<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 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 June 30, 1999
or
[_] TRANSITION REPORTS PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from __________________ to ________________________
Commission File Number: 000-26379
SOFTWARE.COM, INC.
(exact name of registrant as specified in its charter)
Delaware 77-0392373
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
525 Anacapa Street
Santa Barbara, CA 93101
(Address of principal executive offices)
(805) 882-2470
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
by Section 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, $.001 par
value, was 40,792,476 as of July 30, 1999.
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SOFTWARE.COM, INC.
INDEX
PART I: FINANCIAL INFORMATION
<TABLE>
<CAPTION>
Item Page
- ---------- ------------------------------------------------------------------------------------------- ----
<S> <C> <C>
Item 1. Condensed Consolidated Financial Statements - unaudited......................................... 3
Condensed Consolidated Balance Sheets - June 30, 1999 and December 31, 1998..................... 3
Condensed Consolidated Statements of Operations three and six months ended June 30,
1999 and 1998................................................................................... 4
Condensed Consolidated Statements of Cash Flows - six months ended June 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........... 8
Item 3 Quantitative and Qualitative Disclosure About Market Risk....................................... 26
PART II: OTHER INFORMATION
Item 1. Legal Proceedings............................................................................... 27
Item 2. Changes in Securities and Use of Proceeds....................................................... 27
Item 3. Defaults Upon Senior Securities................................................................. 28
Item 4. Submission of Matters to a Vote of Security Holders............................................. 28
Item 5. Other Information............................................................................... 28
Item 6. Exhibits and Reports on Form 8-K................................................................ 28
Signatures...................................................................................... 29
</TABLE>
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PART I: FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Software.com, Inc.
Condensed Consolidated Balance Sheets
(In thousands)
<TABLE>
<CAPTION>
June 30, December 31,
1999 1998
---------------- ---------------
(Unaudited)
<S> <C> <C>
Assets
Current assets:
Cash and cash equivalents...................................... $ 71,515 $ 5,447
Short-term investments......................................... 2,971 496
Accounts receivable, net....................................... 10,787 9,091
Prepaid expenses and other current assets...................... 747 501
-------- --------
Total current assets........................................ 86,020 15,535
Property and equipment, net.................................... 3,244 3,275
Deposits and other assets...................................... 285 249
-------- --------
Total assets................................................ $ 89,549 $ 19,059
======== ========
Liabilities and stockholders' equity (deficit)
Current liabilities:
Accounts payable............................................... $ 3,095 $ 1,129
Accrued liabilities............................................ 2,972 3,139
Deferred revenue............................................... 4,133 3,747
Note payable to bank and current portion of long-term debt..... 546 7,635
-------- --------
Total current liabilities................................... 10,746 15,650
Long-term debt................................................... - 100
Redeemable convertible preferred stock - Series A and Series B... - 13,370
Stockholders' equity (deficit):
Convertible preferred stock - Series C......................... - 6,848
Common stock................................................... 107,967 6,396
Deferred compensation.......................................... (1,977) (1,447)
Accumulated deficit............................................ (27,187) (21,858)
Total stockholders' equity (deficit)........................ $ 78,803 $(10,061)
======== ========
Total liabilities and stockholders' equity (deficit)........ $ 89,549 $ 19,059
======== ========
</TABLE>
See accompanying notes.
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Software.com, Inc.
Condensed Consolidated Statements of Operations
(In thousands, except per share amounts)
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
--------------------- --------------------
1999 1998 1999 1998
-------- --------- -------- --------
<S> <C> <C> <C> <C>
Revenues:
Software licenses................................ $ 5,227 $ 4,325 $10,285 $ 7,423
Services......................................... 3,821 1,815 6,834 3,615
------- ------- ------- -------
Total revenues................................ 9,048 6,140 17,119 11,038
Cost of revenues:
Software licenses................................ 766 273 1,142 757
Services......................................... 2,688 1,586 4,732 3,234
------- ------- ------- -------
Total cost of revenues.......................... 3,454 1,859 5,874 3,991
------- ------- ------- -------
Gross Profit....................................... 5,594 4,281 11,245 7,047
Operating Expenses:
Sales and marketing.............................. 4,262 2,345 7,822 4,629
Research and development......................... 3,177 2,071 5,918 4,208
General and administrative....................... 1,017 973 2,195 1,932
Legal matter..................................... (200) - (200) -
------- ------- ------- -------
Total operating expenses...................... 8,256 5,389 15,735 10,769
------- ------- ------- -------
Loss from operations............................... (2,662) (1,108) (4,490) (3,722)
Interest and other income (expense), net........... (133) (60) (290) (150)
------- ------- ------- -------
Loss before income taxes........................... (2,795) (1,168) (4,780) (3,872)
Provision for income taxes......................... (78) - (146) (2)
------- ------- ------- -------
Net loss........................................... (2,873) (1,168) (4,926) (3,874)
Accretion on redeemable convertible preferred
stock............................................. (193) (210) (403) (420)
------- ------- ------- -------
Net loss applicable to common stockholders......... $(3,066) $(1,378) $(5,329) $(4,294)
======= ======= ======= =======
Basic and diluted net loss per share............... $(0.10) $(0.05) $(0.18) $(0.15)
======= ======= ======= =======
Weighted average shares of common stock
outstanding used in computing basic and diluted
net loss per share................................ 29,886 28,207 29,319 28,132
======= ======= ======= =======
</TABLE>
See accompanying notes.
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Software.com, Inc.
Condensed Consolidated Statement of Cash Flows
(In thousands)
(Unaudited)
<TABLE>
<CAPTION>
Six Months Ended
June 30,
---------------------------------------------
1999 1998
--------------- ---------------
<S> <C> <C>
Operating activities:
Net loss........................................................ $(4,926) $(3,874)
Adjustments to reconcile net loss to net cash used by operating
activities:
Depreciation and amortization......................... 918 776
Deferred compensation................................. 240 -
Provision for doubtful accounts....................... 308 76
Changes in operating assets and liabilities:
Accounts receivable.............................. (2,004) (1,312)
Prepaid expenses and other current assets........ (246) (233)
Accounts payable................................. 1,966 1,072
Accrued liabilities.............................. (1,169) 562
Deferred revenue................................. 385 (888)
-------- -------
Net cash used in operating activities..... (4,528) (3,821)
Investing activities:
Acquisition of property and equipment........................... (887) (629)
Purchase of short-term investments.............................. (2,971) -
Maturities of short-term investments............................ 496 892
Increase in other assets........................................ (36) (16)
-------- -------
Net cash provided by (used in) investing
activities................................ (3,398) 247
Financing activities:
Repayments of long-term debt.................................... (100) (120)
(Repayment of) proceeds from note payable to bank, net.......... (7,089) 66
Exercise of stock options....................................... 2,188 261
Proceeds from issuance of common stock, net..................... 68,995 -
Proceeds from issuance of preferred stock....................... 10,000 -
-------- -------
Net cash provided by financing activities... 73,994 207
Net increase (decrease) in cash and cash equivalents............ 66,068 (3,367)
Cash and cash equivalents at beginning of period................ 5,447 6,083
-------- -------
Cash and cash equivalents at end of period...................... $ 71,515 $ 2,716
======== ========
</TABLE>
See accompanying notes.
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SOFTWARE.COM, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1999
(Unaudited)
Note 1. Basis of Presentation
The accompanying condensed consolidated financial statements have been
prepared by Software.com, Inc. (the "Company") without audit (except for the
balance sheet information as of December 31, 1998, which was derived from
audited consolidated financial statements) in accordance with generally accepted
accounting principles for interim financial information and with the
instructions for Form 10-Q and Rule 10-01 of Regulation S-X. Certain information
and footnote disclosures normally included in the financial statements prepared
in accordance with generally accepted accounting principles have been condensed
or omitted in accordance with such rules and regulations. In the opinion of
management, all adjustments (consisting only of normal recurring adjustments)
considered necessary for a fair presentation have been included. The results of
operations for interim periods are not necessarily indicative of the results
that may be expected for the fiscal year or any other period. The condensed
consolidated financial statements should be read in conjunction with the audited
consolidated financial statements and accompanying notes included in the
Company's Registration Statement on Form S-1 (File No. 333-76263), which was
declared effective by the Securities and Exchange Commission ("SEC") on June 23,
1999.
Principles of Consolidation
The accompanying condensed consolidated financial statements include the
accounts of the Company and its subsidiaries. All significant intercompany
balances and transactions have been eliminated. As further described in Note 4,
the Company acquired Mobility.Net Corporation on April 12, 1999. The acquisition
was accounted for as a pooling-of-interests. Accordingly, the financial
information presented reflects the combined financial position and operations of
the Company and Mobility.Net for all dates and periods presented.
Reincorporation
On June 16, 1999, the Company changed its state of incorporation to
Delaware.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results may differ materially from those estimates.
Cash Equivalents and Short-Term Investments
The Company considers all highly liquid debt instruments purchased with
original maturity dates of three months or less and investments in money market
funds to be cash equivalents. Investments with maturities between three to
twelve months are considered to be short-term investments. Short-term
investments consist of corporate commercial paper.
Note 2. Net Loss Per Share
Basic and diluted net loss per common share are presented in conformity
with Statement of Financial Accounting Standards No. 128, "Earnings Per Share"
(FAS128), for all periods presented. Basic loss per
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share is computed using the weighted-average number of common shares outstanding
during the period. Diluted loss per share is computed using the weighted-average
number of common and common stock equivalents outstanding during the period.
Common stock equivalent shares have been excluded from the computation as their
effect is anti-dilutive.
Note 3. Related Party Transactions
For the three and six months ended June 30, 1998 and 1999, revenues from
companies affiliated with AT&T Corporation totaled approximately $544,000,
$1,551,000, $570,000 and $1,158,000, respectively. AT&T Corporation is
considered a related party due to its involvement with AT&T Ventures, a
preferred shareholder prior to the conversion of preferred shares to common
stock upon the Company's initial public offering. At December 31, 1998 and June
30, 1999, accounts receivable from such companies totaled approximately $847,000
and $1,033,000, respectively.
Note 4. Stock Options
For the three and six months ended June 30, 1999, approximately 555,000 and
828,000 stock options, respectively, were exercised with net proceeds to the
Company of approximately $1.8 million and $2.2 million, respectively.
Note 5. Acquisition of Mobility.Net Corporation
On April 12, 1999, the Company completed its acquisition of Mobility.Net,
incorporated in July 1996, which offers products for Web messaging using a Java-
based technology platform, that complements the Company's product offerings.
Accordingly, the financial information presented reflects the combined financial
position and operations of the Company and Mobility.Net for all dates and
periods presented. The Company issued 1,579,294 shares of its common stock in
exchange for all of the outstanding shares of Mobility.Net. Separate operating
results of Mobility.Net were not material for all periods presented.
Note 6. Series D Preferred Stock
On April 5, 1999, the Company issued to Hewlett-Packard Company 1,626,016
shares of Series D, no par value, convertible preferred stock (the Preferred
Stock D) for proceeds of $10,000,000. The Preferred Stock D automatically
converted into common stock upon closing of the Company's initial public
offering on June 29, 1999.
Note 7. Initial Public Offering Registration
In June of 1999 the Company completed an initial public offering in which
it sold 5,000,000 shares of common stock at $15.00 per share which resulted in
net proceeds to the Company of approximately $68.0 million, net of issuance
costs of approximately $1.8 million. Upon closing of this offering all
outstanding shares of the Company's convertible preferred stock automatically
converted into common stock.
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<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following Management's Discussion and Analysis of Financial Condition
and Results of Operations contains forward-looking statements within the meaning
of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the
Securities Exchange Act of 1934, as amended. Words such as "anticipates,"
"expects," "intends," "plans," "believes," "seeks," "estimates" and similar
expressions identify such forward-looking statements. These forward-looking
statements are subject to risks and uncertainties that could cause actual
results to differ materially from those indicated in the forward-looking
statements. Factors which could cause actual results to differ materially
include those set forth in the following discussion, and, in particular, the
risks discussed below under the subheading "Additional Risk Factors that Could
Affect Operating Results and Market Price of Stock." Unless required by law, the
Company undertakes no obligation to update publicly any forward-looking
statements.
Overview
Software.com is a leading developer and provider of scalable Internet
infrastructure software applications. Our products and services are specifically
designed to enable service providers to market Internet based services to
businesses and consumers. To date, we have focused on developing carrier-scale,
high performance messaging software applications for providers of Internet
communications and services. We currently develop, market, sell, and support a
variety of Internet standards-based messaging software to customers worldwide,
including traditional telecommunications carriers, Internet service providers
and wholesalers, cable-based Internet access providers, competitive local
exchange telephone carriers, and Internet destination sites or portals. We have
developed three product packages: InterMail Post.Office, InterMail Kx, and
InterMail Mx, based on our software platform. These products allow our customers
to provide a variety of advanced messaging services to their Internet-based
consumer and business users. In March 1999, we introduced InterMail Kx, a
product designed for fast-growing, medium-sized service providers.
In March 1999, we entered into a marketing relationship with Hewlett-
Packard and, in connection with this agreement, Hewlett-Packard made an
investment in Software.com in April of 1999. In April 1999, we completed the
acquisition of Mobility.Net Corporation, a California company incorporated in
July 1996. Mobility.Net has developed an integrated Web mail and calendaring
system using a Java-based technology platform that complements our product
offerings. In June 1999 we released WebEdge(TM) Mail and Calendar, a Web-based
email and calendaring server for small and medium sized service providers.
We recognize revenue from sales of software upon delivery of a license key
to the customer, provided that persuasive evidence of an arrangement exists, the
license fee is fixed and determinable, and collection of the fee is considered
probable. If the license agreement has a multi-year term, as is typical with an
InterMail Mx contract, or the license fees are calculated based on variable
measures, such as the number of mailboxes in use, we recognize revenue as the
customer activates mailboxes on their system. When we enter into license
agreements under which our revenues are based on a percentage of our customer's
revenues, we recognize revenue as earned and reported by the customer. Revenues
from sales to resellers are not recognized until the product is sold through to
the end user and the license key is issued.
Service revenue is composed of revenue from support and maintenance
contracts as well as professional services and training. Revenues from support
and maintenance contracts are recognized ratably over the term of the support
and maintenance period. Substantially all of our InterMail Mx and InterMail Kx
customers purchase support and maintenance throughout the terms of their
contracts, which is generally paid on a quarterly basis. Although the majority
of our InterMail Post.Office customers initially purchase an annual support and
maintenance contract, a relatively small percentage of these customers renew the
contracts
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after the first year. This is primarily due to the ease of use of the product
and the customers' ability to purchase more economical "per-incident" support
services. Consulting services revenues are primarily related to deployment
services performed on a time-and-materials basis under separate service
arrangements. We recognize revenues from consulting and training services using
the percentage of completion method. When software and services are billed prior
to the time the related revenue is recognized, deferred revenue is recorded.
In a typical customer relationship, we receive software license revenue,
support and maintenance revenue, and, in some cases, also receive professional
services revenue. We recognize these three types of revenue at different stages
of our customer relationship. Substantially all of our professional services are
performed prior to the activation of mailboxes by the customer. As a result, we
generally recognize revenue from professional services in advance of revenue
from software license fees. If a customer has a large number of existing users,
we typically see a large revenue contribution at the time the customer transfers
existing user mailboxes to our software platform. After this transfer, the
software license revenue primarily reflects the growth in the number of
mailboxes. Support and maintenance revenue generally begins after installation
of our software and also primarily reflects the growth in the number of
mailboxes.
RESULTS OF OPERATIONS
The following table sets forth our results of operations expressed as a
percentage of revenues.
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
-------------------- ------------------
1999 1998 1999 1998
-------- -------- ------- --------
<S> <C> <C> <C> <C>
% of Total Revenues:
Software licenses................................ 58% 70% 60% 67%
Services......................................... 42 30 40 33
----- ----- ----- -----
Total revenues..................................... 100 100 100 100
Gross Margins:
Software licenses................................ 85 94 89 90
Services......................................... 30 13 31 11
----- ----- ----- -----
Gross Profit....................................... 62 70 66 64
Operating expenses:
Sales and marketing.............................. 47 38 46 42
Research and development........................ 35 34 35 38
General and administrative...................... 11 16 13 18
Legal matter..................................... (2) - (1) -
----- ----- ----- -----
Total operating expenses........................... 91 88 92 98
----- ----- ----- -----
Loss from operations............................... (29) (18) (26) (34)
----- ----- ----- -----
Net loss........................................... (32)% (19)% (29)% (35)%
===== ===== ===== =====
</TABLE>
Software Licenses. Software license revenue increased $902,000, or 21%,
from $4.3 million for the three months ended June 30, 1998 to $5.2 million in
the same period in 1999. Software license revenue increased $2.9 million or 39%
from $7.4 million for the six months ended June 30, 1998 to $10.3 million in the
same period in 1999. The increase in software license revenue was primarily due
to greater revenue from
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sales of our InterMail Kx product offerings (introduced in March 1999) which
overlap to some extent with our Post.Office offerings. Both products are
targeted at small and medium size service providers worldwide. Combined sales of
InterMail Kx and Post.Office in the three months ended June 30, 1999 and the six
months ended June 30, 1999 were 46% and 48% higher, respectively, than in the
same periods in 1998.
The largest contributor to software license revenue continues to be our
InterMail Mx product offering, sales of which grew 7% in the three months ended
June 30, 1999 over the same period in 1998. InterMail Mx product revenue
increased $300,000 or 11% from $2.7 million for the three months ended March 31,
1999 to $3.0 million for the three months ended June 30, 1999. During the three
months ended June 30, 1999 we had two large InterMail Mx customers migrate their
existing subscriber base from some other software to our platform, compared to
four large migrations in the same period in 1998. These migrations result in
increased revenues for us as we receive a fee for each mailbox activated. While
revenues from migrations were lower for the three months ended June 30, 1999 as
compared to the three months ended June 30, 1998, the overall revenue growth for
the three months ended June 30, 1999 as compared to the same period in 1998 was
related to incremental increases of activated mailboxes in our existing customer
base.
Services. Services revenue is primarily derived from consulting
services, maintenance and support contracts, and training. Services revenue
increased $2.0 million, or 111%, from $1.8 million for the three months ended
June 30, 1998 to $3.8 million in the same period in 1999. Services revenue
increased $3.2 million or 89% from $3.6 million for the six months ended June
30, 1998 to $6.8 million in the same period in 1999. The increase in services
revenue for the three months and six months ended June 30, 1999 as compared to
the same periods in 1998 was primarily due to a $1.1 million and $1.8 million
increase, respectively, in support and maintenance contracts as our customer
base grew, and an $899,000 and $1.4 million increase, respectively, in
professional services as the number of professional services engagements
increased. As a percentage of total revenues, services revenue increased to 42%
in the three months ended June 30, 1999 from 30% in the same period in 1998. As
a percentage of total revenues, services revenue increased to 40% for the six
months ended June 30, 1999 from 33% in the same period in 1998. These increases
are primarily related to support and maintenance from ongoing and new contracts
as well as an increased number of professional services engagements associated
with new and existing contracts. We expect services revenue as a percentage of
total revenues to increase as the expected number of professional services
engagements and support and maintenance contracts related to new and existing
contracts increases.
Cost of Software License Revenue. Cost of software license revenue
consists primarily of the salaries and related costs for our documentation
department, the production of documentation for our InterMail products, and the
cost of third party products integrated into our products or resold by us. Cost
of software license revenue increased $493,000, or 181%, from $273,000 for the
three months ended June 30, 1998 to $766,000 in the same period in 1999. The
increase was primarily due to the fact that in the three months ended June 30,
1999, we resold a third party database to three of our InterMail Mx customers,
and the cost of that software was included in cost of software license revenue
in that quarter. In the three months ended June 30, 1998, we did not resell any
third-party software, and did not have the associated costs. Cost of software
license revenue increased $385,000, or 51%, from $757,000 for the six months
ended June 30, 1998 to $1.1 million in the same period in 1999. The increase was
due primarily to the fact that during the six months ended June 30, 1999, we
resold a third party database to three of our InterMail Mx customers, as
compared to one customer in the same period in 1998.
Cost of Services Revenue. Cost of services revenue includes salaries and
related costs of our consulting services and customer support organizations,
cost of third parties contracted to provide consulting services to our
customers, and an allocation of our facilities and depreciation expenses. Cost
of services revenue increased $1.1 million, or 69%, from $1.6 million for the
three months ending June 30, 1998 to $2.7 million in the same period in 1999.
Cost of services increased $1.5 million, or 46%, from $3.2 million for the six
months ending June 30, 1998 to $4.7 million in the same period in 1999. The
increases in cost of services
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was primarily due to an increase in our consulting and support organizations
from 30 employees at June 30, 1998 to 55 employees at June 30, 1999 to support
our larger customer base. The improvement in gross margin on services revenue of
30% for the three months ended June 30, 1999 as compared to 13% for the same
period in 1998 was substantially attributable to improved margins on support and
maintenance contracts.
Sales and Marketing. Sales and marketing expense consists primarily of
salaries and benefits of our sales, marketing, product management and business
development organizations, sales commissions, marketing programs, and an
allocation of our facilities and depreciation expenses. Sales and marketing
expense increased by $2.0 million, or 82%, from $2.3 million for the three
months ended June 30, 1998 to $4.3 million in the same period in 1999. Sales and
marketing expense increased by $3.2 million, or 70%, from $4.6 million for the
six months ended June 30, 1998 to $7.8 million in the same period in 1999. The
increase in sales and marketing expense was due to growth in our global sales
organization. The total number of employees in the sales and marketing
organization increased from 40 at June 30, 1998 to 67 at June 30, 1999. We
expect our sales and marketing expenses will increase in absolute dollars in
future periods due to the planned expansion of our international sales and
marketing operations.
Research and Development. Research and development expense consists
primarily of salaries and benefits of our engineering and quality assurance
organizations, and an allocation of our facilities and depreciation expenses.
Research and development expense increased by $1.1 million, or 52%, from $2.1
million for the three months ended June 30, 1998 to $3.2 million in the same
period in 1999. Research and development expense increased by $1.7 million, or
40%, from $4.2 million for the six months ended June 30, 1998 to $5.9 million in
the same period in 1999. The increase in research and development expense was
primarily due to an increase in our development organization from 58 employees
at June 30, 1998 to 87 employees at June 30, 1999. We believe continued
investment in research and development is essential to our future success and we
expect our research and development expenses to increase in absolute dollars in
future periods.
General and Administrative. General and administrative expense consists
primarily of salaries and benefits of our finance, human resources and legal
services organizations, third party legal, accounting, and other professional
services fees, and an allocation of our facilities and depreciation expenses.
General and administrative expense increased by $44,000, or 5%, from $973,000
for the three months ended June 30, 1998 to $1.0 million in the same period in
1999. General and administrative expense increased by $263,000, or 14%, from
$1.9 million for the six months ended June 30, 1998 to $2.2 million in the same
period in 1999. The increase in general and administrative expense was primarily
due to increased fees for accounting and legal services. The increase in general
and administrative expense for the six months ended June 30, 1999 was related to
increased fees for accounting and legal services and one-time relocation costs
for a key executive hired in February 1999. We expect general and administrative
expenses to increase in absolute dollars in future periods as we continue to
build our infrastructure.
Legal Matter. In 1997 we accrued for an asserted claim related to a
minimum royalty obligation of $1 million purportedly owed by us under a
licensing agreement with a third party technology partner. In February 1999, we
and the third party entered into an agreement to settle all outstanding claims.
Under the settlement agreement, we agreed to pay the third party a minimum of
$400,000, with a contingent obligation to pay an additional $200,000 if we did
not take certain actions prior to December 31, 1999. Those actions were taken in
the second quarter of 1999, resulting in the satisfaction of the remaining
obligation. This matter is now completely resolved.
Other Income (Expense). Other income (expense) consists primarily of
interest expense associated with our credit facility and interest income. Total
other income (expense) increased $73,000, or 122%, from $60,000 for the three
months ended June 30, 1998 to $133,000 in the same period in 1999. The increase
was primarily related to an increase in foreign currency transaction costs.
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Provision for Income Taxes. For the three months ended June 30, 1999, we
had a tax provision of $78,000 related to foreign withholding and income taxes.
Liquidity and Capital Resources
We have funded our operations primarily through the private placement of
equity securities and the initial public offering of shares, which have raised
net proceeds of approximately $110.0 million to date, and through a bank line of
credit. At June 30, 1999, our principal sources of liquidity included
approximately $71.5 million of cash and cash equivalents, $2.9 million of short-
term investments, and a bank credit facility. This credit facility provides for
a total line of credit not to exceed the lesser of $15.0 million (of which we
may draw down up to $2.5 million as an equipment acquisition loan), or an amount
based on certain receivables collection criteria. As of June 30, 1999,we had
borrowed $546,000 and an additional $14.5 million was available under this
credit facility. Borrowings under this line of credit bear interest at prime
rate plus 1.5% and borrowings under the equipment acquisition loan bear interest
at prime rate plus 1.75% and all borrowings are secured by substantially all of
our assets. The credit facility includes financial and reporting covenants and
expires on August 31, 2000. Approximately $7.1 million of the net proceeds from
our initial public offering were used to pay down this credit facility.
Net cash used in operations for the six months ended June 30, 1998 and 1999
was $3.8 million and $4.5 million, respectively. Cash used in operating
activities for the six months ended June 30, 1998 was primarily due to our net
loss of $3.9 million and an increase in accounts receivable of $1.3 million,
partially offset by an increase in accounts payable of $1.1 million. Cash used
in operating activities for the six months ended June 30, 1999 was primarily due
to our net loss of $4.9 million and an increase in accounts receivable of $2.0
million, partially offset by an increase in accounts payable of $2.0 million.
Net cash used in investing activities was $3.4 million for the six months
ended June 30, 1999 as compared to net cash provided of $247,000 in the same
period in 1998. The change from 1998 to 1999 was primarily due to the purchase
of $3.0 million in short-term investments.
Net cash provided by financing activities increased $73.8 million from
$207,000 for the six months ended June 30, 1998 to $74.0 million in the same
period in 1999. The increase from 1998 to 1999 resulted primarily from proceeds
from the sale of common stock of $69.0 million in June 1999 as part of our
initial public offering and $10.0 million of convertible preferred stock (Series
D) in April 1999, offset by the partial repayment of our note payable to a bank
of $7.1 million. Cash provided by financing activities for the six months ended
June 30, 1998 was primarily related to the exercise of stock options and
proceeds from notes payable to a bank in the amounts of $261,000 and $120,000.
Year 2000 Readiness Disclosure
Background
Many currently installed computer systems and software products are coded
to accept only two digit entries in the date code field. These date code fields
will need to accept four digit entries to distinguish 21st century dates from
20th century dates. As a result, many companies' software and computer systems
may need to be upgraded or replaced in order to comply with these Year 2000
requirements. The use of software and computer systems that are not Year 2000
ready could result in system failures or miscalculations causing
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disruptions of operations including, among other things, a temporary inability
to process transactions, send invoices or engage in similar normal business
activities.
State of Readiness
We have instituted a Year 2000 Program Plan to address Year 2000
consequences that may materially affect us. Our Program Plan consists of six,
sometimes concurrent, phases: (1) inventory, (2) prioritization, (3) assessment,
(4)contingency planning, (5) remediation, and (6) monitoring and status
reporting.
We began taking preliminary inventory, prioritization and assessment steps
in the first quarter of 1998. To date, we have substantially completed our
inventory, prioritization and assessment phases. We have identified and
inventoried core business functions and their components, including our own
products and integrated third-party software, hardware, software, embedded
systems, critical business partnerships and external infrastructure services. We
defined and assigned preliminary criticality ratings to each of the inventoried
components and substantially completed the validation of our inventory and
prioritization processes during the second quarter of 1999. No assurances can be
made that the inventory or prioritization process will not be redefined at a
later date as we continue to monitor and refine our plans and goals.
Assessment of the various inventoried items has included documentation and
review of the Year 2000 compliance status of third-party vendors and suppliers
of our hardware, software and embedded systems, business partners, and external
infrastructure services. We have received assurances from most of our key
hardware and software suppliers and partners that their products and services
are Year 2000 compliant or that they are also progressing through Year 2000
compliance programs of their own. We will either test products and services that
are not yet compliant or work with the suppliers to gain assurances that we can
rely upon their products and services. For the components of our operations that
are deemed most critical, we are validating these assessments and accordingly
may reevaluate our scheduling and resource allocations as needed.
Currently, our own quality assurance personnel are testing our products
that are used by a substantial majority of our customers. Additionally, we have
enlisted outside consultants to review and advise upon our testing methods, but
we have not secured outside, independent testing services. Our products
interoperate with and depend upon other software, hardware and firmware for
data, including date-related data. Based on our testing to date, we believe that
our products, when interoperating with Year 2000 compliant software, hardware
and firmware, are able to manage and manipulate date-related data in a Year 2000
compliant manner.
We are a comparatively new enterprise, and, accordingly, the majority of
the software and hardware we use to manage our business was purchased or
developed by us within the last 24 months. While this fact pattern does not
uniformly protect us against Year 2000 exposure, we believe we gain some
mitigation from the fact that the information technology we use to manage our
business is not based upon legacy hardware and software systems. Legacy systems
are hardware and software systems that were developed in previous decades when
there was less awareness of Year 2000 issues. Generally, hardware and software
design within the current decade and the past several years in particular has
given greater consideration to Year 2000 issues. However, we have determined
that our financial reporting system requires an update to be Year 2000 compliant
and we intend to make the system compliant through an upgrade to be completed by
the end of the third quarter of 1999. Until completion of the assessment phase,
we will not be able to completely evaluate whether contingency plans are
warranted or what other components of our systems need to be remediated through
replacement or revision. We expect to complete assessment and any necessary
remediation by the third quarter of 1999.
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We have also applied program management practices by monitoring and status
reporting on the progress of our Year 2000 Program. There is a program manager
assigned to monitor and remind various staff of deadlines and status report due
dates, as well as to keep all staff synchronized. Monitoring and status
reporting is an ongoing phase throughout the life of the program.
Costs
To date, we have not incurred significant incremental costs in order to
comply with Year 2000 requirements for our products or internal systems. We have
incurred costs of approximately $30,000 for Year 2000 consulting provided by an
independent third party. We do not believe that we will incur significant
incremental costs in the foreseeable future except for costs associated with the
remediation and independent testing of various components of our systems, which
we do not currently believe will exceed an additional $70,000. However, we
cannot be sure that Year 2000 issues will not be discovered in our products or
internal software systems and, if any issues are discovered, we cannot be sure
that the costs of making such products and systems Year 2000 ready will not harm
our business, operating results, and financial condition.
Risks
Our customers and we rely heavily upon information technology systems and
the Internet to conduct our businesses and internal operations. Our customers'
success in maintaining Year 2000 compliance is significant to our ability to
generate revenues and execute our business plan. We cannot be sure that any
other software application, database software or computer hardware of our
customers which interfaces with our products (and which may be necessary in
order to use our products) is Year 2000 ready. We also cannot be sure that
implementations of our products on our customers' systems are, or will be, Year
2000 ready. Interruptions in our customers' services and on-line activities
caused by Year 2000 problems could harm our revenues to the extent that any
interruptions limit or delay our customers' ability to provide messaging
services to end users. Year 2000 complications may disrupt the operations,
viability, or commercial acceptance of the Internet generally, which also could
harm our business, operating results and financial condition. A significant
percentage of our customers are located overseas and we believe that the level
of Year 2000 readiness may be lower in these areas. Accordingly, our overseas
customers may have greater risks of Year 2000 problems.
If we, our customers, our providers of hardware and software, or external
infrastructure providers fail to remedy any Year 2000 issues, our business and
internal operations could be interrupted and our reputation, business, operating
results, and financial condition could suffer. We would consider an interruption
of our business and internal operations to be the most reasonably likely
unfavorable result of any failure by us, or failure by the third parties upon
which we rely, to achieve Year 2000 compliance.
Some commentators have predicted significant litigation regarding Year 2000
compliance issues, and we are aware of lawsuits regarding Year 2000 compliance
issues against other software vendors. Because we are in the business of selling
software products, our risk of being subjected to lawsuits relating to Year 2000
issues with our software products is likely to be greater than that of companies
in other industries. Because computer systems may involve hardware, firmware and
software components from different manufacturers, it may be difficult to
determine which component in a computer system may cause a Year 2000 issue. As a
result, we may be subjected to Year 2000 related lawsuits independent of whether
our products and services are Year 2000 ready. Any Year 2000 related lawsuits,
whether or not determined in our favor or settled by us, may be costly and may
divert the efforts and attention of our management from normal business
operations. The impact of any Year 2000 related lawsuits cannot be determined at
this time.
Contingency Plans
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Presently, we believe we are unable to reasonably estimate the duration and
extent of any disruptions that may be due to Year 2000 issues, or quantify the
effect that it may have on our future revenues. We have yet to develop a
comprehensive contingency plan to address the issues that could result from any
disruption due to Year 2000 issues. We are prepared to develop a comprehensive
contingency plan if our ongoing assessment leads us to conclude we have
significant exposure based upon the likelihood of a disruption due to Year 2000
issues. Responses received from all third-party vendors and service providers
will be taken into account in determining the need for and nature and extent of
any contingency plans. We intend to develop any required contingency plan by the
end of the third quarter of 1999.
Additional Risk Factors That Could Affect Operating Results and Market Price of
Stock
Our future revenues are unpredictable and we expect our quarterly operating
results to fluctuate, which could cause our stock price to decline
We cannot accurately forecast our revenues in any given period as a result
of our limited operating history, the emerging nature of the markets in which we
compete and our reliance on a small number of products and large customers. Our
revenues could fall short of our expectations if we experience delays in signing
new customer accounts or cancellation of one or more current or new customer
accounts. A number of factors are likely to cause fluctuations in our operating
results, including:
. the volume and timing of mailbox activation by our InterMail Mx service
provider customers;
. the length of our sales and product deployment cycles for our InterMail
products;
. our ability to attract and retain customers in new markets, including
Europe and Asia;
. our continuing dependence on the InterMail line of products and related
services for all of our revenues;
. our dependence on a small number of large customers;
. our dependence on continued growth of the service provider market;
. any delays in our introduction of new products or enhancements;
. the amount and timing of operating costs and capital expenditures
relating to expansion of our operations;
. the announcement or introduction of new or enhanced products or
services by our competitors;
. adverse customer reaction to technical difficulties or "bugs" in our
software;
. the growth rate and performance of the Internet in general and of
Internet messaging in particular;
. the volume of sales by our distribution partners and resellers;
. any slowdown in software and systems spending or in general business
expansion by service providers in the latter part of 1999 and the
beginning of 2000 in connection with Year 2000 issues; and
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. our pricing policies and those of our competitors.
Due to the foregoing factors, our quarterly operating results have
fluctuated significantly and we expect that future operating results will be
subject to similar fluctuations. Our revenue from large-scale installations of
our software depends heavily on the customers' timing of deployment of our
software, the migration of their installed base of users to our software
platform, and the rate of growth of their customer base. Accordingly, a delay in
a deployment past the end of a particular quarter could negatively impact our
results of operations for that quarter. It is possible that in future quarters
our operating results could fall below the expectations of public market
analysts or investors. In this event, the price of our common stock may fall.
We plan to significantly increase our operating expenses to expand our
international sales and marketing operations and fund greater levels of research
and development. Our operating expenses, which include sales and marketing,
research and development, and general and administrative expenses, are based on
expectations of future revenues and are relatively fixed in the short term. If
revenues fall below our expectations and we are not able to quickly reduce our
spending in response, our business, financial condition, and operating results
will suffer. Accordingly, period-to-period comparisons of our operating results
are not a good indication of our future performance. It is possible that our
operating results in some quarters will not meet the expectations of stock
market analysts and investors. In that event, our stock price would probably
decline.
Variations in the time it takes to sell, deploy and activate mailboxes using our
InterMail Mx product may cause fluctuations in our operating results, which
could cause our stock price to decline
Variations in the length of our sales and deployment cycles for InterMail
Mx could cause our revenue, and thus our business, financial condition and
operating results, to fluctuate widely from period to period. Our customers
generally take a long time to evaluate our InterMail Mx product, and many people
are involved in the evaluation process. We expend significant resources
educating and providing information to our prospective customers regarding the
use and benefits of InterMail Mx. Even after the purchase, our customers tend to
integrate InterMail Mx into their existing systems slowly and deliberately. The
timing of the deployment depends upon: .
. the efforts of our professional services staff;
. the geographic disbursement of the customer's hardware;
. the complexity of the customer's network and the resulting degree of
hardware configuration necessary to deploy InterMail Mx on their system;
. the internal technical capabilities of the customer;
. the customer's budgetary constraints; and
. the stability and sophistication of the customer's current messaging
system.
Because of the number of factors influencing the sales and deployment
processes, the period between our initial contact with a new customer and the
time when we begin to recognize revenue from that customer varies widely in
length. Our sales cycles for InterMail Mx typically range from six months to a
year, and our software deployment cycles typically range from three to six
months thereafter, although occasionally these cycles can be much longer. During
these cycles, we commit substantial resources in advance of receiving any
revenue.
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In addition, the amount of revenue that we are able to recognize in any
given period depends on how quickly our customers activate new mailboxes and
report the activation of those new mailboxes to us. Under our InterMail Mx
license agreements, our customers typically pay us a fee for each new user
account, or "mailbox," they activate using InterMail Mx. We recognize revenue
from these agreements when our customer reports its mailbox activations to us or
we otherwise learn of such activations. Customers typically report activations
on a quarterly basis after they have completed a deployment of InterMail Mx.
Because we charge our customers only for activating "new" mailboxes, a customer
can reassign a lost subscriber's mailbox to a new subscriber without having to
pay us a fee. We cannot control how quickly our customers activate new
mailboxes. The primary factors affecting the timing are the ability of our
customers to retain subscribers and grow their subscriber bases by attracting
end users to their online services, and their willingness to promote InterMail
Mx messaging services with their subscribers. Mailbox activations and the
associated revenue may be concentrated in a particular quarter and, as a result,
our revenue for a particular quarter is not a good indication of our future
revenue. Our revenues may fluctuate widely from period to period depending on
the timing of our customers' activation of new mailboxes, and any delay in or
failure by our customers to activate new mailboxes will harm our business,
financial condition, and operating results.
In addition, we base our quarterly revenue projections, in part, upon our
expectations of how many mailboxes our InterMail Mx customers will activate in
that quarter. Because the timing of mailbox activation is outside of our
control, it is often difficult for us to make accurate forecasts. If our
expectations, and thus our revenue projections, are not accurate for a
particular quarter, our actual operating results for that quarter could fall
below the expectations of analysts and investors.
Because we have a limited operating history, it may be difficult for you to
evaluate our business and prospects
We have only a limited operating history, which makes it difficult for
investors to predict our future operating performance. When making your
investment decision, you should consider the risks, expenses, and difficulties
that we may encounter as a young company in a rapidly evolving market. These
risks include our ability to:
. expand our sales and marketing activities;
. expand our customer base;
. develop and introduce new products and services;
. identify and integrate acquisitions; and
. compete effectively.
We cannot be certain that our business strategy will be successful or that we
will successfully address these risks.
We have a history of losses and we expect future losses
We have a history of losses, and we may not achieve or sustain
profitability. We have historically invested heavily in our sales and marketing
efforts and in technology research and development. We expect to continue to
spend substantial resources on developing and introducing new software products
and on expanding our sales and marketing activities, particularly in Europe and
Asia. As a result, we need to generate significant revenues to achieve and
maintain profitability. We expect that our sales and marketing expenses,
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research and development expenses, and general and administrative expenses will
continue to increase in absolute dollars and may increase as percentages of
revenues.
We incurred net losses of approximately $20.1 million for the period from
July 1994 through December 31, 1998. As of June 30, 1999, we had an accumulated
deficit of approximately $27.2 million. Although our revenues have grown
significantly in recent quarters, we may not be able to sustain these growth
rates or obtain sufficient revenues to achieve profitability. If we do achieve
profitability, we may not be able to sustain or increase profitability in the
future. Our failure to achieve and maintain profitability could adversely affect
our stock price.
We depend on a small number of customers for most of our revenues, and our
business, financial condition, and operating results could be harmed by a
decline or delay in revenue from these customers
We have generated a significant portion of our revenues from a limited
number of customers. We expect that a small number of customers will continue to
account for a significant portion of revenues for the foreseeable future. Our
target market is made up only of service providers, which constitute only a
small portion of all users of messaging solutions. As a result, if we lose a
major customer, or if there is a decline in usage, or if there is a downturn in
the service provider industry, our business, financial condition, and operating
results will suffer. In the year ended December 31, 1998, GTE Internetworking
Services accounted for approximately 12% of our revenue, and our top ten clients
accounted for approximately 56% of our revenue. For the three and six months
ended June 30, 1999 we had no customer that accounted for 10% or greater of our
total revenues. We cannot be certain that customers that have accounted for
significant revenues in past periods, individually or as a group, will continue
to generate revenues for us in any future period.
We must overcome significant and increasing competition in order to continue our
growth
The market for Internet standards-based messaging products and services is
intensely competitive, and we expect it to become increasingly so in the future.
We compete in our core service provider market with many software providers. We
also compete against messaging solutions based on public domain software that is
developed internally by service providers principally on the basis of
performance, features and price. We compete to a more limited extent with
providers of messaging applications designed for the enterprise market. Our
current competitors in the service provider market include Netscape and Sun
Microsystems, which has agreed to acquire many of Netscape's software
operations. We also compete with Microsoft whose current product was developed
for the enterprise market but is sold to some service providers. We believe that
competition will intensify as our current competitors increase the
sophistication of their offerings and as new market participants, including
providers of "outsourced" e-mail solutions, also known as wholesalers, enter the
market. Many of our current and future competitors have longer operating
histories, larger installed customer bases, greater brand recognition, and
significantly greater financial, marketing and other resources than we do. In
addition, these competitors may benefit from existing strategic and other
relationships with each other or with our current customers. We must respond
quickly and effectively to the new products, services, and enhancements offered
by our competitors in order to continue our growth.
Microsoft and other competitors possess many competitive advantages over us that
present risks to the sales of our products
Microsoft and Lucent Technologies, among others, are well-positioned to
become increasingly competitive in our core service provider messaging market.
We believe that Microsoft is currently in the process of developing electronic
messaging software to compete more directly in our core service provider market.
Because of its dominance in other software markets, Microsoft has many
competitive advantages over us. For example, Microsoft could incorporate
electronic messaging technology into its Web browser software,
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its client operating system or email interface, or its server software
offerings, possibly at no additional cost to service providers or end users. In
addition, Microsoft may promote technologies and standards that are not
compatible with our technology, or that are less compatible with our technology
than competitive products offered by Microsoft. We believe that Microsoft's
increasing presence in the electronic messaging software industry will
dramatically increase competitive pressure in the market, leading to increased
pricing pressure and longer sales cycles. These competitive pressures may force
us to reduce the prices of our products, and may also materially reduce our
market share. In addition, Lucent Technologies could be a formidable competitor
in the Internet voicemail market because it owns Octel, a voicemail provider,
and because it owns a proprietary access server for the conversion of voice to
data. If we are unable to compete effectively with Microsoft, Lucent
Technologies or other emerging competitors, our business, financial condition,
and operating results will suffer.
Our new InterMail Kx product may not be accepted by the market, and its
introduction may interfere with sales of our other products
If our target customers do not widely adopt and purchase InterMail Kx, our
business, financial condition, and operating results will suffer. Our software
licenses revenue have been derived primarily from the sale of our InterMail
Post.Office and InterMail Mx products. We introduced our InterMail Kx product in
March 1999, and our future growth depends in part on the commercial success of
this product. Although we have tested InterMail Kx prior to making it available
to customers, we cannot be certain that we have discovered and corrected all
significant performance errors. We are initially targeting service providers
with 25,000 to 250,000 subscribers for our InterMail Kx product. Several other
software vendors, including Microsoft, Netscape and Sun Microsystems, offer
messaging products to service providers of this size. These service providers
may not choose our InterMail Kx product for technical, cost, support, or other
reasons.
Competition from InterMail Kx could have a negative effect on our sales of
InterMail Post.Office or InterMail Mx, or the prices we could charge for these
products. We currently have several licenses for our InterMail Post.Office
product with service providers that have more than 25,000 subscribers and we
have licensed our InterMail Mx product to service providers with fewer than
250,000 subscribers. Accordingly, InterMail Kx may compete to some extent with
our other products. We may also divert sales and marketing resources from
InterMail Post.Office in order to successfully launch and promote InterMail Kx.
This diversion of resources could have a further negative effect on our sales of
InterMail Post.Office. If our revenues from InterMail Kx are not sufficient to
compensate for the effect of any decrease in sales or prices of our other
products, our business, financial condition, and operating results will suffer.
Our acquisition strategy could cause financial or operational problems
Our success depends on our ability to continually enhance and broaden our
product offerings in response to changing technologies, customer demands, and
competitive pressures. To this end, we may acquire new and complementary
businesses, products, or technologies, instead of developing them ourselves. We
do not know if we will be able to complete any acquisitions or that we will be
able to successfully integrate any acquired business, operate them profitably,
or retain their key employees. For example, we completed the acquisition of
Mobility.Net Corporation in April 1999. Integrating Mobility.Net or any other
newly acquired business, product or technology could be expensive and time-
consuming, could disrupt our ongoing business, and could distract our
management. We may face competition for acquisition targets from larger and more
established companies with greater financial resources. In addition, in order to
finance any acquisitions, we might need to raise additional funds through public
or private financings. In that event, we could be forced to obtain equity or
debt financing on terms that are not favorable to us and, in the case of equity
financing, that results in dilution to our stockholders. If we are unable to
integrate Mobility.Net or any other newly acquired entities or technologies
effectively, our business, financial condition, and operating
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results would suffer. In addition, any amortization of goodwill or other assets,
or other charges resulting from the costs of acquisitions could harm our
business, financial condition, and operating results.
Our expanding international operations are subject to significant uncertainties
in addition to those we face in domestic markets
For the three months ended June 30, 1999 and 1998 and the six months ended
June 30, 1999 and 1998, approximately 48%, 30%, 50% and 25% of our total
revenues, respectively were attributable to customers outside of North America.
If our revenues from international operations, and particularly from our
operations in the countries and regions on which we have focused our spending,
do not exceed the expense of establishing and maintaining these operations, our
business, financial condition, and operating results will suffer. We recently
began to invest significant financial and managerial resources to expand our
sales and marketing operations in international markets, and we must continue to
do so for the foreseeable future in order to succeed in these markets. In
particular, we are making significant expenditures on expansion in Europe and
Asia, including the localization of our products for use in these regions, and
we expect these expenditures to continue or increase. We are expending the most
resources in the countries and regions that we think will be the most receptive
markets for our products. We have only limited experience in international
operations, and we may not be able to capitalize on our investment in these
markets. In this regard, we face certain risks inherent in conducting business
internationally, including:
. fluctuations in currency exchange rates;
. problems caused by the ongoing conversion of various European currencies
into a single currency, the Euro;
. any imposition of currency exchange controls;
. unexpected changes in regulatory requirements applicable to the Internet
or our business;
. difficulties and costs of staffing and managing international
operations;
. differing technology standards;
. difficulties in collecting accounts receivable and longer collection
periods;
. seasonal variations in customer buying patterns or electronic messaging
usage;
. political instability or economic downturns;
. potentially adverse tax consequences; and
. reduced protection for intellectual property rights in certain
countries.
Any of these factors could harm our international operations and, consequently,
our business, financial condition, and operating results.
The loss of any of our senior management or key personnel could harm our
business, financial condition, and operating results
Our success depends on the skills, experience and performance of our senior
management and certain other key personnel, some of whom have worked together
for only a short period of time. We do not have
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employment agreements with any of our senior management or other key personnel,
and their employment is at will. The loss of the services of any of our senior
management or other key personnel could harm our business, financial condition,
and operating results.
If we are unable to attract and retain highly skilled employees, our financial
and operational results may suffer
Our success depends on our ability to recruit, integrate, retain, and
motivate highly skilled sales and marketing, engineering, and quality assurance
personnel. In particular, our ability to attract and retain qualified sales
management personnel is critical to the success of our planned expansion in
Europe and Asia. Competition for these people in the Internet messaging industry
is intense, and we may not be able to successfully recruit, train, or retain
qualified personnel. If we fail to retain and recruit necessary sales and
marketing, engineering, and quality assurance personnel, our ability to obtain
new customers, develop new products and provide acceptable levels of customer
service could suffer, and this could harm our business, financial condition, and
operating results.
We must adapt to rapid changes in technology and customer preferences in order
to remain competitive
The Internet messaging industry is characterized by rapidly changing
technology, changes in customer and end user requirements and preferences, and
evolving industry standards and practices that could render our software
products obsolete. Our success depends on our ability to enhance our existing
messaging platform and products on a timely basis and to develop new products
that address the increasingly sophisticated and varied needs of our customers
and their end users. We must accurately forecast the features and functionality
required by our target customers and end users in order to continually improve
our products. For example, in response to customer and end user demand, we have
recently developed for some of our products a voicemail feature based on
Internet standards that govern data transmission and receipt, known as Internet
Protocol or "IP." The development of proprietary technology and product
enhancements has required, and will continue to require, substantial
expenditures and lead-time, and we may not always be able to keep pace with the
latest technological developments. If we cannot, for technical, legal,
financial, or other reasons, adapt our products to changing customer or end user
requirements or industry standards in a cost-effective and timely fashion, or if
any new product, enhancement, or feature, including InterMail Kx, IP voicemail,
or Web-applications technology acquired in the Mobility.Net acquisition such as
WebEdge Mail and Calendar, is not favorably received and accepted by customers
and end users, our business, financial condition, and operating results will
suffer.
Our software products may have unknown defects, which could harm our reputation
or impede market acceptance of our products
Despite testing by us, defects have in the past and may in the future occur
in our software. Complex software like ours is difficult to integrate with
customers' existing systems and often contains errors or defects, particularly
when first introduced or when new versions or enhancements are released.
Although we conduct extensive testing, we may not discover software defects that
affect our current or new products, including our InterMail Kx and IP voicemail
products, or Web-applications technology acquired in the Mobility.Net
acquisition such as WebEdge Mail and Calendar, until after they are sold. We
also experience difficulty in deploying software at our customer's sites due to
its complex nature. Any defect in other software or hardware with which our
software interacts could be mistakenly attributed to our software by our
customers or their end users. These defects or perceptions of defects could
cause our customers and their end users to experience service interruptions.
Because our customers depend on our software to provide critical services to
their end users, any service interruptions could damage our reputation or
increase our product
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development costs, divert our product development resources, cause us to lose
revenue, or delay market acceptance of our products, any of which could harm our
business, financial condition, and operating results.
The rapid growth of our operations could strain our resources and harm our
business, financial condition, and operating results
Our recent growth has placed and will continue to place a significant
strain on our management systems, infrastructure, and resources. We are
increasing the scope of our operations and our customer base domestically and
internationally, and we have recently increased our headcount substantially.
From December 31, 1997 to June 30, 1999 our total number of employees increased
from 144 to 257. We expect that we will need to continue to improve our
financial and managerial controls and reporting systems and procedures, and will
need to continue to expand, train, and manage our workforce worldwide. We expect
that we will be required to manage an increasing number of relationships with
various customers and other third parties. Our ability to successfully offer
products and services and implement our business plan in a rapidly evolving
market requires an effective planning and management process. Any failure to
expand any of the foregoing areas efficiently and effectively could harm our
business, financial condition and operating results. In addition, there can be
no assurance that our business will continue to grow at historical rates.
Our business depends on continued growth in use and improvement of the Internet
The infrastructure, products, and services necessary to maintain and expand
the Internet may not be developed, and the Internet may not continue to be a
viable medium for secure and reliable personal and business communication, in
which case our business, financial condition, and operating results would be
harmed. Because we are in the business of providing electronic messaging
software, our future success depends on the continued expansion of, and reliance
of consumers and businesses on, the Internet for communications. The Internet
may not be able to support an increased number of users or an increase in the
volume of data transmitted over it. As a result, the performance or reliability
of the Internet in response to increased demands will require timely improvement
of the high speed modems and other communications equipment that form the
Internet's infrastructure. The Internet has already experienced temporary
outages and delays as a result of damage to portions of its infrastructure. The
effectiveness of the Internet may also decline due to delays in the development
or adoption of new technical standards and protocols designed to support
increased levels of activity and due to the transmission of computer viruses.
Future sales of our common stock may depress our stock price
If our stockholders sell a substantial number of our shares in the public
market during a short period of time, our stock price could decline
significantly. As of July 30, 1999, we had 40,792,476 shares of common stock
outstanding. Of these, 6,935,650 shares, or approximately 17% of the
outstanding shares, were available for sale on the public markets. The
remaining 33,856,826 shares of common stock held by existing stockholders are
"restricted shares," as that term is defined in Rule 144 under the Securities
Act of 1933, as amended. The 33,856,826 restricted shares are subject to lock-
up agreements or other contractual restrictions providing that the stockholder
will not offer, sell, contract to sell or otherwise dispose of the shares, for a
period of 180 days after June 23, 1999, without the prior written consent of
Credit Suisse First Boston Corporation. As a result of these lock-up agreements
and other contractual restrictions, and unless Credit Suisse First Boston elects
to remove the restrictions at an earlier date, none of these shares will be
resellable until 181 days after June 23, 1999.
Beginning 181 days after June 23, 1999, approximately 30,050,817 restricted
shares will be eligible for sale in the public market, all of which are subject
to volume limitations under Rule 144, except approximately 15,682,083 shares
eligible for sale under Rule 144(k) and 762,213 shares eligible for sale under
Rule 701. Under Rule 144(k), a person who is not deemed to have been an
affiliate of ours at any time
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<PAGE>
during the three months preceding a sale, and who has beneficially owned the
shares proposed to be sold for at least two years, including the holding period
of any prior owner except an affiliate, is entitled to sell such shares without
complying with the manner of sale, public information, volume limitation, or
notice provisions of Rule 144. In addition, as of July 30, 1999, 2,629,620
shares of our common stock were subject to vested stock options, 6,344,993 were
subject to unvested stock options, and 809,585 remained available for grant
under our stock plans. Those options, as well as warrants to purchase 866,903
shares of common stock, are also subject to lock-up agreements for a period of
180 days after June 23, 1999. Credit Suisse First Boston Corporation may, in its
sole discretion and at any time without notice, release any portion of the
securities subject to lock-up agreements or other contractual restrictions.
Sales of substantial amounts of our common stock in the public market after the
restrictions lapse could adversely affect the prevailing market price and our
ability to raise equity capital in the future.
Problems related to the Year 2000 could harm our products or our reputation, or
cause our customers to decrease spending on our products and services
Many currently installed computer systems and software products are coded
to accept only two digit entries in the date code field. As a result, software
that records only the last two digits of the calendar year may not be able to
distinguish whether "00" means 1900 or 2000. This may result in software
failures or errors that could harm our business.
We are in the process of assessing our Year 2000 readiness and are
investigating and performing testing to determine whether our software products
are Year 2000 compliant. Our software products operate in complex network
environments, including the Internet, and directly and indirectly interact with
a number of other hardware and software systems. Despite preliminary
investigation and testing by us and our customers and partners, our software
products and the underlying systems and protocols running our products may
contain errors or defects associated with Year 2000 date functions. We are
unable to predict to what extent our business may be affected if our software or
the systems that operate in conjunction with our software, including the
Internet, experience a Year 2000 failure. Known or unknown errors or defects
that affect the operation of our software could result in delays or losses of
revenue, interruptions of email service, cancellations of contracts by our
customers, diversions of our development resources, damage to our reputation,
increased service and warranty costs, and litigation costs, any of which could
harm our business, financial condition, and operating results.
If the performance of our software is adversely affected by Year 2000
problems in our customers' hardware or software programs with which our software
interacts, our customers or their end users may mistakenly believe that these
problems were caused by our software. These customers and end users could react
by demanding extensive technical support from us or by filing suit against us,
either of which would cause a significant diversion of our management and
financial resources. Regardless of whether we experience Year2000 problems,
service providers and enterprises may reduce their spending on software,
systems, and related services during the latter part of 1999 and the beginning
of 2000 in connection with actual or anticipated Year 2000-relatedproblems. Any
reduction in software, systems and related services spending could impede our
ability to attract new customers and harm our business, financial condition, and
operating results.
Our intellectual property or proprietary rights could be misappropriated, which
could force us to become involved in expensive and time-consuming litigation
Our ability to compete and continue to provide technological innovation is
substantially dependent upon internally developed technology, including the
entire InterMail product line. We rely on a combination of copyright, trade
secret, and trademark law to protect our technology, although we believe that
other factors such as the technological and creative skills of our personnel,
new product developments, frequent product
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<PAGE>
and feature enhancements, and reliable product support and maintenance are more
essential to maintaining a technology leadership position. We currently do not
have any patents issued or pending.
We generally enter into confidentiality and nondisclosure agreements with
our employees, consultants, prospective customers, licensees, and corporate
partners. In addition, we control access to and distribution of our software,
documentation, and other proprietary information. Except for certain limited
escrow arrangements, we do not provide third parties with access to the source
code for our products. Despite our efforts to protect our intellectual property
and proprietary rights, unauthorized parties may attempt to copy or otherwise
obtain and use our products or technology. Effectively policing the unauthorized
use of our products is time-consuming and costly, and there can be no assurance
that the steps taken by us will prevent misappropriation of our technology,
particularly in foreign countries where in many instances the local laws or
legal systems do not offer the same level of protection as in the United States.
If others claim that our products infringe their intellectual property rights,
we may be forced to seek expensive licenses, reengineer our products, engage in
expensive and time-consuming litigation, or stop marketing our products
We attempt to avoid infringing known proprietary rights of third parties in
our product development efforts. However, we do not regularly conduct
comprehensive patent searches to determine whether the technology used in our
products infringes patents held by third parties. There are many issued patents
as well as patent applications in the electronic messaging field. Because patent
applications in the United States are not publicly disclosed until the patent is
issued, applications may have been filed which relate to our software products.
In addition, our competitors and other companies as well as research and
academic institutions have conducted research for many years in the electronic
messaging field, and this research could lead to the filing of further patent
applications. If we were to discover that our products violated or potentially
violated third party proprietary rights, we might not be able to obtain licenses
to continue offering those products without substantial reengineering. Any
reengineering effort may not be successful, nor can we be certain that any
licenses would be available on commercially reasonable terms.
Substantial litigation regarding intellectual property rights exists in the
software industry, and we expect that software products may be increasingly
subject to third-party infringement claims as the number of competitors in our
industry segments grows and the functionality of software products in different
industry segments overlaps. Any third-party infringement claims could be time-
consuming to defend, result in costly litigation, divert management's attention
and resources, cause product and service delays or require us to enter into
royalty or licensing agreements. Any royalty or licensing arrangements, if
required, may not be available on terms acceptable to us, if at all. A
successful claim of infringement against us and our failure or inability to
license the infringed or similar technology could have a material adverse effect
on our business, financial condition, and results of operations.
The geographic dispersement of our senior management could impede their ability
to communicate effectively
Our senior management and key personnel are based in several different
offices, which makes coordination of projects more difficult. For example, John
MacFarlane, our Chief Executive Officer, and John Ingalls, our Chief Financial
Officer, are based at our headquarters in Santa Barbara, California, while
Valdur Koha, our President, and John Poulack, our Senior Vice President,
Operations, are based at our office in Lexington, Massachusetts. The geographic
dispersement of our senior management team and key personnel could impede their
ability to communicate effectively or work together efficiently, either of which
could harm our business, financial condition, and operating results.
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The security provided by our messaging products could be breached, in which case
our reputation, business, financial condition, and operating results could
suffer
The occurrence or perception of security breaches could harm our business,
financial condition, and operating results. A fundamental requirement for online
communications is the secure transmission of confidential information over the
Internet. Third parties may attempt to breach the security provided by our
messaging products, or the security of our customers' internal systems. If they
are successful, they could obtain confidential information about our customers'
end users, including their passwords, financial account information, credit card
numbers, or other personal information. Our customers or their end users may
file suits against us for any breach in security. Even if we are not held
liable, a security breach could harm our reputation, and even the perception of
security risks, whether or not valid, could inhibit market acceptance of our
products. Despite our implementation of security measures, our software is
vulnerable to computer viruses, electronic break-ins and similar disruptions,
which could lead to interruptions, delays, or loss of data. We may be required
to expend significant capital and other resources to license encryption or other
technologies to protect against security breaches or to alleviate problems
caused by these breaches. In addition, our customers might decide to stop using
our software if their end users experience security breaches.
Future governmental regulation of the Internet could limit our ability to
conduct our business
Although there are currently few laws and regulations directly applicable
to the Internet and commercial messaging, a number of laws have been proposed
involving the Internet, including laws addressing user privacy, pricing,
content, copyrights, distribution, antitrust, and characteristics and quality of
products and services. Further, the growth and development of the market for
online messaging may prompt calls for more stringent consumer protection laws
that may impose additional burdens on those companies, including us, that
conduct business online. The adoption of any additional laws or regulations may
impair the growth of the Internet or commercial online services, which would
decrease the demand for our services and could increase our cost of doing
business or otherwise harm our business, financial condition, and operating
results. Moreover, the applicability of existing laws governing property
ownership, sales and other taxes, libel, and personal privacy to the Internet is
uncertain and may take years to resolve.
Our stock price may be volatile, exposing us to expensive and time-consuming
securities class action litigation
The stock market in general, and the stock prices of Internet-related
companies in particular, have recently experienced extreme volatility, which has
often been unrelated to the operating performance of any particular company or
companies. If market or industry-based fluctuations continue, our stock price
could decline below current levels or the initial public offering price
regardless of our actual operating performance. In the past, securities class
action litigation has often been brought against companies following periods of
volatility in their stock prices. We may in the future be the target of similar
litigation. Securities litigation could result in substantial costs and divert
our management's time and resources, which could harm our business, financial
condition, and operating results.
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<PAGE>
Provisions of our corporate documents and Delaware law could deter takeovers and
prevent you from receiving a premium for your shares
Provisions of our certificate of incorporation, our bylaws and Delaware law
could make it more difficult for a third party to acquire us, even if doing so
might be beneficial to our stockholders. For example, our certificate of
incorporation provides that our board may issue up to 5,000,000 shares of
preferred stock without stockholder approval.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
We develop products in the United States and sell in North America, South
America, Asia and Europe. As a result, our financial results could be affected
by factors such as changes in foreign currency exchange rates or weak economic
conditions in foreign markets. As all sales are currently made in U.S. dollars,
a strengthening of the dollar could make our products less competitive in
foreign markets. Our interest income is sensitive to changes in the general
level of U.S. interest rates, particularly since the majority of our investments
are in short-term instruments. Our interest expense is sensitive to changes in
the prime rate. Due to the nature of our short-term investments and debt, we
have concluded that there is no material market risk exposure.
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<PAGE>
SOFTWARE.COM, INC.
PART II: OTHER INFORMATION
Item 1. Legal Proceedings
None
Item 2. Changes in Securities and Use of Proceeds
a) Under our 1995 Stock Option Plan, on April 23, 1999, we granted options
to purchase 384,950 shares of our common stock at an exercise price of $9.00 per
share; on May 28, 1999, we granted options to purchase 551,000 shares of our
common stock at an exercise price of $11.00 per share; on June 11, 1999, we
granted options to purchase 175,000 shares of our common stock at an exercise
price of $11.00 per share, and on June 29, 1999, we granted options to purchase
23,000 shares of our common stock at an exercise price of $20.25 per share. From
April 1, 1999 to June 30, 1999, we issued and sold 551,303 shares of common
stock at prices ranging from $0.63 to $11.00 per share upon the exercise of
stock options granted under our 1995 Stock Option Plan. The option grants and
the stock issuances were exempt from registration under the Securities Act of
1933, as amended (the "Securities Act"), in reliance on Rule 701 of the
Securities Act. The shares of Common Stock acquired upon exercise of options are
restricted securities.
(b) On April 5, 1999, we issued and sold an aggregate of 1,626,016 shares
of our Series D preferred stock to Hewlett-Packard Company for an aggregate
purchase price of approximately $10,000,000. This stock issuance was exempt
from registration in reliance on Regulation D promulgated under Section 4(2) of
the Securities Act. The shares of Series D preferred stock issued in the
transaction are restricted securities.
(c) On April 12, 1999, we issued 1,579,294 shares of our common stock in
exchange for all of the outstanding shares of Mobility.Net Corporation. This
stock issuance was exempt from registration in reliance on Regulation D
promulgated under Section 4(2) of the Securities Act. The shares of common
stock issued in the transaction are restricted securities.
(d) On June 23, 1999, we commenced our initial public offering, which
consisted of 6,000,000 shares of our common stock (including 1,000,000 shares
offered by the selling stockholders named in the registration statement) at
$15.00 per share pursuant to a registration statement (No. 333-76263) (the
"Registration Statement") declared effective by the Securities and Exchange
Commission on June 23, 1999. Subsequently, and prior to the closing of the
initial public offering, the underwriters elected to exercise their over-
allotment option, resulting in the sale of an additional 900,000 shares by the
selling stockholders. The offering has been terminated and all shares have been
sold. The managing underwriters for the initial public offering were Credit
Suisse First Boston Corporation, Merrill Lynch, Pierce, Fenner & Smith
Incorporated and BancBoston Robertson Stephens Inc. Aggregate proceeds from the
offering were $75,000,000.
We incurred the following expenses in connection with the offering:
underwriters' discounts and commissions of $5,250,000 and approximately
$1,800,000 in other expenses, for total expenses of $7,050,000.
After deducting expenses of the offering, we received net offering proceeds
of $67,950,000. From June 23, 1999, the effective date of the registration
statement, to June 30, 1999, the ending date of the reporting period, the
approximate amount of net offering proceeds used were $7.1 million to repay
borrowings under our line of credit with Coast Business Credit. The remaining
net proceeds were invested in short-term financial instruments.
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<PAGE>
No payments constituted direct or indirect payments to any of our
directors, officers or general partners or their associates, to persons owning
10% or more of any class of our equity securities, or to any of our affiliates.
Item 3. Defaults upon Senior Securities
Not applicable
Item 4. Submission of Matters to a Vote of Security Holders
During the fiscal quarter ended June 30, 1999, we solicited written consent
(effective April 12, 1999) from our sole stockholder regarding the approval of
the actions by our incorporator and approval of the amendment and restatement of
our Restated Articles of Incorporation in connection with our formation as a
wholly-owned subsidiary of Software.com, Inc., a California corporation
("Software.com California") and the subsequent reincorporation of Software.com
California into Delaware.
During this quarter, we also solicited written consent (effective May 4,
1999) from our sole stockholder regarding the following matters; (i) approval of
our merger with Software.com California in which we were the surviving
corporation and Software.com is reincorporated into Delaware (the
"Reincorporation"); (ii) approval and authorization indemnification agreements
to be entered into with the our officers and directors; (iii) approval of the
second amended and restated of incorporation which provided for (a) an increase
in the number of shares of authorized common stock to 150,000,000, (b) the
authorization of 5,000,000 shares of undesignated preferred stock, (c) the
establishment of a classified board of directors with staggered three year terms
as follows: Class 1: John MacFarlane, Neal Douglas and Frank Perna, Class 2:
Bernard Puckett and Don Listwin, Class 3: Judith Hamilton and Bernard Woebker,
and (e) the elimination of the ability of stockholders to take action by written
consent; (iv) the approval of the amendment and restatement of the 1995 Stock
Option Plan; (v) the approval of the adoption of the 1999 Employee Stock
Purchase Plan and the reservation of 1,000,000 shares of common stock to be
issued thereunder. Each written consent and each matter contained therein was
approved by our sole stockholder.
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K
a) Exhibit 27 Financial Data Schedule
b) Reports on Form 8-K - No reports on Form 8-K were filed during the
quarter ended June 30, 1999.
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<PAGE>
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto.
Date: August 12, 1999
__________________________ By: /s/ John S. Ingalls
----------------------------
John S. Ingalls
Chief Financial Officer
(Principal financial officer)
Date: August 12, 1999 By: /s/ Mark A. Root
__________________________ ----------------------------
Mark A. Root
Director of Accounting
(Principal accounting officer)
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