......................... 5
Notes to Condensed Consolidated Financial Statements ................ 6
ITEM 2: Management's Discussion and Analysis of Financial Condition and
Results of Operations ............................................. 7
ITEM 3: Quantitative and Qualitative Disclosures about Market Risk .......... 15
PART II OTHER INFORMATION
ITEM 1: Legal Proceedings ................................................... 16
ITEM 5. Change in Management ................................................ 16
ITEM 6: Exhibits and Reports on Form 8-K .................................... 16
Signature ........................................................... 17
Exhibits ............................................................ 18
2
<PAGE>
PART I: FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
<TABLE>
WORLDTALK COMMUNICATIONS CORPORATION AND SUBSIDIARY
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except per share data)
(Unaudited)
<CAPTION>
ASSETS
September 30, December 31,
1999 1998
-------- --------
<S> <C> <C>
Current assets:
Cash and cash equivalents ............................................................ $ 11,027 $ 3,858
Short-term investments ............................................................... -- 2,166
Accounts receivable, net of allowance for doubtful
accounts of $1,052 and $1,840 respectively ......................................... 3,131 2,960
Prepaid expenses ..................................................................... 621 613
-------- --------
Total current assets ......................................................... 14,779 9,597
Property and equipment, net ............................................................ 873 1,108
Other assets ........................................................................... 417 441
-------- --------
$ 16,069 $ 11,146
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable ..................................................................... $ 1,342 $ 787
Short-term debt ...................................................................... 242 250
Capital lease obligations ............................................................ 16 128
Accrued expenses ..................................................................... 3,027 3,419
Deferred revenue ..................................................................... 1,204 2,474
-------- --------
Total liabilities ............................................................ 5,831 7,058
-------- --------
Commitments and contingencies Stockholders' equity:
Common stock, $.01 par value; 25,000 shares authorized, 14,379 and
10,686 shares issued and outstanding in 1999 and 1998, respectively ................ 144 107
Additional paid-in capital ........................................................... 43,328 32,773
Deferred compensation ................................................................ (15) (47)
Accumulated deficit .................................................................. (33,219) (28,745)
-------- --------
Total stockholders' equity ................................................... 10,238 4,088
-------- --------
$ 16,069 $ 11,146
======== ========
<FN>
See accompanying notes to condensed consolidated financial statements.
</FN>
</TABLE>
3
<PAGE>
<TABLE>
WORLDTALK COMMUNICATIONS CORPORATION AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
(Unaudited)
<CAPTION>
Three Months Nine Months
ended September 30, ended September 30,
1999 1998 1999 1998
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Revenues:
Continuing products:
Software licenses $ 2,255 $ 1,626 $ 6,256 $ 5,994
Maintenance, installation and training 459 67 1,101 231
-------- -------- -------- --------
Total revenues from continuing products 2,714 1,693 7,357 6,225
Discontinued products revenue 272 960 1,472 4,146
-------- -------- -------- --------
Total revenues 2,986 2,653 8,829 10,371
-------- -------- -------- --------
Cost of revenues:
Software licenses 173 130 325 522
Maintenance, installation and training 581 659 1,671 1,967
-------- -------- -------- --------
Total cost of revenues 754 789 1,996 2,489
-------- -------- -------- --------
Gross profit 2,232 1,864 6,833 7,882
-------- -------- -------- --------
Operating expenses:
Product development 1,026 939 3,017 3,011
Sales and marketing 2,816 1,921 7,343 5,573
General and administrative 802 2,262 1,606 3,629
-------- -------- -------- --------
Total operating expenses 4,644 5,122 11,966 12,213
-------- -------- -------- --------
Operating loss (2,412) (3,258) (5,133) (4,331)
Other income:
Interest income, net 113 79 291 302
Gain on sale of discontinued products 443 -- 443 --
-------- -------- -------- --------
Loss before income taxes (1,856) (3,179) (4,399) (4,029)
Income taxes 40 -- 75 170
-------- -------- -------- --------
Net loss (1,896) (3,179) (4,474) (4,199)
======== ======== ======== ========
Basic and diluted net loss per share $ (0.14) $ (0.30) $ (0.38) $ (0.40)
-------- -------- -------- --------
Shares used in computing basic and diluted net loss per share 14,020 10,594 11,886 10,559
======== ======== ======== ========
<FN>
See accompanying notes to condensed consolidated financial statements.
</FN>
</TABLE>
4
<PAGE>
<TABLE>
WORLDTALK COMMUNICATIONS CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
<CAPTION>
Nine Months Ended Sept 30,
1999 1998
-------- --------
<S> <C> <C>
Cash flows from operating activities:
Net loss $ (4,474) $ (4,199)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization 484 590
Allowance for doubtful accounts (788) 1,670
Amortization of deferred compensation 32 32
Changes in operating assets and liabilities:
Accounts receivable 617 (1,417)
Prepaid expenses (8) 312
Accounts payable 555 279
Accrued expenses (392) 521
Deferred revenue (1,270) (1,828)
-------- --------
Net cash used in operating activities (5,244) (4,040)
-------- --------
Cash flows from investing activities:
Purchase of property and equipment (249) (159)
Sales and maturities of short-term investments 2,166 4,337
Other assets 24 91
-------- --------
Net cash provided by investing activities 1,941 4,269
-------- --------
Cash flows from financing activities:
Net proceeds from issuance of common stock 10,592 316
Repayment of bank borrowings (8) --
Principal payments under capital lease obligations (112) (265)
-------- --------
Net cash provided by financing activities 10,472 51
-------- --------
Change in cash and cash equivalents 7,169 280
Cash and cash equivalents at beginning of period 3,858 4,662
-------- --------
Cash and cash equivalents at end of period $ 11,027 $ 4,942
======== ========
Supplemental disclosures:
Cash paid for interest: $ 16 $ 47
======== ========
<FN>
See accompanying notes to condensed consolidated financial statements.
</FN>
</TABLE>
5
<PAGE>
WORLDTALK COMMUNICATIONS CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Period ended September 30, 1999 and 1998
(In thousands, except per share data)
(Unaudited)
(1) Basis of Presentation
The accompanying unaudited condensed consolidated balance sheet of
Worldtalk Communications Corporation and its subsidiary ("Worldtalk" or the
"Company") as of September 30, 1999 and December 31, 1998, the related unaudited
condensed consolidated statements of operations for the three and nine month
periods ended September 30, 1999 and 1998 and the cash flows for the nine month
periods ended September 30, 1999 and 1998 have been prepared on substantially
the same basis as are the annual consolidated financial statements. The December
31, 1998 balance sheet was derived from audited financial statements, but does
not include all disclosures required by generally accepted accounting
principles. The results of operations for the three and nine month periods ended
September 30, 1999 are not necessarily indicative of results to be expected for
the entire year.
For software transactions entered into after January 1, 1998, the
Company adopted the American Institute of Certified Public Accountants'
("AICPA") Statement of Position ("SOP") No. 97-2, "Software Revenue
Recognition." SOP No. 97-2 generally requires revenue earned on software
arrangements involving multiple elements to be allocated to each element based
on its relative fair value. The fair value of the element must be based on
objective evidence that is specific to the vendor. If the vendor does not have
objective evidence of the fair value of all elements in a multiple-element
arrangement, all revenue from the arrangement must be deferred until such
evidence exists or until all elements have been delivered. The revenue allocated
to software products is generally recognized upon shipment of the products
provided there is persuasive evidence that an agreement exists, the fee is
fixed, determinable and collectible and the arrangement does not involve
significant customization, modification or production. The revenue allocated to
post contract customer support is recognized ratably over the term of the
support and revenue allocated to service elements is recognized as the services
are performed. The adoption of SOP No. 97-2 did not have a material effect on
the Company's operating results.
Earnings per Share
Basic earnings per share are computed using the weighted average number
of common shares outstanding during the period. Diluted earnings per share are
computed using the weighted average number of potentially dilutive common
equivalent shares outstanding for the period, if any. For the three and nine
month periods ended September 30, 1999 and 1998, common stock options totaling
2,265 and 1,120, respectively, were omitted from the computation, as their
impact would be antidilutive.
(2) 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.
On December 11, 1998, the Company filed a lawsuit against i4
Corporation, formerly known as ASCII Something Good Corporation in the United
States District Court for the Northern District of California (Case No.
C-98-21231) regarding alleged breach by i4 of a Distribution Agreement for the
Company's products in Japan, seeking damages in excess of $2.7 million plus
attorneys' fees and costs. On April 13, 1999, the Company announced that it had
entered into a settlement agreement with i4. Under the terms of the settlement,
i4 has agreed to pay the Company $1.5 million in scheduled payments over the
succeeding four quarters. The Company has received through September 30, 1999,
payments totaling approximately $900,000. The final payment under the terms of
the settlement is due by February 15, 2000 and may be reduced by $100,000 if i4
exercises certain prepayment options.
6
<PAGE>
(3) Recent 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 was amended by Statement No. 137, issued in June 1999, to defer the
effective date to fiscal quarters of all years beginning after June 15, 2000.
The Company does not expect the adoption of SFAS No. 133 to have a material
impact on its financial position, results of operations or cash flows.
In December 1998, the AICPA issued SOP No. 98-9, "Modification of SOP
97-2, Software Revenue Recognition, with Respect to Certain Transactions." SOP
No. 98-9 requires recognition of revenue using the "residual method" in a
multiple-element software arrangement when fair value does not exist for one or
more of the delivered elements in the arrangement. Under the "residual method,"
the total fair value of the undelivered elements is deferred and recognized in
accordance with SOP No. 97-2. The Company will be required to implement SOP No.
98-9 for the year ending December 31, 2000. SOP No. 98-9 also extends the
deferral of the application of SOP No. 97-2 to certain other multiple-element
software arrangements through the Company's year ending December 31, 1999. The
Company is evaluating the provisions of SOP No. 98-9 and has not yet determined
what impact, if any, SOP No. 98-9 will have on its financial position, results
of operations or cash flows.
- --------------------------------------------------------------------------------
PART I: FINANCIAL INFORMATION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Overview
This report (including the following discussion and analysis of
financial condition and results of operations) contains descriptions of the
Company's expectations regarding future trends affecting its business. Words
such as "expects," "intends," "anticipates," "plans," "believes," "seeks,"
"estimates" and similar expressions or variations of such words are intended to
identify forward-looking statements. Additionally, statements concerning future
matters such as the development of new products, enhancements or technologies,
expense levels, possible changes in legislation and other statements regarding
matters that are not historical are forward-looking statements. 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.
Although forward-looking statements in this report reflect the good
faith judgment of the Company's management, such statements can only be based on
facts and factors currently known by the Company. Forward-looking statements are
inherently subject to risks and uncertainties and 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" as well as those discussed in the Company's 1998 Annual Report on Form
10-K. Readers are urged not to place undue reliance on
7
<PAGE>
these forward-looking statements, which speak only as of the date of this
report. The Company undertakes no obligation to revise or update any
forward-looking statement in order to reflect any event or circumstance that may
arise after the date of this report. Readers are urged to carefully review and
consider the various disclosures made by the Company in this report, which
attempt to advise interested parties of the risks and uncertainties that may
affect the Company's business, financial condition, operating results and
prospects.
The Company is a leading provider of Internet content security and
policy management solutions. The Company's WorldSecure(TM) policy management
platform enables organizations to define and manage Internet e-mail and Web
security and usage policies, reducing the risks and liabilities associated with
Internet communications. The Company delivered the industry's first solutions
for managing and enforcing e-mail security policies in September 1997. The
Company's products include WorldSecure Mail, a Windows NT-based content firewall
and policy management solution, WorldSecure Web, a Windows NT-based content
security product, WorldSecure/ESP, a surveillance program for Internet e-mail,
WorldSecure Client, a desktop e-mail encryption product and NetTalk(TM), a
Windows NT-based e-mail and directory solution.
The Company has experienced a significant and planned shift in product
mix from almost 100% of software license revenue coming from UNIX-based
NetJunction products in 1996 to over 80% of software license revenue coming from
Windows NT-based Internet content security, policy management and e-mail
directory products in the first nine months of 1999. Following the sale of the
NetJunction business in July 1999, the Company is concentrating all future sales
efforts on its Windows NT-based Internet security products. A significant
portion of the revenue recognized in the first nine months of 1999 arose from
minimum non-refundable commitment terms with one large reseller, which do not
directly reflect sales to end-users. The realization of revenue in excess of the
non-refundable prepaid amount noted above has depended on the success of this
reseller in the marketplace. Since 1998, the reseller has sold insignificant
amounts of the Company's products. The Company believes that reaching and
maintaining profitability will depend on increased market acceptance of its
WorldSecure product line. A key element of the Company's future revenue growth
will be the ability of the Company's resellers and international distributors to
sell the Company's products in volume. In 1998, the Company terminated its
relationship with its Japanese distributor and has not yet entered into an
agreement with a replacement distribution partner in Japan. There can be no
assurance that the Company will successfully replace its Japanese distributor,
that the Company's resellers will be successful in marketing these products or
that the Company's products will achieve broad market acceptance.
The Company is currently concentrating its development, sales and
marketing efforts on the Windows NT-based security products. The Company plans
to utilize its resources to exploit the Internet security market, but there can
be no assurance that the Company's Internet security products will achieve broad
market acceptance.
The Company's Windows NT-based Internet security and policy management
products have also placed the Company into competition with a new set of
vendors, many of whom have significantly greater resources than the Company.
Accordingly, the Company continues 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; competitive
conditions in the industry; and the distraction to the information technology
departments of many corporations that Year 2000 problems are creating.
Results of Operations
<TABLE>
The following table sets forth certain consolidated statements of
operations data for the periods indicated as a percentage of total revenues:
8
<PAGE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
1999 1998 1999 1998
----- ------ ----- -----
<S> <C> <C> <C> <C>
Revenues:
Continuing products:
Software licenses 75.5% 61.3% 70.9% 57.8%
Maintenance, installation and training 15.4 2.5 12.5 2.2
----- ------ ----- -----
Total revenues from continuing products 90.9 63.8 83.3 60.0
Discontinued products revenue 9.1 36.2 16.7 40.0
Total revenues 100.0 100.0 100.0 100.0
----- ------ ----- -----
Cost of revenues:
Software licenses 5.8 4.9 3.7 5.0
Maintenance, installation and training 19.5 24.8 18.9 19.0
----- ------ ----- -----
Total cost of revenues 25.3 29.7 22.6 24.0
----- ------ ----- -----
Gross profit 74.7 70.3 77.4 76.0
----- ------ ----- -----
Operating expenses:
Product development 34.4 35.4 34.2 29.0
Sales and marketing 94.3 72.4 83.2 53.7
General and administrative 26.9 85.3 18.2 35.0
----- ------ ----- -----
Total operating expenses 155.5 193.1 135.5 117.8
----- ------ ----- -----
Operating loss (80.8) (122.8) (58.1) (41.8)
Other income:
Interest income, net 3.8 3.0 3.3 2.9
Gain on sale of discontinued products 14.8 -- 5.0 --
----- ------ ----- -----
Loss before income taxes (62.2) (119.8) (49.8) (38.8)
Income taxes 1.3 -- 0.8 1.6
----- ------ ----- -----
Net loss (63.5)% (119.8)% (50.7)% (40.5)%
===== ====== ===== =====
</TABLE>
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. 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.
In July 1999, the Company completed the sale of its NetJunction e-mail
connectivity and directory integration business to Wingra Technologies, LLC.
Under the terms of the agreement, Wingra has acquired the assets related to the
NetJunction product and has assumed support and development responsibilities for
NetJunction customers and resellers with current agreements. In addition,
Worldtalk has appointed Wingra as a reseller of Worldtalk's NetTalk product
line. Due to the sale of the Company's NetJunction product line, the revenue in
the "Condensed Consolidated Statement of Operations" has been divided into
continuing product revenue and discontinued product revenue. The continuing
product revenue represents the WorldSecure and NetTalk product lines and the
discontinued product revenue accounts for all NetJunction related revenue.
For the three months ended September 30, 1999, the Company's total
revenue was $3.0 million, compared to $2.7 million for the same period in 1998,
representing an increase of 12.6%. Software license revenue from continuing
products was $2.3 million for the three months ended September 30, 1999,
compared to $1.6 million for the same period in 1998, representing a increase of
38.7%. Maintenance, installation and training from continuing product revenue
was $459,000 for the three months ended September 30, 1999, compared to $67,000
for the same period in 1998, representing a increase of 585.1%. With the sale of
the NetJunction product line, the Company's primary focus has been on developing
and increasing revenue for the WorldSecure product line. The increase in
continuing product revenue in 1999 from 1998, is a direct result of this effort.
9
<PAGE>
Total revenue for the nine months ended September 30, 1999 was $8.8
million, compared to $10.4 million for the same period in 1998, representing a
decrease of 14.9%. Software license revenue for continuing products for the nine
months ended September 30, 1999 was $6.3 million, compared to $6.0 million for
the period ended September 30, 1998, representing an increase of 4.4%.
Maintenance, installation and training for continuing product revenue was $1.1
million for the nine months ended September 30, 1999, compared to $231,000 for
the same period in 1998, representing an increase of 376.6%. Several factors
contributed to the decrease in total revenue for the nine-month period ended
September 30, 1999. The Company terminated its Japanese distributor in the third
quarter of 1998, resulting in no software license revenues from the Japanese
market for the first nine months of 1999. In addition, the Company has shifted
its focus away from sales of the NetJunction product in favor of the Windows
NT-based WorldSecure product line, resulting in a significant decrease in
license revenue from the NetJunction product. Further, total revenue for the
nine-month period ended September 30, 1998 includes a one-time original
equipment manufacture agreement, which has not been duplicated in 1999. Again,
when comparing the continuing product revenue for 1999 to the same period for
1998, the increase is a result of the Company focusing substantially all of its
efforts on the development and sales of its WorldSecure product line.
A significant portion of the revenue reported during the first nine
months of 1998 came from shipments of products pursuant to minimum
non-refundable, non-recurring commitment terms with one reseller.
The Company expects that maintenance, installation and training revenue
will decline as a percentage of total revenue in the future as sales of Windows
NT-based Internet content security and policy management software increase as a
percentage of total revenue.
Cost of Revenues
The Company's total cost of revenues was $754,000 for the three months
ended September 30, 1999, compared to $789,000 for the same period in 1998,
representing a decrease of 4.4%. Total cost of revenue for the nine months ended
September 30, 1999 was $2.0 million, compared to $2.5 million for the same
period in 1998, representing a decrease of 19.8%.
Cost of product revenues consists of the costs of royalties paid to
third-party vendors, product media and duplication, packaging materials and
shipping expenses. Cost of product revenues was $173,000 for the three months
ended September 30, 1999, compared to $130,000 for the same period in 1998,
representing an increase of 33.1%. Cost of product revenues was $325,000 for the
nine months ended September 30, 1999, compared to $522,000 for the same period
in 1998, representing a decrease of 37.7%. The increase in cost of product
revenue for the three months ended September 1999 when compared to the same
period for 1998, was due to the third quarter product launch of WorldSecure 4.0
in 1999. The decrease in cost of product revenues for the nine months ended
September 30, 1999, when compared to the same periods last year, was primarily
due to reductions in certain royalty and other amortized costs.
Maintenance, installation and training costs consist principally of
personnel-related costs for consulting, training and technical support.
Maintenance, installation and training costs were $581,000 for the three months
ended September 30, 1999, compared to $659,000 for the same period in 1998,
representing a decrease of 11.8%. Maintenance, installation and training costs
were $1.7 million for the nine months ended September 30, 1999, compared to $2.0
million for the same period in 1998, representing a decrease of 15.0%.
Maintenance, installation and training costs have declined as a percentage of
revenue as the Company has increased sales of Windows NT-based e-mail security
and policy management products which require less maintenance, installation and
training.
Product Development
Product development expenses consist primarily of personnel-related
costs, including salaries and benefits of personnel, as well as equipment and
facility costs. Product development expenses are 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.
10
<PAGE>
Product development expenses were approximately $1.0 for the three months ended
September 30, 1999, compared to approximately $900,000 for the same period in
1998. Product development expenses for the nine months ended September 30, 1999
were approximately $3.0 million, compared to approximately $3.0 million for the
same period in 1998. Product development expenses represented 34.4% of total
revenues for the third quarter of 1999 and 35.4% of total revenue for the same
period in 1998. Product development expenses represented 34.2% of total revenues
for the first nine months of 1999 and 29.0% of total revenues for the same
period in 1998. The increase as a percentage of revenue in the nine month period
ended September 30, 1999 when compared to the same periods in 1998 are due to
product development spending remaining relatively flat as revenue decreased. The
Company believes that continued commitment to product development, such as the
newly developed and released WorldSecure 4.0 product line is required for the
Company's products to compete effectively in the market for Internet security
and policy management. The Company intends to allocate additional resources to
product research and development. Consequently, such expenses may increase in
both dollar amounts and as a percentage of total revenues 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 were $2.8 million for the
three months ended September 30, 1999, compared to $1.9 million for the same
period in 1998. For the nine month periods ended September 30, 1999, sales and
marketing expenses were $7.3 million, compared to $5.6 million for the same
period in 1998. Sales and marketing expenses represented 94.3% of total revenues
for the three months ended September 30, 1999 and 72.4% of revenues for the same
period in 1998. Sales and marketing expenses represented 83.2% of total revenues
for the nine months ended September 30, 1999 and 53.7% of total revenues for the
same period in 1998. The increase in sales and marketing expenses as a
percentage of total revenues was attributable to the addition of sales personnel
and the opening of new sales office space during the first half of 1999. The
Company expects to continue hiring additional sales and marketing personnel,
increase promotion and advertising efforts and expand internationally through a
combination of distributors, value-added resellers and direct sales personnel.
Consequently, sales and marketing 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 general management of the
Company. General and administrative expenses were $802,000 for the three months
ended September 30, 1999, compared to $2.3 for the same period in 1998. General
and administrative expenses were $1.6 million for the nine months ended
September 30, 1999, compared to $3.6 million for the same period in 1998. In the
three and nine month periods ended September 30, 1999, general and
administrative expenses were offset to a significant extent by the reversal of
approximately $900,000 in bad debt reserve related to settlement payments from
the Company's former Japanese distributor. In addition to this offset, the
decrease in absolute dollars for the first nine months of 1999, when compared to
the same period in 1998, was also attributable to decreased staffing and
overhead 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 the reversal of the bad debt reserve and
fluctuations in revenue for the respective periods and the fact that general and
administrative expenses do not fluctuate in direct proportion to total revenues.
In the third quarter of 1998, the Company created a bad debt reserve for all
receivables related to the above mentioned Japanese distributor in the amount of
$1.7 million as a result of a settlement. The Company believes that general and
administrative expenses will 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. In the three and nine month periods
ended September 30, 1999, net proceeds of approximately $163,000
11
<PAGE>
from the sale of the NetJunction product line have been recorded. In addition,
approximately $280,000 in deferred maintenance revenue related to the
NetJunction product line was recognized in September 1999. Net interest income
was $113,000 and $79,000 for the three months ended September 30, 1999 and 1998,
respectively. Net interest income was $291,000 and $302,000 for the nine months
ended September 30, 1999 and 1998, respectively. The fluctuations in net
interest were primarily attributable to fluctuations in the Company's cash and
cash equivalent and short-term investment balances, coupled with interest rate
fluctuations during the comparable periods.
Liquidity and Capital Resources
At September 30, 1999, the Company had cash and cash equivalents and
short-term investments of $11.0 million. Net cash used in operating activities
amounted to $5.2 million for the nine months ended September 30, 1999, which was
comprised principally of the Company's net loss of $4.5 million, a decrease in
deferred revenue of $1.3 million, a decrease in accrued expenses of $392,000,
and an increase in accounts receivable of $171,000 offset by an increase in
accounts payable of $555,000.
Net cash provided by sales and maturities of short-term investments
offset by investing activities amounted to $1.9 million for the nine months
ended September 30, 1999, which included $249,000 in purchases of property and
equipment. The Company currently has no significant capital commitments for the
remainder of fiscal 1999.
Net cash provided by financing activities amounted to $10.5 million for
the nine months ended September 30, 1999 which consisted primarily of net
proceeds from approximately $10 million in equity financing, coupled with
proceeds from the issuance of common stock of $593,000, offset by payments of
bank borrowings of $8,000 and principal payments under capital lease obligations
of $112,000.
In July 1999, the Company completed an equity financing with affiliates
of Hilal Capital Management and others in the amount of approximately $10
million. In the financing transaction, the Company issued 3,333,334 shares of
its common stock and warrants to purchase 1,666,666 additional shares of its
common stock. These warrants have an exercise price of $7.00 per share and
expire on July 7, 2006.
The Company has a $1.75 million bank line of credit and equipment term
loan facility, which was entered into in December 1998. As of September 30,
1999, the Company had no balance outstanding on the $1.5 million line of credit,
which expires December 1999, and had fully utilized the $250,000 equipment term
loan facility.
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 cash and earnings per share dilution caused by reduced
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 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 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 $33.2 million as of September 30, 1999. The Company's prospects must
be considered in light of the risks, expenses and difficulties frequently
encountered by companies in
12
<PAGE>
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. The Company
anticipates that its marketing strategy for the WorldSecure product line will,
in the future, depend more significantly on distribution by third-party
resellers and on managing international distribution channels. Revenues in the
short-term may be adversely affected by the year 2000 concerns of the Company's
potential customers who may defer significant purchases or licenses of
Information Technology until after January 1, 2000. In addition, significant
revenue was reported during 1998 and during the first nine months of 1999 from
non-refundable, non-recurring minimum commitments from one large reseller which
do not directly reflect sales to end-users. The Company believes that reaching
and maintaining profitability will depend on increased market acceptance of its
WorldSecure Internet content security and policy management products. Failure of
the Company's resellers and international distributors 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 and international distributors 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. Also, new direct sales and
telesales personnel can take up to three-quarters to become fully productive
against quotas that are in line with industry norms. 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 also depends on the performance of management and
key personnel. There have been several executive level changes during 1998 and
during the first nine months of 1999, including the appointment of a new
Chairman of the Board, President and Chief Financial Officer, Vice President,
Engineering and Vice President, Sales as well as the resignation of the former
President and Chief Executive Officer. To be successful, the Company's
management team must be able to implement the Company's business strategy.
In the second quarter of 1999, the Company was the subject of a review
by Nasdaq to remove the Company's Common Stock from listing on Nasdaq National
Market because of the Company's failure to meet either set of criteria for
continued listing. In July 1999, the Company closed a financing transaction in
which approximately $10 million was raised. With these funds, the Company now
meets the criteria for continued listing of its Common Stock on Nasdaq and
received a letter from Nasdaq dated July 30, 1999 confirming the continued
listing. While the Company believes it can remain in compliance with the Nasdaq
National Market listing criteria, in the future, it is possible that the Company
may in the future fail to meet the criteria for continued listing, particularly
if the Company's net tangible worth (total assets, excluding goodwill, minus
total liabilities) again falls below $4 million. Failure to remain listed on the
Nasdaq National Market could harm the Company's business and prospects.
The Company's success is also dependent upon market acceptance of its
WorldSecure product line 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 products, which could have a material
adverse effect on the Company's business, financial condition and results of
operations.
13
<PAGE>
The Company's future operating results are significantly dependent upon
market acceptance of the Company's Windows NT-based Internet content security
and policy management products. The Company has devoted substantial resources to
market and sell these products and to develop new sales channels. However, there
can be no assurance that the Company will be able to recognize increased
revenues from these products 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.
Worldtalk is subject to intense competition in the Internet content
security and policy management markets and expects to face increased competition
in the future. Some of the Company's competitors have longer operating
histories, greater name recognition, larger technical staffs, established
relationships with hardware vendors, and or greater financial, technical and
marketing resources. These factors may provide the Company's competitors with an
advantage in penetrating the market with their electronic mail and Internet
security products. Increased competition could reduce average selling prices and
sales volume, which would harm the Company's revenues and operating results.
International sales accounted for 15% of the Company's total sales for
the three months ended September 30, 1999 compared to 7% for the same period in
1998. It is not certain that revenues from the licensing and support of the
Company's products in international markets will be a substantial percentage of
total revenue, particularly in light of the fact that the Company does not yet
have a new Japanese distributor. International sales involve a number of risks,
including the impact of possible recessionary economic environments 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 authorization by license or license
exemption pursuant to the Export Administration Regulations administered by the
United States Department of Commerce, Bureau of Export Administration. These
licenses contain certain restrictions as well as administrative requirements
that must be assumed by the Company. There is no assurance that the Company will
be successful in obtaining additional licenses or license exemptions. 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. 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.
Year 2000 Compliance
Many currently installed computer systems and software products are
coded to accept, store, or report only two digit year entries in date code
fields. Beginning in the Year 2000, these date code fields will need to accept
four digit entries to distinguish 21st century dates from 20th century dates.
The Year 2000 issue is a result of these programs being written with two digits
instead of four. As a result, computer systems and software used by companies,
including the Company and its vendors and customers, will need to comply with
Year 2000 requirements. The Company believes that potential problems related to
the Year 2000 will not have a material effect on the Company's current financial
position, liquidity or results of operations. However, it is possible that
unanticipated problems related to the Year 2000 could harm the Company's
business and operations.
The Company is aware of the Year 2000 issue and has been addressing the
issue internally and externally. The Company's primary internal software system
is currently Year 2000 compliant. The Company does not depend on in-house custom
systems and generally purchases off the shelf software from reputable vendors
who have tested their software for Year 2000 compliance. The Company's
telecommunications systems have been upgraded to
14
<PAGE>
become Year 2000 compliant with existing upgrades from the Company's current
vendor. The Year 2000 issue is being considered for all future software
purchases. The Company has evaluated significant suppliers and large customers
systems to determine the extent to which the Company's interface with these
systems is vulnerable to the Year 2000 issue. The Company has not identified any
Year 2000 problems that would materially harm the Company.
Although the Company believes the Year 2000 issue will not pose
material operational problems for its computer systems, it is possible that
unforeseen problems arising from the Year 2000 issue will arise in the future.
The anticipated cost to become Year 2000 compliant is under $100,000.
The Company believes it has an effective program in place to resolve
Year 2000 issues in a timely manner. The Company also has contingency plans for
certain critical applications and is working on such plans for others. These
contingency plans involve, among other actions, manual workarounds, switching to
alternative vendors for standard office productivity and financial application
software and adjusting staffing strategies. In the event that the Company does
not completely resolve all of the Year 2000 issues, the Company's business,
financial condition and results of operations could be harmed, although the
resulting costs and loss of business cannot be reasonably estimated at this
time.
ITEM 3. Quantitative and Qualitative Disclosure about Market Risk
The primary objective of the Company's investment activities is to
preserve principal while at the same time maximizing the income received from
investments without significantly increasing risk. Some of the securities that
the Company has invested in may be subject to market risk. The Company's market
risk results from changes in prevailing interest rates that may cause the
principal amount of the investment to fluctuate. To minimize this risk, the
Company maintains a portfolio of cash equivalents and short-term investment in a
variety of securities. In addition, the Company invests in relatively short-term
securities. As of September 30, 1999, all of the Company's investments mature in
less than 90 days.
15
<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.
On December 11, 1998, the Company filed a lawsuit against i4
Corporation, formerly known as ASCII Something Good Corporation in the United
States District Court for the Northern District of California (Case No.
C-98-21231) regarding alleged breach by i4 of a Distribution Agreement for the
Company's products in Japan, seeking damages in excess of $2.7 million plus
attorneys' fees and costs. On April 13, 1999, the Company announced that it had
entered into a settlement agreement with i4. Under the terms of the settlement,
i4 has agreed to pay the Company $1.5 million in scheduled payments over the
succeeding four quarters. The Company has received through September 30, 1999,
payments totaling approximately $900,000. The final payment under the terms of
the settlement is due by February 15, 2000 and may be reduced by $100,000 if i4
exercises certain prepayment options.
ITEM 4. Submission of Matters to a Vote of Security Holders.
None
ITEM 5. Other Information.
Change in Management.
Bernard Harguindeguy, former President and Chief Executive Officer
resigned effective August 30, 1999. Mr. Harguindeguy's separation agreement
includes one year of consulting along with a one-year continuation of all
benefits. As of Mr. Harguindeguy's resignation date, James A. Heisch has assumed
the role of acting President and Chief Financial Officer.
ITEM 6. Exhibits and Reports on Form 8-K.
(a) The following exhibit is being filed as part of this report on Form 10-Q:
27.1 Financial Data Schedule
(b) Report on Form 8-K.
The Company filed a Report on Form 8-K dated July 19, 1999 reporting
the following items:
1. The Company reported the sale of 3,333,334 shares of its common
stock and warrants to purchase up to 1,666,666 additional shares of its common
stock to certain affiliates of Hilal Capital Management LLC and others in the
amount of approximately $10 million.
2. The Company reported its hearing results before the Nasdaq Stock
Market's Listing Qualification Panel and the resulting return to compliance with
the criteria for continued listing on the Nasdaq National Market. As requested
by Nasdaq, the Company also presented pro forma condensed balance sheet as of
June 30, 1999, which was not required to be included pursuant to Regulation S-X.
16
<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: November 12, 1999
WORLDTALK COMMUNICATIONS
CORPORATION
By: /s/ JAMES A. HEISCH
---------------------------
James A. Heisch
President and Chief
Financial Officer
(Duly authorized officer)
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> SEP-30-1999
<CASH> 11,027
<SECURITIES> 0
<RECEIVABLES> 4,183
<ALLOWANCES> 1,052
<INVENTORY> 0
<CURRENT-ASSETS> 14,779
<PP&E> 3,956
<DEPRECIATION> 3,083
<TOTAL-ASSETS> 16,069
<CURRENT-LIABILITIES> 5,831
<BONDS> 0
0
0
<COMMON> 144
<OTHER-SE> 10,094
<TOTAL-LIABILITY-AND-EQUITY> 16,069
<SALES> 8,829
<TOTAL-REVENUES> 8,829
<CGS> 1,996
<TOTAL-COSTS> 1,996
<OTHER-EXPENSES> 11,966
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 291
<INCOME-PRETAX> (4,399)
<INCOME-TAX> (75)
<INCOME-CONTINUING> (4,474)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (4,474)
<EPS-BASIC> (0.38)
<EPS-DILUTED> (0.38)
</TABLE>
