<PAGE> 1
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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, 2000
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ____________ TO ____________ .
COMMISSION FILE NUMBER
CRITICAL PATH, INC.
<TABLE>
<S> <C>
A CALIFORNIA CORPORATION I.R.S. EMPLOYER NO. 91-1788300
</TABLE>
320 FIRST STREET
SAN FRANCISCO, CALIFORNIA 94105
415-808-8800
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed 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. [X] Yes [ ] No
As of July 31, 2000, the company had outstanding 63,877,571 shares of
common stock, $ 0.001 par value per share.
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<PAGE> 2
CRITICAL PATH, INC.
INDEX
<TABLE>
<CAPTION>
PAGE
----
<S> <C> <C>
PART I
Item 1. Consolidated Financial Statements (Unaudited)...............
Consolidated Balance Sheet.................................. 1
Consolidated Statement of Operations........................ 2
Consolidated Statement of Cash Flows........................ 3
Notes to Consolidated Financial Statements.................. 4
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................... 12
Supplemental Pro Forma Financial Data (Unaudited)........... 32
Item 3. Quantitative and Qualitative Disclosures About Market
Risk........................................................ 33
PART II
Item 1. Legal Proceedings........................................... 34
Item 2. Changes in Securities and Use of Proceeds................... 34
Item 3. Defaults Upon Senior Securities............................. 34
Item 4. Submission of Matters to a Vote of Security Holders......... 34
Item 5. Other Information........................................... 35
Item 6. Exhibits and Reports on Form 8-K............................ 35
</TABLE>
i
<PAGE> 3
PART I
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
CRITICAL PATH, INC.
CONSOLIDATED BALANCE SHEET
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
DECEMBER 31, JUNE 30,
1999 2000
------------ -----------
(UNAUDITED)
<S> <C> <C>
ASSETS
Current assets
Cash and cash equivalents................................. $ 75,932 $ 291,309
Restricted cash........................................... 325 325
Accounts receivable, net.................................. 10,147 33,306
Other current assets...................................... 40,800 7,706
--------- ----------
Total current assets............................... 127,204 332,646
Investments................................................. 18,426 26,326
Notes receivable from officers.............................. 669 977
Property and equipment, net................................. 52,517 73,555
Intangible assets, net...................................... 474,297 1,159,083
Other assets................................................ 692 9,260
--------- ----------
Total assets....................................... $ 673,805 $1,601,847
========= ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities
Accounts payable.......................................... $ 35,621 $ 30,714
Accrued expenses.......................................... 7,120 16,496
Deferred revenue.......................................... 1,818 14,552
Capital lease and other obligations, current.............. 6,585 9,637
--------- ----------
Total current liabilities.......................... 51,144 71,399
Convertible subordinated notes payable...................... -- 300,000
Capital lease and other obligations, long-term.............. 5,669 8,198
--------- ----------
Total liabilities.................................. 56,813 379,597
--------- ----------
Minority interest in consolidated subsidiary................ -- 325
Commitments and contingencies
Shareholders' Equity
Preferred Stock and paid-in-capital, $0.001 par value
Shares authorized: 5,000
Shares issued and outstanding: none -- --
Common Stock and paid-in-capital, $0.001 par value
Shares authorized: 150,000
Shares issued and outstanding: 46,937 and 63,523 (net of
134 and 150 treasury shares at cost of $229 and $278,
respectively)........................................... 864,699 1,677,303
Notes receivable from shareholders........................ (1,154) (1,180)
Unearned compensation..................................... (124,906) (119,353)
Accumulated deficit, including other comprehensive
income.................................................. (121,647) (334,845)
--------- ----------
Total shareholders' equity......................... 616,992 1,221,925
--------- ----------
Total liabilities and shareholders' equity......... $ 673,805 $1,601,847
========= ==========
</TABLE>
The accompanying notes are an integral part of these Consolidated Financial
Statements.
1
<PAGE> 4
CRITICAL PATH, INC.
CONSOLIDATED STATEMENT OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
--------------------- ---------------------
JUNE 30, JUNE 30, JUNE 30, JUNE 30,
1999 2000 1999 2000
-------- --------- -------- ---------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C>
Net revenues
Licenses.................................... $ -- $ 13,897 $ -- $ 24,967
Services.................................... 2,006 19,598 3,055 33,081
-------- --------- -------- ---------
Total net revenues.................. 2,006 33,495 3,055 58,048
-------- --------- -------- ---------
Cost of net revenues
Licenses.................................... -- 737 -- 1,744
Services.................................... 3,234 16,738 5,148 31,078
Amortization of purchased technology........ -- 4,421 -- 6,535
Acquisition-related retention bonuses....... -- 390 -- 780
Stock-based expenses........................ 743 383 1,189 876
-------- --------- -------- ---------
Total cost of net revenues.......... 3,977 22,669 6,337 41,013
-------- --------- -------- ---------
Gross profit (loss)........................... (1,971) 10,826 (3,282) 17,035
-------- --------- -------- ---------
Operating expenses
Sales and marketing......................... 3,219 17,342 5,203 30,947
Research and development.................... 1,430 9,213 2,809 15,536
General and administrative.................. 2,691 7,332 4,241 14,098
Amortization of intangible assets........... 550 88,986 550 136,685
Acquisition-related retention bonuses....... -- 3,693 -- 6,372
Stock-based expenses........................ 8,162 11,942 19,819 18,645
-------- --------- -------- ---------
Total operating expenses............ 16,052 138,508 32,622 222,283
-------- --------- -------- ---------
Loss from operations.......................... (18,023) (127,682) (35,904) (205,248)
Interest and other income (expense), net...... 1,882 4,697 2,233 5,954
Interest expense.............................. (180) (5,260) (244) (5,533)
Minority interest in net income of
consolidated subsidiary..................... -- (325) -- (325)
-------- --------- -------- ---------
Loss before income taxes...................... (16,321) (128,570) (33,915) (205,152)
Provision for income taxes.................... -- (1,439) -- (1,799)
-------- --------- -------- ---------
Net loss...................................... $(16,321) $(130,009) $(33,915) $(206,951)
======== ========= ======== =========
Net loss per share -- basic and diluted....... $ (0.49) $ (2.22) $ (1.70) $ (3.79)
======== ========= ======== =========
Weighted average shares -- basic and
diluted..................................... 32,977 58,592 19,994 54,581
======== ========= ======== =========
</TABLE>
The accompanying notes are an integral part of these Consolidated Financial
Statements.
2
<PAGE> 5
CRITICAL PATH, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
1999 2000
-------- ---------
SIX MONTHS ENDED JUNE 30, (UNAUDITED)
<S> <C> <C>
Operations
Net loss.................................................. $(33,915) $(206,951)
Provision for doubtful accounts........................... 99 575
Depreciation and amortization............................. 2,015 14,604
Amortization of intangible assets......................... 550 143,220
Amortization of stock-based costs and expenses............ 21,146 19,552
Minority interest in net income of consolidated
subsidiary............................................. -- 325
Accounts receivable....................................... (1,793) (12,038)
Other assets.............................................. (6,985) 3,206
Accounts payable.......................................... 2,548 (10,151)
Accrued expenses.......................................... 462 7,686
Deferred revenue.......................................... (500) 965
-------- ---------
Net cash used in operating activities.................. (16,373) (39,007)
-------- ---------
Investing
Notes receivable from officers............................ (200) (241)
Property and equipment purchases.......................... (7,255) (25,972)
Investments in unconsolidated entities, net............... (3,000) (13,508)
Payments for acquisitions, net of cash acquired........... (12,000) (9,494)
Repayment of promissory note receivable................... -- 10,000
-------- ---------
Net cash used in investing activities.................. (22,455) (39,215)
-------- ---------
Financing
Proceeds from issuance of Preferred Stock, net............ 12,496 --
Proceeds from issuance of Common Stock, net............... 257,221 7,077
Proceeds from convertible debt offering, net.............. -- 289,221
Proceeds from payments of shareholder notes receivable.... 55 --
Principal payments on lease obligations................... (1,168) (2,498)
Purchase of treasury stock................................ (227) (49)
-------- ---------
Net cash provided by financing activities.............. 268,377 293,751
-------- ---------
Net change in cash and cash equivalents..................... 229,549 215,529
Effect of exchange rates on cash and cash equivalents....... -- (152)
Cash and cash equivalents at beginning of period............ 14,791 75,932
-------- ---------
Cash and cash equivalents at end of period.................. $244,340 $ 291,309
======== =========
</TABLE>
The accompanying notes are an integral part of these Consolidated Financial
Statements.
3
<PAGE> 6
CRITICAL PATH, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE 1 -- BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The Company
Critical Path, Inc. was incorporated in California on February 19, 1997. In
connection with the Annual Shareholders meeting held in June of 2000, the
shareholders approved the reincoporation of Critical Path, Inc. in Delaware, as
well as an increase in the authorized shares of Common Stock from 150 million to
500 million. Management expects these changes to take place during the third
quarter of 2000. The unaudited Consolidated Financial Statements ("Financial
Statements") of Critical Path, Inc. and Subsidiaries (the "Company" or "Critical
Path") furnished herein reflect all adjustments that are, in the opinion of
management, necessary to present fairly the financial position and results of
operations for each interim period presented. All adjustments are normal
recurring adjustments. The Financial Statements should be read in conjunction
with the consolidated financial statements and notes thereto, together with
management's discussion and analysis of financial condition and results of
operations, presented in the Company's 1999 Annual Report on Form 10-K/A. The
results of operations for the interim periods presented herein are not
necessarily indicative of the results to be expected for the entire year.
Investments
The Company's marketable securities are classified as available-for-sale as
of each balance sheet date and are reported at fair value, with unrealized gains
and losses, net of tax, recorded in shareholders' equity. Realized gains or
losses and permanent declines in value, if any, on available-for-sale securities
will be reported in other income or expense as incurred. The Company uses the
equity method to account for investments in unconsolidated entities if the
investment gives the Company the ability to exercise significant influence, but
does not have a direct controlling interest. The Company uses the cost method to
account for equity investments in unconsolidated entities in which it has a
minority interest and does not have the ability to exercise significant
influence. The Company periodically evaluates these investments for other-than-
temporary impairment.
Recent Accounting Pronouncement
In March 2000, the Financial Accounting Standards Board ("FASB") issued
FASB Interpretation ("FIN") No. 44, "Accounting for Certain Transactions
Involving Stock Compensation, an Interpretation of APB Opinion No. 25" (the
"Interpretation"). The Interpretation is intended to clarify certain issues that
have arisen in practice since the issuance of Accounting Principals Board No.
25, "Accounting for Stock Issued to Employees." Effective with the issuance of
the second quarter 2000 Financial Statements, the Company implemented the
provisions of FIN No. 44. Management does not believe that the adoption of FIN
No. 44 will have a significant impact on future results.
NOTE 2 -- ACQUISITIONS AND JOINT VENTURE
ISOCOR Corporation
On January 19, 2000, the Company acquired ISOCOR Corporation ("ISOCOR"), a
leading supplier of Internet messaging, directory and meta-directory software
solutions. The acquisition was accounted for using the purchase method of
accounting and accordingly, the purchase price was allocated to the tangible and
intangible net assets acquired on the basis of their respective fair values on
the acquisition date. The fair value of intangible assets was determined based
upon an independent valuation using a combination of methods, including an
income approach for the acquired existing and in-process technologies and the
customer base, and a replacement cost approach for the value of the assembled
workforce.
The total purchase price of approximately $274.9 million consisted of
$226.7 million of the Company's Common Stock (5,043,054 shares), assumed stock
options with a fair value of $37.2 million, and other acquisition related
expenses of approximately $11.0 million, consisting primarily of payments for
financial advisory and other professional fees. Of the total purchase price,
$18.7 million was allocated to net tangible
4
<PAGE> 7
CRITICAL PATH, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED)
assets, and the remainder was allocated to intangible assets, including
in-process technology ($200,000), existing technology ($18.3 million), customer
base ($9.8 million), assembled workforce ($3.4 million) and goodwill ($224.5
million). The acquired in-process technology was recognized as research and
development expense in the period the transaction was consummated. The fair
value of other acquired intangible assets, excluding goodwill, was capitalized
and is being amortized over their estimated useful lives of three years.
Goodwill is being amortized using the straight-line method over three years.
The ISOCOR acquisition was recognized as follows:
<TABLE>
<S> <C>
(In thousands)
Fair Value of assets acquired............................... $ 290,176
Liabilities assumed......................................... (15,291)
Fair value of Common Stock and options issued............... (263,885)
---------
Cash paid, including acquisition costs...................... 11,000
Less: cash acquired......................................... 18,989
---------
Net cash acquired........................................... $ 7,989
=========
</TABLE>
The docSpace Company
On March 8, 2000, the Company acquired all outstanding stock of The
docSpace Company ("docSpace"), a provider of Web-based services for secure file
delivery, storage and collaboration. The acquisition was accounted for using the
purchase method of accounting and accordingly, the purchase price was allocated
to the tangible and intangible assets acquired on the basis of their respective
fair values on the acquisition date. The fair value of intangible assets was
determined based upon an independent valuation using a combination of methods,
including a cost approach for the acquired existing technology, and the
replacement cost approach for the value of the assembled workforce.
The total purchase price of $258.0 million consisted of $30.0 million cash,
Common Stock (3,805,820 shares) valued at $281.0 million, and other acquisition
costs of approximately $10.0 million. Of the total purchase price, approximately
$7.1 million has been allocated to net tangible liabilities and the remainder
has been allocated to intangible assets, including assembled workforce
($500,000), existing technology ($21.5 million), and goodwill ($243.1 million).
The fair value of acquired intangible assets, excluding goodwill, was
capitalized and is being amortized over their estimated useful lives of three
years. Goodwill is being amortized using the straight-line method over three
years.
The docSpace acquisition was recognized as follows:
<TABLE>
<S> <C>
(In thousands)
Fair Value of assets acquired............................... $ 266,128
Liabilities assumed......................................... (8,154)
Fair value of Common Stock issued........................... (217,979)
---------
Cash paid, including acquisition costs...................... 39,995
Less: cash acquired......................................... 153
---------
Net cash paid............................................... $ 39,842
=========
</TABLE>
RemarQ Communities, Inc.
On March 30, 2000, the Company acquired RemarQ Communities, Inc.
("RemarQ"), a provider of Internet collaboration services for corporations, Web
portals and Internet service providers. The acquisition was accounted for using
the purchase method of accounting and accordingly, the purchase price was
allocated to the tangible and intangible net assets acquired on the basis of
their respective fair values on the acquisition date. The total purchase price
of approximately $267.6 million, consisted of Common Stock (3,868,450
5
<PAGE> 8
CRITICAL PATH, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED)
shares) valued at $259.3 million, assumed stock options with an estimated fair
market value of $7.7 million, and other acquisition related expenses of
approximately $600,000, consisting primarily of payments for legal and other
professional fees. Of the total purchase price, approximately $7.8 million was
allocated to net tangible assets, and the remainder was allocated to intangible
assets, including existing technology ($4.5 million), assembled workforce ($3.3
million), customer base ($5.9 million), and goodwill totaling ($246.1 million).
The fair value of the acquired intangible assets, excluding goodwill, was
capitalized and is being amortized over their estimated useful lives of two to
three years. Goodwill is being amortized using the straight-line method over
three years.
The RemarQ acquisition was recognized as follows:
<TABLE>
<S> <C>
(In thousands)
Fair Value of assets acquired............................... $ 279,033
Liabilities assumed......................................... (11,453)
Fair value of Common Stock and options issued............... (267,000)
---------
Cash paid, including acquisition costs...................... 580
Less: cash acquired......................................... 11,203
---------
Net cash acquired........................................... $ 10,623
=========
</TABLE>
Netmosphere, Inc.
On June 26, 2000, the Company acquired Netmosphere, Inc. ("Netmosphere"), a
provider of e-business solutions for project collaboration and communications.
The acquisition was accounted for using the purchase method of accounting and
accordingly, the purchase price was allocated to the tangible and intangible net
assets acquired on the basis of their respective fair values on the acquisition
date. The fair value of intangible assets was determined based upon an
independent valuation using a combination of methods, including an income
approach for the acquired technologies and customer base, and a replacement cost
approach for the value of the assembled workforce.
The total purchase price was approximately $41.3 million, which consisted
of the Company's Common Stock (1,007,835 shares) valued at $33.0 million,
assumed stock options with an estimated fair market value of $5.7 million,
assumed warrants with an estimated fair value of $1.0 million, and other
acquisition related expenses of approximately $1.6 million, consisting primarily
of payments for financial advisory and other professional fees. Of the total
purchase price, approximately $1.0 million was allocated to net tangible
liabilities, and the remainder was allocated to intangible assets, including
existing technology ($3.6 million), assembled workforce ($1.4 million), customer
base ($9.0 million), and goodwill totaling $28.3 million. The fair value of the
acquired intangible assets, excluding goodwill, was capitalized and is being
amortized over their estimated useful lives of four years. Goodwill is being
amortized using the straight-line method over four years.
The Netmosphere acquisition was recognized as follows:
<TABLE>
<CAPTION>
(In thousands)
<S> <C>
Fair value of assets acquired............................... $ 43,089
Liabilities assumed......................................... (1,749)
Fair value of Common Stock, options and warrants issued..... (39,726)
--------
Cash paid, including acquisition costs...................... 1,614
Less: cash acquired......................................... 23
--------
Net cash paid............................................... $ 1,591
========
</TABLE>
6
<PAGE> 9
CRITICAL PATH, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED)
ProForma Results
The following unaudited pro forma information presents the Company's
consolidated results of operations for the six months ended June 30, 1999 and
2000, as if the acquisition had been consummated at the beginning of each
period. The pro forma consolidated results of operations include certain pro
forma adjustments, including the amortization of intangible assets and the
accretion of the acquisition-related retention bonuses.
<TABLE>
<CAPTION>
1999 2000
--------- ---------
<S> <C> <C>
Six Months Ended June 30
(In thousands, except per share data)
Net revenues........................................... $ 21,750 $ 62,497
Net loss............................................... (185,738) (269,339)
Net loss per share -- basic and diluted................ (5.89) (4.51)
</TABLE>
The pro forma results are not necessarily indicative of those that would
have actually occurred had the acquisition taken place at the beginning of the
periods presented.
Peerlogic Inc. Acquisition. On August 8, 2000 the Company signed a
definitive agreement to acquire Peerlogic Inc. ("Peerlogic"), a provider of
eBusiness infrastructure software. The total estimated purchase price will be
approximately $416.0 million in Common Stock, assumed stock options and
warrants, and other acquisition related expenses. The acquisition, which is
expected to close on or before September 30, 2000, will be accounted for using
the purchase method of accounting and accordingly, the purchase price will be
allocated to the tangible and intangible net assets acquired on the basis of
their respective fair values on the acquisition date.
Critical Path Pacific
The Company established a joint venture, Critical Path Pacific ("CP
Pacific"), with Mitsui and Co., Ltd., NTT Communications Corporation and NEC
Corporation to deliver advanced Internet messaging solutions to Asia/Pacific
businesses. The Company has invested $7.5 million and holds a 40% ownership
interest in the joint venture. This investment is being accounted for using the
equity method.
NOTE 3 -- ACQUISITION-RELATED RETENTION BONUS
In connection with the acquisitions of dotOne Corporation ("dotOne"),
Amplitude Software Corporation ("Amplitude"), Xeti, Inc. ("Xeti"), FaxNet
Corporation ("FaxNet"), ISOCOR, and docSpace, the Company established a
retention bonus program in the aggregate amount of $20.7 million to provide
incentives for certain former employees of these companies to continue their
employment with Critical Path. Payment of bonuses to the listed employees will
occur one year following the date of acquisition, unless the listed employees
voluntarily terminate their employment with the Company prior to the respective
acquisition's one-year anniversary. The aggregate amount of the eligible bonuses
is reduced for the bonus amount allocated to each former dotOne, Amplitude,
Xeti, FaxNet, ISOCOR, and docSpace employee that chooses to terminate his or her
employment with the Company. A ratable share of the adjusted eligible bonus
amount will be accrued and charged to compensation expense over the respective
12-month period commencing on the date the bonuses are granted.
As of June 30, 2000, the aggregate, adjusted eligible bonus amount was
$18.3 million, and the amount recognized as compensation expense was $4.1
million and $7.2 million during the three- and six-month periods then ended,
respectively. Based on the functions of the employees scheduled to receive
acquisition-related retention bonuses, $390,000 and $780,000 of the compensation
charge was allocated to cost of net revenues and the remaining $3.7 million and
$6.4 million was allocated to operating expenses, for the three-and six-month
periods ended June 30, 2000, respectively.
7
<PAGE> 10
CRITICAL PATH, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED)
NOTE 4 -- INVESTMENTS
The Company's investments in unconsolidated entities consist of the
following:
<TABLE>
<CAPTION>
DECEMBER 31, JUNE 30,
1999 2000
------------ --------
<S> <C> <C>
(In thousands)
Marketable securities................................. $10,926 $ 5,318
Non-marketable securities, at cost.................... 7,500 13,500
Investments, at equity................................ -- 7,508
------- -------
Total Investments........................... $18,426 $26,326
======= =======
</TABLE>
The Company made investments totaling $16.5 million during the three months
ended June 30, 2000, including $7.5 million related to CP Pacific (Note 2),
which is being accounted for using the equity method of accounting. The
remaining $9.0 million was composed of three, $3.0 million strategic investments
in private entities, which are being accounted for using the cost method of
accounting.
Additionally, in July 2000, the Company made strategic investments totaling
$8.0 million in two other private entities.
NOTE 5 -- INTANGIBLE ASSETS
<TABLE>
<CAPTION>
DECEMBER 31, JUNE 30,
1999 2000
------------ ----------
<S> <C> <C>
(In thousands)
Goodwill........................................... $475,368 $1,220,714
Customer base...................................... 12,800 37,500
Assembled workforce................................ 6,960 15,560
Existing technology................................ 9,940 59,240
Patent license..................................... 1,488 1,488
-------- ----------
506,556 1,334,502
Less: accumulated amortization..................... (32,259) (175,419)
-------- ----------
Intangible assets, net........................... $474,297 $1,159,083
======== ==========
</TABLE>
Amortization of intangible assets totaled $93.4 million and $143.2 million
during the three- and six-month periods ended June 30, 2000, respectively.
During the three- and six-month periods ended June 30, 1999, amortization of
intangible assets totaled $550,000.
NOTE 6 -- BORROWINGS
On March 30, 2000, the Company issued $300 million of five-year, 5.75%
Convertible Subordinated Notes ("Notes") due April 2005, to qualified
institutional buyers in reliance on Rule 144A under the Securities Act of 1933.
Holders may convert the Notes into shares of Critical Path's Common Stock at any
time before their maturity or the business day before their redemption or
repurchase of Critical Path. The conversion rate is 9.8546 shares per $1,000
principal amount of Notes, subject to adjustment in certain circumstances This
rate is equivalent to a conversion price of approximately $101.48 per share.
The Company incurred approximately $10.8 million in debt issuance costs,
consisting primarily of payments for an underwriting discount and legal and
other professional fees. These costs have been capitalized and will be
recognized as a component of interest expense on a straight-line basis over the
five-year term of the Notes.
8
<PAGE> 11
CRITICAL PATH, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED)
Interest is payable on April 1 and October 1 of each year with the first
interest payment due on October 1, 2000. The Notes subordinated in right of
payment to all senior debt of Critical Path and effectively subordinated to all
existing and future debt and other liabilities of Critical Path's subsidiaries.
On or after the third business day after April 1, 2003, through March 31,
2004, the Company has the option to redeem all or a portion of the Notes that
have not been previously converted at the redemption price equal to 102.30% of
the principal amount. During the period from April 1, 2004 through March 31,
2005, the Company has the option to redeem all or a portion of the Notes that
have been previously converted at the redemption price equal to 101.15% of the
principal amount. Thereafter the redemption price is equal to 100% of principal
amount. The Notes are non-callable for three years. In the event of a "Change in
Control," as defined in Notes' Offering Circular, the Holders have the option of
requiring the Company to repurchase any Notes held at a price of 100% of the
principal amount of the Notes plus accrued interest to the date of repurchase.
NOTE 7 -- COMMITMENTS AND CONTINGENCIES
On March 8, 2000, the Company acquired docSpace, which is involved in a
patent infringement action with Tumbleweed Communications Corp. The lawsuit
relates to a Tumbleweed patent that describes an apparatus for delivering
documents via the Internet. The Company has denied the allegations of
infringement and has counterclaimed for violations of the antitrust laws and
related state law claims. Both parties have moved for summary judgment. This
case is in the initial discovery phase and the Company is not currently able to
assess the impact, if any, on its financial position or results of operations.
The Company is party to various legal proceedings in the ordinary course of
its business. The Company believes that the ultimate outcome of these matters
will not have a material adverse impact on its financial position or results of
operations.
In the ordinary course of business, the Company has issued certain letters
of credit and refundable security deposits providing various degrees of recourse
to the Company. At June 30, 2000, the Company's share under such arrangements
was $1.2 million. The Company believes it is remote that it will pay under these
various arrangements.
NOTE 8 -- MINORITY INTEREST IN SUBSIDIARY
The Company owns a 60% interest in CP Italia, a consolidated subsidiary. In
July 2000, the Company purchased an additional 12.87% interest for $1.3 million
and recognized goodwill of $688,659, which will be amortized over 3 years. In
addition, in the event certain performance levels are achieved, the Company
agreed to purchase the remaining 27.13% minority interest it doesn't own by
January 31, 2001, for a purchase price ranging from $2.7 million to $4.2
million.
NOTE 9 -- SHAREHOLDERS' EQUITY
WARRANTS
America Online/ICQ
In January 1999, the Company entered into an agreement with ICQ, Inc., a
subsidiary of America Online, Inc. ("ICQ"), pursuant to which the Company
provides email hosting services that are integrated with ICQ's instant messaging
service provided to ICQ's customers. As part of the agreement, ICQ agreed to
provide sub-branded advertising for the Company in exchange for warrants to
purchase 2,442,766 shares of the Company's Common Stock, issuable upon
attainment of each of five milestones.
As of April 9, 2000, all five milestones had been attained. Aggregate
charges to stock-based expenses of $3.5 million and $5.6 million were recorded
during the three-month periods ended June 30, 1999 and 2000, respectively, and
$11.4 million and $7.7 million were recorded during the six-month periods ended
June 30,
9
<PAGE> 12
CRITICAL PATH, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED)
1999 and 2000, respectively, related to these warrants. At April 9, 2000 the
final revised aggregate fair value of all vested warrants was $93.8 million. The
aggregate exercise price of the vested warrants totals $16.5 million.
Qwest Communications Corporation
In October 1999, the Company entered into an agreement with Qwest
Communications Corporation ("Qwest"), a telecommunications company, pursuant to
which the Company provides email hosting services to Qwest's customers. As part
of the agreement, Qwest agreed to provide sub-branded advertising for Critical
Path in exchange for warrants to purchase up to a maximum of 3,534,540 shares of
Common Stock upon attainment of each of six milestones.
As of June 30, 2000, only the first of the six milestones had been
attained. None of the remaining milestones are considered probable and as a
result, the fair value of the warrants relating to the shares underlying the
second through sixth milestones has not been recognized. During the three- and
six-month periods ended June 30, 2000, $1.8 million and $3.7 million,
respectively, was charged to stock-based expense related to these vested
warrants.
Worldsport Network Ltd.
In December 1999, the Company entered into an agreement with Worldsport
Network Ltd. ("Worldsport"), exclusive provider of Internet solutions for the
General Association of International Sports Federations ("GAISF") and a majority
of the international federations it recognizes. Worldsport offers Critical
Path's advanced Web-based email and calendaring services to the entire GAISF
network and its members. As part of the agreement, Worldsport agreed to provide
sub-branded advertising for the Company in exchange for warrants to purchase up
to a 1.25% equity interest in the Company on a fully diluted basis upon
attainment of each of five milestones.
As of June 30, 2000, none of the milestones were considered probable and as
a result, the fair value associated with these warrants has not been recognized.
Telco
In January of 2000, docSpace entered into an agreement with a major
telecommunications company ("Telco") pursuant to which docSpace would provide
secure messaging services to the Telco's customers. As part of the agreement,
Telco agreed to provide marketing, publicity, and promotional services to
docSpace. As a result of the completion of the Company's acquisition of
docSpace, Critical Path assumed warrants that allowed Telco to purchase up to a
maximum of 349,123 shares of Common Stock upon attainment of each of three
milestones.
Subsequent to the acquisition, the Company entered into discussions with
Telco to modify their relationship. Accordingly, the vesting provisions of the
proposed agreement are being modified to reflect the requirements of the new
relationship.
As of June 30, 2000, none of the vesting milestones had been attained;
however, the Company believes that all shares underlying these warrants are
probable of issuance. As a result, the shares underlying these milestones were
remeasured using the June 30, 2000, closing price of the Company's Common Stock
of $58.31, resulting in a revised fair value of the warrants of $17.0 million.
The fair value of the warrants will be recognized on a straight-line basis over
the greater of the term of the contract or the expected period of benefit of the
strategic relationship. During the three- and six-month periods ended June 30,
2000, no amount was recognized as stock-based expense related to these warrants.
10
<PAGE> 13
CRITICAL PATH, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED)
NOTE 10 -- COMPREHENSIVE LOSS
The components of comprehensive loss, net of tax, are as follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
--------------------- ---------------------
1999 2000 1999 2000
-------- --------- -------- ---------
<S> <C> <C> <C> <C>
(In thousands)
Net loss...................................... $(16,321) $(130,009) $(33,915) $(206,951)
Unrealized investment gains (losses).......... 14,489 (3,399) 14,489 (6,116)
Foreign currency translation adjustments...... -- 37 -- (131)
-------- --------- -------- ---------
Comprehensive loss............................ $ (1,832) $(133,371) $(19,426) $(213,198)
======== ========= ======== =========
</TABLE>
Accumulated other comprehensive loss consists of unrealized gains (losses)
on available-for-sale securities, net of tax, and cumulative translation
adjustments, as presented on the accompanying consolidated balance sheet.
NOTE 11 -- NET LOSS PER SHARE
Net loss per share is calculated as follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
--------------------- ---------------------
1999 2000 1999 2000
-------- --------- -------- ---------
<S> <C> <C> <C> <C>
(In thousands, except per share amounts)
Net loss...................................... $(16,321) $(130,009) $(33,915) $(206,951)
-------- --------- -------- ---------
Weighted average shares outstanding........... 35,909 62,283 23,157 57,890
Weighted average shares subject to repurchase
agreements.................................. (2,932) (1,840) (3,163) (1,849)
Weighted average shares held in escrow related
to acquisitions............................. -- (1,851) -- (1,460)
-------- --------- -------- ---------
Shares used in computation of basic and
diluted net loss per share.................. 32,977 58,592 19,994 54,581
======== ========= ======== =========
Net loss per share -- basic and diluted....... $ (0.49) $ (2.22) $ (1.70) $ (3.79)
======== ========= ======== =========
</TABLE>
For the three- and six-month periods ended June 30, 1999, approximately
15.4 million and 15.7 million, potential common shares, respectively, were
excluded from the determination of diluted net loss per share, as the effect of
such shares on a weighted average basis is anti-dilutive. For the three- and
six-month periods ended June 30, 2000, approximately 20.4 million and 19.9
million potential common shares, respectively, were excluded.
NOTE 12 -- SUBSEQUENT EVENT
Restructuring Charge. On July 19, 2000, the Company announced its plan to
reduce its worldwide employee headcount by approximately 13% and recognize a
one-time charge for severance and stock-based compensation totaling
approximately $5.1 million and $2.1 million, respectively, in the third quarter
of 2000. This employee reduction plan has been executed with the intent to
realize various synergies gained through the nine acquisitions the Company
completed in 1999 and the first half of 2000.
11
<PAGE> 14
CRITICAL PATH, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion and analysis of Critical Path, Inc., and
Subsidiaries ("Company" or "Critical Path") should be read in conjunction with
the Consolidated Financial Statements and Notes thereto of the Company included
herein, as well as the Company's 1999 Annual Report on Form 10-K/A. The
following discussion contains forward-looking statements. The Company's actual
results may differ significantly from those projected in these forward-looking
statements. Factors that might cause future results to differ materially from
those projected in the forward-looking statements include, but are not limited
to, future enhancements of our service and product offerings, potential
expansion of our employee base and operating assets, acquisitions, competition,
development of new strategic relationships, opening of new data centers and
sales offices, additional investments in technology, and those discussed in
"Additional Factors That May Affect Future Operating Results" and elsewhere in
this report. Readers are cautioned not to place undue reliance on these
forward-looking statements. The Company has no obligation to publicly release
the results of any revisions to these forward-looking statements to reflect
events or circumstances after the date of this filing.
OVERVIEW
Critical Path is a leading global provider of complete end-to-end Internet
messaging and collaboration solutions for wireless, Internet-centric,
telecommunication and corporate businesses. Through its allsourcing strategy,
Critical Path is the only advanced messaging provider to offer businesses the
flexibility to outsource, midsource or insource all or part of their messaging
and collaboration applications. Critical Path has built an industry-leading
global infrastructure with data centers connected to key Internet exchange
points. The Company is headquartered in San Francisco, with offices in locations
throughout the United States and in Argentina, Brazil, Canada, Denmark, England,
France, Germany, Ireland, Italy, Japan and Switzerland. The Company was founded
in February 1997.
Acquisitions and Joint Venture
ISOCOR Corporation. On January 19, 2000, the Company acquired ISOCOR
Corporation ("ISOCOR"), a leading supplier of Internet messaging, directory and
meta-directory software solutions. The acquisition was accounted for using the
purchase method of accounting and accordingly, the purchase price was allocated
to the tangible and intangible net assets acquired on the basis of their
respective fair values on the acquisition date. The fair value of intangible
assets was determined based upon an independent valuation using a combination of
methods, including an income approach for the acquired existing and in-process
technologies and the customer base, and a replacement cost approach for the
value of the assembled workforce.
The total purchase price of approximately $274.9 million consisted of
$226.7 million of the Company's Common Stock (5,043,054 shares), assumed stock
options with a fair value of $37.2 million, and other acquisition related
expenses of approximately $11.0 million, consisting primarily of payments for
financial advisory and other professional fees. Of the total purchase price,
$18.7 million was allocated to net tangible assets, and the remainder was
allocated to intangible assets, including in-process technology ($200,000)
existing technology ($18.3 million), customer base ($9.8 million), assembled
workforce ($3.4 million) and goodwill ($224.5 million). The acquired in-process
technology was recognized as research and development expense in the period the
transaction was consummated. The fair value of the other acquired intangible
assets, excluding goodwill, was capitalized and is being amortized over their
estimated useful lives of three years. Goodwill is being amortized using the
straight-line method over three years.
The docSpace Company. On March 8, 2000, the Company acquired all
outstanding stock of The docSpace Company ("docSpace"), a provider of Web-based
services for secure file delivery, storage and collaboration. The acquisition
was accounted for using the purchase method of accounting and accordingly, the
purchase price was allocated to the tangible and intangible assets acquired on
the basis of their respective fair values on the acquisition date. The fair
value of intangible assets was determined based upon an
12
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CRITICAL PATH, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS (CONTINUED)
independent valuation using a combination of methods, including a cost approach
for the acquired existing technology, and the replacement cost approach for the
value of the assembled workforce.
The total purchase price of $258.0 million consisted of $30.0 million cash,
Common Stock (3,805,820 shares) valued at $218.0 million, and other acquisition
costs of approximately $10.0 million. Of the total purchase price, approximately
$7.1 million has been allocated to net tangible liabilities and the remainder
has been allocated to intangible assets, including assembled workforce
($500,000), existing technology ($21.5 million), and goodwill ($243.1 million).
The fair value of the acquired intangible assets, excluding goodwill, was
capitalized and is being amortized over their estimated useful lives of three
years. Goodwill is being amortized using the straight-line method over three
years.
RemarQ Communities, Inc. On March 30, 2000, the Company acquired all
outstanding stock of RemarQ Communities, Inc. ("RemarQ"), a provider of Internet
collaboration services for corporations, Web portals and Internet service
providers. The acquisition was accounted for using the purchase method of
accounting and accordingly, the purchase price was allocated to the tangible and
intangible assets acquired on the basis of their respective fair values on the
acquisition date. The total purchase price of approximately $267.6 million
consisted of Common Stock (3,868,450 shares) valued at $259.3 million, assumed
stock options valued at approximately $7.7 million, and other acquisition
related expenses of approximately $600,000. Of the total purchase price,
approximately $7.8 has been allocated to net tangible assets and the remainder
was allocated to intangible assets, including existing technology ($4.5
million), assembled workforce ($3.3 million), customer base ($5.9 million), and
goodwill totalling approximately ($246.1 million). The fair market of the
acquired intangible assets, excluding goodwill, was capitalized and is being
amortized over the estimated useful lives of two to three years. Goodwill is
being amortized using the straight-line method over three years.
Netmosphere, Inc. On June 26, 2000, the Company acquired Netmosphere, Inc.
("Netmosphere"), a provider of e-business solutions for project collaboration
and communications. The acquisition was accounted for using the purchase method
of accounting and accordingly, the purchase price was allocated to the tangible
and intangible net assets acquired on the basis of their respective fair values
on the acquisition date. The total purchase price was approximately $41.3
million, which consisted of the Company's Common Stock (1,007,835 shares) valued
at $33.0 million, assumed stock options with an estimated fair market value of
$5.7 million, assumed warrants with an estimated fair value of $1.0 million, and
other acquisition related expenses of approximately $1.6 million, consisting
primarily of payments for legal and other professional fees. Of the total
purchase price, approximately $1.0 million was allocated to net tangible
liabilities, and the remainder was allocated to intangible assets, including
existing technology ($3.6 million), assembled workforce ($1.4 million), customer
base ($9.0 million), and goodwill totaling $28.3 million. The fair value of the
acquired intangible assets, excluding goodwill, was capitalized and is being
amortized over their estimated useful lives of four years. Goodwill is being
amortized using the straight-line method over four years.
Critical Path Pacific. The Company established a joint venture, Critical
Path Pacific ("CP Pacific"), with Mitsui and Co., Ltd., NTT Communications
Corporation and NEC Corporation to deliver advanced Internet messaging solutions
to Japanese businesses. The Company has invested $7.5 million and holds a 40%
ownership interest in the joint venture. This investment is being accounted for
using the equity method.
Peerlogic, Inc. Acquisition. On August 8, 2000 the Company signed a
definitive agreement to acquire Peerlogic, Inc. ("Peerlogic"), a provider of
eBusiness infrastructure software. The total estimated purchase price will be
approximately $416.0 million in Common Stock, assumed stock options and
warrants, and other acquisition related expenses. The acquisition, which is
expected to close on or before September 30, 2000, will be accounted for using
the purchase method of accounting and accordingly, the purchase price will be
allocated to the tangible and intangible net assets acquired on the basis of
their respective fair values on the acquisition date.
13
<PAGE> 16
CRITICAL PATH, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS (CONTINUED)
Warrants
America Online/ICQ. In January of 1999, the Company entered into an
agreement with ICQ, Inc., a subsidiary of America Online, Inc. ("ICQ"), pursuant
to which the Company provides email hosting services that are integrated with
ICQ's instant messaging service provided to ICQ's customers. As part of the
agreement, ICQ agreed to provide sub-branded advertising for the Company in
exchange for warrants to purchase 2,442,766 shares of the Company's Common
Stock, issuable upon attainment of each of five milestones.
As of April 9, 2000, all five milestones had been attained. Aggregate
charges to stock-based expenses of $3.5 million and $5.6 million were recorded
during the three-month periods ended June 30, 1999 and 2000, respectively, and
$11.4 million and $7.7 million were recorded during the six-month periods ended
June 30, 1999 and 2000, respectively, related to these warrants. At April 9,
2000 the final revised aggregate fair value of all vested warrants was $93.8
million. The aggregate exercise price of the vested warrants totals $16.5
million.
Qwest Communications Corporation. In October 1999, the Company entered into
an agreement with Qwest Communications Corporation ("Qwest"), a
telecommunications company, pursuant to which the Company provides email hosting
services to Qwest's customers. As part of the agreement, Qwest agreed to provide
sub-branded advertising for Critical Path in exchange for warrants to purchase
up to a maximum of 3,534,540 shares of Common Stock upon attainment of each of
six milestones.
As of June 30, 2000, only the first of the six milestones had been
attained. None of the remaining milestones are considered probable and as a
result, the fair value of the warrants relating to the shares underlying the
second through sixth milestones has not been recognized. During the three- and
six-month periods ended June 30, 2000, $1.8 million and $3.7 million,
respectively, was charged to stock-based expense related to these vested
warrants.
Worldsport Network Ltd. In December 1999, the Company entered into an
agreement with Worldsport Network Ltd. ("Worldsport"), the sole and exclusive
provider of Internet solutions for the General Association of International
Sports Federations ("GAISF") and a majority of the international federations it
recognizes. Worldsport offers Critical Path's advanced Web-based email and
calendaring services to the entire GAISF network and its members. As part of the
agreement, Worldsport agreed to provide sub-branded advertising for the Company
in exchange for warrants to purchase up to a 1.25% equity interest in the
Company on a fully diluted basis upon attainment of each of five milestones.
As of June 30, 2000, none of the milestones were considered probable and as
a result, the fair value associated with these warrants has not been recognized.
Telco. In January 2000, The docSpace Company ("docSpace") entered into an
agreement with a major telecommunications company ("Telco") pursuant to which
docSpace would provide secure messaging services to the Telco's customers. As
part of the agreement, Telco agreed to provide marketing, publicity, and
promotional services to docSpace. As a result of the completion of the Company's
acquisition of docSpace, Critical Path assumed warrants that allowed Telco to
purchase up to a maximum of 349,123 shares of Common Stock upon attainment of
each of three milestones.
Subsequent to the acquisition, the Company entered into discussions with
Telco to modify its relationship. Accordingly, the vesting provisions of the
proposed agreement are being modified to reflect the requirements of the new
relationship.
As of June 30, 2000, none of the vesting milestones had been attained;
however, the Company believes that all shares underlying these warrants are
probable of issuance. As a result, the shares underlying these milestones were
remeasured using the June 30, 2000, closing price of the Company's Common Stock
of $58.31, resulting in a revised fair value of the warrants of $17.0 million.
The fair value of the warrants will be recognized on a straight-line basis over
the greater of the term of the contract or the expected period of benefit
14
<PAGE> 17
CRITICAL PATH, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS (CONTINUED)
of the strategic relationship. During the three- and six-month periods ended
June 30, 2000, no amount was recognized as stock-based expense related to these
warrants.
The Company believes that each of its warrant agreements could have a
significant current and potential future impact on the Company's results of
operations. The Company expects that future changes in the trading price of the
Company's Common Stock at the end of each quarter, and at the time certain
milestones are considered probable and achieved, may cause additional
substantial changes in the ultimate amount of the related stock-based charges.
RESULTS OF OPERATIONS
In view of the rapidly evolving nature of the Company's business, recent
acquisitions, and limited operating history, the Company believes that
period-to-period comparisons of revenues and operating results, including gross
profit margin and operating expenses as a percentage of total net revenues, are
not meaningful and should not be relied upon as indications of future
performance. At June 30, 2000, the Company had 945 employees, in comparison with
488 employees at December 31, 1999 and 212 at June 30, 1999. The Company does
not believe that its historical growth rates for revenue, expenses, or personnel
are indicative of future results.
Net Revenues
Net revenues increased to $33.5 million during the three months ended June
30, 2000, from $2.0 million during the same period in 1999. During the six
months ended June 30, 2000, net revenues increased to $58.0 million from $3.1
million during the same period in 1999. The Company recognized $13.9 million and
$25.0 million from software licenses during the three- and six-month periods
ended June 30, 2000, respectively, as compared to no license revenues in the
first and second quarters of 1999. These increases over 1999 were primarily
attributed to the continued success of the Company's InScribe Messaging Server,
InJoin Directory Server and InJoin Meta-Directory.
The Company's net services revenues increased as a result of continued
penetration of the hosted messaging services market, including a substantial
increase in the number of email boxes hosted, and a strong demand for
value-added outsourced services including InScribe Fax Messaging, InSchedule
Calendaring, InScribe Secure File Services and InScribe Message Boards.
The Company's international operations accounted for approximately 40% of
net revenues during the three-and six-month periods ended June 30, 2000.
Cost of Net Revenues
Licenses. Cost of net license revenues consists primarily of product media
duplication, manuals and packaging materials, personnel and facility costs
associated with the assembly operation, and third-party royalties.
Services. Cost of net services revenues consists primarily of costs
incurred in the delivery and support of messaging services, including
depreciation of capital equipment used in network infrastructure, amortization
of purchased technology, Internet connection charges, accretion of
acquisition-related retention bonuses, personnel costs incurred in operations,
customer support functions and professional services including custom
engineering, installation and training services, and other direct and allocated
indirect costs.During the three months ended June 30, 2000, total cost of net
revenues was $22.7 million, or 68% of net revenues, in comparison with costs of
$4.0 million, or 198% of net revenues, for the comparable period of 1999. For
the six months ended June 30, 2000, total cost of net revenues was $41.0
million, or 71% of net revenues, in comparison with costs of $6.3 million, or
207% of net revenues in the comparable period of 1999. The Company added 8 and 7
new hosted mail clusters to its data centers during the first and second
quarters of
15
<PAGE> 18
CRITICAL PATH, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS (CONTINUED)
2000, respectively, expanding the capacity of its hosting network to manage
current customer requirements and anticipated growth. Additional costs were
incurred during the first and second quarters of 2000 to add technology
platforms for new service offerings. As a result of these significant
acquisitions of equipment, depreciation expense for such equipment during the
first two quarters of 2000 increased substantially in comparison with the same
quarters in 1999.
Cost of net revenues was also impacted by the increased compensation and
other personnel costs resulting from the additional headcount added through the
Company's nine acquisitions completed during 1999 and the first half of 2000,
and through its continued efforts to enhance its complete end-to-end messaging
services. Operations, customer support, and professional services staff
increased from 63 employees at June 30, 1999, to 277 employees at June 30, 2000.
During the three- and six-month periods ended June 30, 2000, the Company
recognized stock-based charges associated with employee stock options in the
amounts of $383,000 and $876,000, respectively. During the three- and six-month
periods ended June 30, 1999, the Company recognized stock-based charges of
$743,000 and $1.2 million, respectively. Additionally, the Company recognized
charges associated with amortization of acquired technology and
acquisition-related retention bonuses in cost of net revenues. For the three-and
six-month periods ended June 30, 2000, amortization of acquired technology was
$4.4 million and $6.5 million, respectively. For the three- and six-month
periods ended June 30, 2000, amortization of acquisition-related retention
bonuses was $390,000 and $780,000, respectively.
Operating Expenses
Sales and Marketing. Sales and marketing expenses consist primarily of
compensation for sales and marketing personnel, advertising, public relations,
other promotional costs, and, to a lesser extent, related overhead. Sales and
marketing expenses during the three- and six-month periods ended June 30, 2000,
amounted to $17.3 million, or 52% of net revenues, and $30.9 million, or 53% of
net revenues, respectively, in comparison with approximately $3.2 million, or
160% of net revenues, and $5.2 million, or 170% of net revenues, respectively,
during the comparable periods of 1999. Increases in marketing and promotional
expenses, incentive compensation payments to sales personnel, and increases in
compensation associated with additional headcount accounted for the increase in
sales and marketing expenses. Sales and marketing staff increased from 73
employees to 291 employees at June 30, 1999 and 2000, respectively.
Research and Development. Research and development expenses consist
primarily of compensation for technical staff, payments to outside contractors,
depreciation of capital equipment associated with research and development
activities, and, to a lesser extent, related overhead. The Company recognizes
research and development expenses, including in-process research and development
costs, as they are incurred. Research and development expenses amounted to $9.2
million, or 28% of net revenues, and $15.5 million, or 27% of net revenues
during the three- and six-month periods ended June 30, 2000, respectively, in
comparison with approximately $1.4 million, or 71% of net revenues, and $2.8
million, or 92% of net revenues, during the comparable periods of 1999,
respectively.
These significant increases resulted primarily from increases in personnel
as the Company continues to develop and enhance its messaging service and
product offerings and to develop new electronic messaging services and products.
Research and development staff increased from 56 employees to 222 employees at
June 30, 1999 and 2000, respectively.
General and Administrative. General and administrative expenses consist
primarily of compensation for personnel, fees for outside professional services,
occupancy costs and, to a lesser extent, related overhead. General and
administrative expenses amounted to approximately $7.3 million, or 22% of net
revenues, and $14.1 million, or 24% of net revenues, during the three- and
six-month periods ended June 30, 2000, respectively, in comparison with
approximately $2.7 million, or 134% of net revenues, and $4.2 million, or 139%
of net revenues, during the comparable periods of 1999, respectively.
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CRITICAL PATH, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS (CONTINUED)
These increases were attributable primarily to increases in compensation
associated with additional headcount and higher fees for outside professional
services. General and administrative staff increased from 20 employees to 155
employees at June 30, 1999 and 2000, respectively.
Acquisition-Related Bonus Program
In connection with the acquisitions of dotOne Corporation ("dotOne"),
Amplitude Software Corporation ("Amplitude"), Xeti, Inc. ("Xeti"), FaxNet
Corporation ("FaxNet"), ISOCOR, and docSpace, the Company established a
retention bonus program in the aggregate amount of $20.7 million to provide
incentives for certain former employees of these companies to continue their
employment with Critical Path. Payment of bonuses to the listed employees will
occur one year following the date of acquisition, unless the listed employees
voluntarily terminate their employment with the Company prior to the respective
acquisition's one-year anniversary. The aggregate amount of the eligible bonuses
is reduced for the bonus amount allocated to each former dotOne, Amplitude,
FaxNet, ISOCOR Corporation ("ISOCOR"), and docSpace employee that chooses to
terminate his or her employment with the Company. A ratable share of the
adjusted eligible bonus amount will be accrued and charged to compensation
expense over the respective 12-month period commencing on the date the bonuses
are granted.
As of June 30, 2000, the aggregate, adjusted eligible bonus amounted to
$18.3 million, and the amount recognized as compensation expense was $4.1
million and $7.2 million during the three- and six-month periods ended June 30,
2000, respectively. Based on the functions of the employees scheduled to receive
acquisition-related retention bonuses, for the three months ended June 30, 2000,
$390,000 of the compensation charge was allocated to cost of net revenues and
the remaining $3.7 million was allocated to operating expenses. During the six
months ended June 30, 2000, $780,000 of the compensation charge was allocated to
cost of net revenues and the remaining $6.4 million was allocated to operating
expenses. There was no compensation charges recognized related to
acquisition-related retention bonuses during the three- and six-month periods
ended June 30, 1999.
Amortization of Intangible Assets
In connection with its acquisitions of the Connect Service business of
Fabrik Communications ("Fabrik"), dotOne, Amplitude, Xeti, FaxNet, ISOCOR,
docSpace, RemarQ, and Netmosphere which are accounted for under the purchase
method of accounting, the Company recorded goodwill and other intangible assets
representing the excess of the purchase price paid over the fair value of net
assets acquired. Other intangible assets primarily include assembled workforce,
customer base and existing technology. The aggregate amortization of these
intangibles was $93.4 million and $143.2 million during the three- and six-
month periods ended June 30, 2000. For the three months ended June 30, 2000,
$4.4 million of the amortization charge related purchased technology and was
charged to cost of net revenues and the remaining $89.0 million was charged to
operating expenses. For the six months ended June 30, 2000, $6.5 million of the
amortization charge related to purchased technology and was charged to cost of
net revenues and the remaining $136.7 million was charged to operating expenses.
There were no acquisitions during the first quarter of 1999 and charges to
operating expenses related to amortization of intangibles amounted to $550,000
for the six months ended June 30, 1999.
The Company anticipates that future amortization of intangibles associated
with its 1999 and first and second quarter 2000 acquisitions will continue to be
amortized on a straight-line basis over their expected useful lives ranging from
two to eight years. It is likely that the Company will continue to expand its
business through acquisitions and internal development. Any additional
acquisitions or impairment of goodwill and other purchased intangibles could
result in additional merger and acquisition related costs.
17
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CRITICAL PATH, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS (CONTINUED)
Stock-Based Expenses
In connection with certain stock option grants and Common Stock issuances
during the years ended December 31, 1998 and 1999, the Company recognized
unearned compensation totaling $19.9 million and $22.3 million, respectively,
which is being amortized over the vesting periods of the related options.
Amortization expense recognized during the three-and six-month periods ended
June 30, 2000, totaled approximately $4.8 million and $8.0 million,
respectively. During the three- and six-month periods ended June 30, 1999,
amortization expense totaled $4.9 million and $8.5 million, respectively.
Approximately $383,000 and $876,000 of amortized unearned compensation was
allocated to cost of net revenues, and the remaining $4.4 million and $7.1
million was amortized to operating expenses for the three- and six-month periods
ended June 30, 2000, respectively.
The Company incurred stock-based expenses for warrants the Company granted
to ICQ (a subsidiary of AOL), Qwest, Telco and a lessor and for Common Stock
issued to one other strategic partner. Amortization of the fair value of these
warrants and Common Stock resulted in stock-based expenses of approximately $4.0
million and $7.5 million for the three-month periods ended June 30, 1999 and
2000, respectively. During the six-month periods ended June 30, 1999 and 2000,
approximately $12.5 million and $11.5 million was recognized as stock-based
expenses as a result of these warrants. The decrease in amortization expense
during the period resulted from the decrease in the market price of the
Company's Common Stock as of June 30, 2000.
Interest and Other Income (Expense) and Interest Expense
Interest and other income consists primarily of interest earnings on cash
and cash equivalents as well as net realized gains (losses) on foreign exchange
transactions. The Company completed private placements of equity securities in
April 1998, September 1998, and January 1999, and closed public offerings of
Common Stock in April 1999 and June 1999. In addition, on March 30, 2000, the
Company issued $300.0 million of five-year, 5.75% Convertible Subordinated Notes
due April 1, 2005 (the "Notes"). As a result, interest income increased
significantly during the latter half of 1999 and into 2000 in comparison with
early 1999 due to higher cash balances available for investing. Interest income
amounted to $1.9 million and $4.8 million during the three-month periods ended
June 30, 1999 and 2000, respectively, and $2.2 million and $5.9 million for the
six-month periods ended June 30, 1999 and 2000, respectively. The Company
recognized a net realized loss from foreign exchange transactions associated
with its international operations in the amount of $91,000 during the
three-month period ended June 30, 2000, and a net realized gain of $79,000 for
the six months then ended.
The interest related to the Notes, which includes the amortization of
related issuance costs, was approximately $4.3 million in the second quarter of
2000. Additionally, during the three- and six-month periods ended June 30, 2000,
the Company incurred interest expense of $912,000 and $1.2 million,
respectively, comprised of interest on capital lease obligations, stock-based
charges, and interest on other long-term debt obligations. For the three- and
six-month periods ended June 30, 2000, amortization of stock-based charges were
$16,000 and $32,000, respectively, and interest payments on capital lease
obligations amounted to $896,000 and $1.2 million, respectively.
Income Taxes
No provision for federal or state income taxes has been recorded as the
Company has incurred net operating losses from its inception through June 30,
2000. The Company recognized a provision for foreign income taxes during the
three- and six-month periods ended June 30, 2000 in the amount of $1.4 million
and $1.8 million, respectively, as certain of the Company's European operations
generated income taxable in certain European jurisdictions. As of December 31,
1999, the Company had approximately $94.9 million of state and federal net
operating loss carryforwards, which expire in varying amounts through 2005 and
2019,
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CRITICAL PATH, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS (CONTINUED)
respectively, available to offset future taxable income. Under the Tax Reform
Act of 1986, the amounts of and benefits from net operating loss carryforwards
may be impaired or limited in certain circumstances. For example, the amount of
net operating losses that the Company may utilize in any one year would be
limited in the presence of a cumulative ownership change of more than 50% over a
three-year period. At December 31, 1999, the Company also had research and
development credit carryforwards of approximately $717,000 and $1.2 million for
state and federal purposes, respectively. These research and development credit
carryforwards begin to expire through 2019 for federal purposes, and do not
expire for state purposes. There is significant doubt as to whether the Company
will realize any benefit from this deferred tax asset, and accordingly, the
Company has established a full valuation allowance as of December 31, 1999, and
June 30, 2000.
Restructuring Charge
On July 19, 2000, the Company announced its plan to reduce its worldwide
employee headcount by approximately 13% and recognize a one-time charge for
severance and stock-based compensation totaling approximately $5.1 million and
$2.1 million, respectively, in the third quarter of 2000. This employee
reduction plan has been executed with the intent to realize various synergies
gained through the nine acquisitions the Company completed in 1999 and the first
half of 2000.
LIQUIDITY AND CAPITAL RESOURCES
The Company invests excess cash primarily in money market funds and other
highly liquid securities with maturities of less than 90 days with the intent to
make such funds readily available for operating purposes. During the six months
ended June 30, 2000, cash and cash equivalents increased $215.5 million to
$291.3 million.
For the six months ended June 30, 2000, the Company used $39.0 million in
cash to fund operating activities primarily due to its net loss adjusted for
non-cash charges, notably the amortization of intangibles resulting from the
Company's acquisitions. For the six months ended June 30, 1999, the Company used
$16.4 million, respectively, to fund operating activities.
Cash used in investing activities during the six months ended June 30,
2000, was approximately $39.2 million. During the six months ended June 30,
2000, the Company disbursed $26.0 million to purchase property and equipment.
Installation of network infrastructure equipment in the Company's data centers,
licenses of new software platforms, and purchases of furniture and equipment for
new employees accounted for the significant increase in capital expenditures.
The Company expects that investments in property and equipment will continue to
be a significant use of cash as the Company seeks to increase its capacity to
provide end-to-end messaging and collaboration services. In addition, the
Company completed its acquisitions of ISOCOR, docSpace, RemarQ and Netmosphere
during the first six months of 2000, and as a result, expended approximately
$9.5 million, net of cash received. Furthermore, the Company made strategic
investments totaling $9.0 million in three private entities. The Company made an
initial capital contribution of $7.5 million to CP Pacific and advanced
approximately $241,000 to certain officers pursuant to promissory notes. These
uses of cash were offset by the receipt of $10.0 million previously advanced to
a private company pursuant to a promissory note. During the first six months of
1999, the Company issued $200,000 in notes to certain officers of the Company,
made capital expenditures which totaled $7.3 million, completed an investment in
a privately held strategic corporate partner of $3.0 million and expended
approximately $12.0 million in net cash proceeds and other acquisition costs
related to the acquisition of Fabrik Connect Service. Cash from financing
activities during the six months ended June 30, 2000, totaled $293.8 million.
The Company received $289.2 million in net proceeds from the sale of its $300.0
million five-year, 5.75% Convertible Subordinated Notes due April 2005, as well
as approximately $7.1 million from the exercise of employee stock options. These
increases were offset by payments totaling $2.5 million to retire principal on
capital lease obligations. During the six months ended June 30, 1999, the
Company completed the second round of the Series B Convertible Preferred Stock
financing through the issuance of approximately 3.2 million shares, including
454,544 shares issued
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CRITICAL PATH, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS (CONTINUED)
pursuant to outstanding stock purchase rights, for net proceeds of $12.5
million. Also in January 1999, the Company sold 1,090,909 shares of Common Stock
for net proceeds of $2.4 million. In April 1999, the Company received
approximately $114.1 million in net proceeds upon the closing of its initial
public offering of Common Stock. In June 1999, Critical Path received
approximately $140.7 million in net proceeds upon the closing of its secondary
offering of Common Stock. In addition, the Company paid $1.2 million to retire
principal on capital lease obligations and $227,000 to purchase treasury stock.
The Company has experienced a substantial increase in its capital
expenditures and operating lease arrangements since its inception and
anticipates that this expenditure level will continue in the future. The Company
expects to incur capital expenditures of approximately $22.0 million during the
remaining six months of 2000, including significant cash expenditures in
connection with its financial accounting integration system. In July 2000, the
Company made strategic investments totaling $8.0 million in two private
entities, and completed its purchase of an additional 12.87% interest in
Critical Path Italia from certain minority shareholders for approximately $1.3
million.
Additionally, the Company will continue to evaluate possible acquisitions
of, or investments in, businesses, products and technologies that are
complementary to those of the Company, which may require the use of cash. In the
first six months of 2000, the Company completed its acquisitions of ISOCOR,
docSpace, RemarQ and Netmosphere and as a result, expended approximately $53.2
million in cash consisting of approximately $30.0 million in acquisition
consideration and $23.2 million for other acquisition costs, consisting
primarily of financial advisory and other professional fees. The Company expects
that future acquisitions of businesses and other strategic assets will require
considerable outlays of capital. Management believes that existing capital
resources will enable it to maintain current and planned operations for at least
the next 12 months. However, operating and investing activities on a long-term
basis may require the Company to seek additional equity or debt financing.
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CRITICAL PATH, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS (CONTINUED)
ADDITIONAL FACTORS THAT MAY AFFECT FUTURE OPERATING RESULTS
WE HAVE A LIMITED OPERATING HISTORY UPON WHICH YOU CAN EVALUATE OUR BUSINESS AND
FACE RISKS ASSOCIATED WITH EARLY STAGE COMPANIES THAT MAY ADVERSELY AFFECT OUR
BUSINESS.
Because we have had a limited operating history, it is difficult to
evaluate our business and we may face various risks, expenses and difficulties
associated with early stage companies. You should consider the risks, expenses
and difficulties that we may encounter when making your investment decision.
These risks include our ability to:
- Acquire businesses and technologies;
- Integrate the operations of the companies that we have recently acquired;
- Manage growing domestic and international operations;
- Create and maintain strategic relationships;
- Expand sales and marketing activities;
- Expand our customer base and retain key clients;
- Introduce new services;
- Compete in a highly competitive market;
- Upgrade our systems and infrastructure to handle any increases in
messaging traffic;
- Reduce service interruptions; and
- Recruit and retain key personnel.
WE HAVE A HISTORY OF LOSSES, EXPECT CONTINUING LOSSES AND MAY NEVER ACHIEVE
PROFITABILITY.
As of June 30, 2000, we had an accumulated deficit of approximately $336.4
million. We have not achieved profitability in any period, and expect to
continue to incur net losses for the foreseeable future. We expect that our
operating expenses will increase as we spend resources on building our business
and that this increase may have a negative effect on operating results and
financial condition in the near term.
We have spent heavily on technology and infrastructure development. We
expect to continue to spend substantial financial and other resources on
developing and introducing new end-to-end Internet messaging and collaboration
solutions, and expanding our sales and marketing organizations, strategic
relationships and operating infrastructure. We expect that our cost of revenues,
sales and marketing expenses, general and administrative expenses, operations
and customer support expenses, and depreciation and amortization expenses will
continue to increase in absolute dollars and may increase as a percent of
revenues. If revenues do not correspondingly increase, our operating results and
financial condition could be negatively affected. Should we continue to incur
net losses in future periods, we may not be able to increase the number of
employees or investment in capital equipment, sales and marketing programs, and
research and development in accordance with our present plans. We may never
obtain sufficient revenues to achieve profitability. If we do achieve
profitability, we may not sustain or increase profitability in the future. This
may, in turn, cause our stock price to decline.
DUE TO OUR LIMITED OPERATING HISTORY AND THE EMERGING NATURE OF THE INTERNET
MESSAGING AND COLLABORATION SOLUTIONS MARKET, FUTURE REVENUES ARE UNPREDICTABLE,
AND OUR QUARTERLY OPERATING RESULTS MAY FLUCTUATE.
We cannot accurately forecast our revenues as a result of our limited
operating history and the emerging nature of the Internet messaging and
collaboration solutions market. Our revenues could fall short of expectations if
we experience delays or cancellations of even a small number of orders. We often
offer volume-
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CRITICAL PATH, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS (CONTINUED)
based pricing, which may affect operating margins. A number of factors are
likely to cause fluctuations in operating results, including, but not limited
to:
- Continued growth of the Internet in general and of messaging and
collaboration usage in particular;
- Demand for outsourced messaging services;
- Demand for licensing of messaging, directory, and other products;
- Our ability to attract and retain customers and maintain customer
satisfaction;
- Our ability to upgrade, develop and maintain our systems and
infrastructure;
- The amount and timing of operating costs and capital expenditures
relating to expansion of business and infrastructure;
- Technical difficulties or system outages;
- The announcement or introduction of new or enhanced services by
competitors;
- Our ability to attract and retain qualified personnel with Internet
industry expertise, particularly sales and marketing personnel;
- The pricing policies of competitors;
- Failure to increase international sales; and
- Governmental regulation surrounding the Internet and messaging in
particular.
In addition to the factors set forth above, operating results will be
impacted by the extent to which we incur non-cash charges associated with
stock-based arrangements with employees and non-employees. In particular, we
have incurred and expect to continue to incur substantial non-cash charges
associated with the grant of warrants to our customers and other parties with
which we have commercial relationships.
Period-to-period comparisons of operating results are not a good indication
of future performance. It is likely that operating results in some quarters will
be below market expectations. In this event, the price of our Common Stock is
likely to decline.
FURTHER ACQUISITIONS COULD RESULT IN DILUTION, OPERATING DIFFICULTIES AND OTHER
CONSEQUENCES.
We expect to acquire or invest in additional businesses, products, services
and technologies that complement or augment our service offerings and customer
base. Since January 1999, we have completed the acquisition of nine companies
for an aggregate consideration consisting of cash, Common Stock and the
assumption of stock options and warrants totaling approximately $1.3 billion. In
addition, on August 8, 2000, we announced that we had entered into a definitive
agreement to acquire Peerlogic Inc. for stock valued at approximately $416.0
million.
We are currently engaged in discussions with a number of companies
regarding strategic acquisitions or investments. Although these discussions are
ongoing, we have not signed any definitive agreements, other than the Peerlogic
acquisition, and cannot assure you that any of these discussions will result in
actual acquisitions. To be successful, we will need to identify suitable
acquisition candidates, integrate disparate technologies and corporate cultures
and manage a geographically dispersed company. We cannot assure you that we will
be able to do this successfully. Acquisitions could divert attention from other
business concerns and could expose us to unforeseen liabilities. In addition, we
may lose key employees while integrating any new companies.
We expect to pay for acquisitions by issuing additional Common Stock, which
would dilute current shareholders. We may also use cash to make acquisitions. It
may be necessary for us to raise additional funds through public or private
financings. We cannot assure you that we will be able to raise additional funds
at any
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CRITICAL PATH, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS (CONTINUED)
particular point in the future or on favorable terms. In addition, we may be
required to amortize significant amounts of goodwill and other intangible assets
in connection with future acquisitions, which would materially increase
operating expenses.
WE WILL FACE TECHNICAL, OPERATIONAL AND STRATEGIC CHALLENGES THAT MAY PREVENT US
FROM SUCCESSFULLY CONTINUING THE INTEGRATION OF ANY ACQUIRED BUSINESS.
Acquisitions involve risks related to the integration and management of
acquired technology, operations and personnel. The integration of businesses
that we have acquired into our business has been and will be a complex, time
consuming and expensive process and may disrupt our business if not completed in
a timely and efficient manner. For example, on July 19, 2000, we announced plans
to reduce employee headcount in order to eliminate duplicative positions
totaling approximately 13% of our worldwide workforce that were created by our
acquisitions. The elimination is necessary to achieving synergies with our
acquisitions, but it may negatively affect employee morale. We must operate as a
combined organization utilizing, common information and communication systems,
operating procedures, financial controls and human resources practices. In
particular, we are currently evaluating, upgrading or replacing our financial
information systems and establishing uniformity among the systems of the
acquired businesses. We may encounter substantial difficulties, costs and delays
involved in integrating the operations of our subsidiaries, including:
- potential incompatibility of business cultures;
- perceived adverse changes in business focus;
- potential conflicts in sponsor, advertising or strategic relationships;
and
- the loss of key employees and diversion of the attention of management
from other ongoing business concerns.
Consequently, we may not be successful in integrating acquired businesses
or technologies and may not achieve anticipated revenue and cost benefits. We
also cannot guarantee that these acquisitions will result in sufficient revenues
or earnings to justify our investment in, or expenses related to, these
acquisitions or that any synergies will develop. If we fail to execute our
acquisition strategy successfully for any reason, our business will suffer
significantly.
WE HAVE EXPERIENCED RAPID GROWTH THAT HAS PLACED A STRAIN ON RESOURCES AND OUR
FAILURE TO MANAGE GROWTH COULD CAUSE OUR BUSINESS TO SUFFER.
We have expanded our operations rapidly and intend to continue this
expansion. The number of our employees increased from 93 on December 31, 1998 to
945 on June 30, 2000. This expansion has placed, and is expected to continue to
place, a significant strain on managerial, operational and financial resources.
To manage any further growth, we will need to improve or replace our existing
operational, customer service and financial systems, procedures and controls.
Any failure to properly manage these systems and procedural transitions could
impair our ability to attract and service customers, and could cause us to incur
higher operating costs and delays in the execution of our business plan. We will
also need to continue the expansion of our operations and employee base.
However, in July 2000, we determined that we were eliminating approximately 13%
of our worldwide employees to operational synergies that were observed due to
the acquisitions we have completed. Our management may not be able to hire,
train, retain, motivate and manage required personnel. In addition, our
management may not be able to successfully identify, manage and exploit existing
and potential market opportunities. If we cannot manage growth effectively, our
business and operating results could suffer.
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CRITICAL PATH, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS (CONTINUED)
IF WE FAIL TO EXPAND SALES AND MARKETING ACTIVITIES, WE MAY BE UNABLE TO EXPAND
OUR BUSINESS.
Our ability to increase revenues will depend on our ability to successfully
recruit, train and retain sales and marketing personnel. We plan to continue to
invest significant resources to expand our sales and marketing organizations.
Competition for additional qualified personnel is intense and we may not be able
to hire and retain personnel with relevant experience.
The complexity and implementation of our Internet messaging services
require highly trained sales and marketing personnel to educate prospective
customers regarding the use and benefits of our services. Current and
prospective customers, in turn, must be able to educate their end-users. With
our relatively brief operating history and our plans for expansion, we have
considerable need to recruit, train and retain qualified staff. Any delays or
difficulties encountered in these staffing efforts would impair our ability to
attract new customers and to enhance our relationships with existing customers.
This in turn would adversely impact the timing and extent of revenues. Because
the majority of our sales and marketing personnel have recently joined us and
have limited experience working together, our sales and marketing organizations
may not be able to compete successfully against the larger and more experienced
sales and marketing organizations of our competitors. If we do not successfully
expand sales and marketing activities, our business could suffer and our stock
price could decline.
UNPLANNED SYSTEM INTERRUPTIONS AND CAPACITY CONSTRAINTS COULD REDUCE OUR ABILITY
TO PROVIDE MESSAGING AND COLLABORATION SERVICES AND COULD HARM OUR BUSINESS AND
REPUTATION.
Our customers have in the past experienced some interruptions in our
messaging service. We believe that these interruptions will continue to occur
from time to time. These interruptions are due to hardware failures, unsolicited
bulk email, or "spam," attacks and operating system failures. For example, in
January 2000, our customers experienced a service interruption due to an
operating system failure. Our revenues depend on the number of end-users who use
our messaging services. Our business will suffer if we experience frequent or
long system interruptions that result in the unavailability or reduced
performance of systems or networks or reduce our ability to provide email
services. We expect to experience occasional temporary capacity constraints due
to sharply increased traffic, which may cause unanticipated system disruptions,
slower response times, impaired quality and degradation in levels of customer
service. If this were to continue to happen, our business and reputation could
suffer dramatically.
We have entered into service agreements with some customers that require
minimum performance standards, including standards regarding the availability
and response time of messaging services. If we fail to meet these standards, our
customers could terminate their relationships with us and we could be subject to
contractual monetary penalties. Any unplanned interruption of services may
adversely affect our ability to attract and retain customers.
IF WE DO NOT SUCCESSFULLY ADDRESS THE RISKS INHERENT IN THE EXPANSION OF OUR
INTERNATIONAL OPERATIONS, OUR BUSINESS COULD SUFFER.
We intend to continue to expand into international markets and to spend
significant financial and managerial resources to do so. If revenues from
international operations do not exceed the expense of establishing and
maintaining these operations, our business, financial condition and operating
results will suffer. At present, we have international operations in Canada,
Argentina, Brazil, Denmark, France, Germany, Ireland, Italy, Japan, Switzerland
and the United Kingdom and for the six months ended June 30, 2000 we derived
approximately 43% of our revenues from international sales. We have limited
experience in international operations and may not be able to compete
effectively in international markets. We face certain risks inherent in
conducting business internationally, such as:
- Unexpected changes in regulatory requirements including U.S. export
restrictions on encryption technologies;
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CRITICAL PATH, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS (CONTINUED)
- Difficulties and costs of staffing and managing international operations;
- Differing technology standards;
- Difficulties in collecting accounts receivable and longer collection
periods;
- Political and economic instability;
- Fluctuations in currency exchange rates;
- Imposition of currency exchange controls;
- Potentially adverse tax consequences; and
- Reduced protection for intellectual property rights in some countries.
Any of these factors could adversely affect international operations and,
consequently, business and operating results. Specifically, failure to
successfully manage international growth could result in higher operating costs
than anticipated, or could delay or preclude altogether our ability to generate
revenues in key international markets.
WE DEPEND ON STRATEGIC RELATIONSHIPS AND OTHER SALES CHANNELS AND THE LOSS OF
ANY STRATEGIC RELATIONSHIPS COULD HARM OUR BUSINESS AND HAVE AN ADVERSE IMPACT
ON REVENUES.
We depend on strategic relationships to expand distribution channels and to
undertake joint product development and marketing efforts. Our ability to
increase revenues depends upon marketing services through new and existing
strategic relationships. We have entered into written agreements with ICQ (a
subsidiary of America Online), E*TRADE, Network Solutions, Sprint, MCI Worldcom,
US West, Yahoo!, and Aether Systems, among others. We depend on a broad
acceptance of outsourced messaging services on the part of potential partners
and acceptance of our company as the supplier for these outsourced messaging
services. We also depend on joint marketing and product development through
strategic relationships to achieve market acceptance and brand recognition. For
example, through our relationship with E*TRADE, we can conduct shared
advertising campaigns and include messaging services in E*TRADE's international
strategic relationships. Our agreements with strategic partners typically do not
restrict them from introducing competing services. These agreements typically
are for terms of one to three years, and automatically renew for additional
one-year periods unless either party gives prior notice of its intention to
terminate the agreement. In addition, these agreements are terminable by our
partners without cause, and some agreements are terminable by us, upon 30 - 120
days' notice. Most of the agreements also provide for the partial refund of fees
paid or other monetary penalties in the event that our services fail to meet
defined minimum performance standards. Distribution partners may choose not to
renew existing arrangements on commercially acceptable terms, or at all. If we
lose any strategic relationships, fail to renew these agreements or
relationships or fail to develop new strategic relationships, business will
suffer. The loss of any key strategic relationships would have an adverse impact
on current and future revenue. In addition to strategic relationships, we also
depend on the ability of our customers to sell and market our services to their
end-users.
WE MAY NOT BE ABLE TO RESPOND TO THE RAPID TECHNOLOGICAL CHANGE OF THE INTERNET
MESSAGING AND COLLABORATION INDUSTRY.
The Internet messaging industry is characterized by rapid technological
change, changes in user and customer requirements and preferences, and the
emergence of new industry standards and practices that could render our existing
services, proprietary technology and systems obsolete. We must continually
improve the performance, features and reliability of our services, particularly
in response to competitive offerings. Our success depends, in part, on our
ability to enhance our existing email and messaging services and to develop new
services, functionality and technology that address the increasingly
sophisticated and varied needs of prospective customers. If we don't properly
identify the feature preferences of prospective customers, or if we fail to
deliver email features that meet the standards of these customers, our ability
to market our service successfully and to increase revenues could be impaired.
The development of proprietary technology and
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CRITICAL PATH, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS (CONTINUED)
necessary service enhancements entail significant technical and business risks
and require substantial expenditures and lead-time. We may not be able to keep
pace with the latest technological developments. We may also be unable to use
new technologies effectively or adapt services to customer requirements or
emerging industry standards.
IF OUR SYSTEM SECURITY IS BREACHED, OUR BUSINESS AND REPUTATION COULD SUFFER.
A fundamental requirement for online communications is the secure
transmission of confidential information over public networks. Third parties may
attempt to breach our security or that of our customers. If these attempts are
successful, customers' confidential information, including customers' profiles,
passwords, financial account information, credit card numbers or other personal
information could be breached. We may be liable to our customers for any breach
in security and a breach could harm our reputation. We rely on encryption
technology licensed from third parties. Although we have implemented network
security measures, our servers are vulnerable to computer viruses, physical or
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 technology and additional technologies to
protect against security breaches or to alleviate problems caused by any breach.
Failure to prevent security breaches may have a material adverse effect on
business and operating results.
WE WILL CONTINUE TO DEPEND ON BROAD MARKET ACCEPTANCE FOR OUTSOURCED
INTERNET-BASED EMAIL SERVICE.
The market for outsourced Internet-based email service is new and rapidly
evolving. Concerns over the security of online services and the privacy of users
may inhibit the growth of the Internet and commercial online services. We cannot
estimate the size or growth rate of the potential market for our service
offerings, and we do not know whether our service will achieve broad market
acceptance. To date a substantial portion of our revenues have been derived from
sales of email service offerings and we currently expect that email service
offerings will account for a substantial portion of our revenues for the
foreseeable future. We depend on the widespread acceptance and use of
outsourcing as an effective solution for email. If the market for outsourced
email fails to grow or grows more slowly than we currently anticipate, our
business would suffer dramatically.
WE EXPECT THE MESSAGING SERVICES MARKET WILL BE VERY COMPETITIVE AND WE WILL
NEED TO COMPETE SUCCESSFULLY IN THIS MARKET.
We expect that the market for Internet-based email service will be
intensely competitive. In addition to competing with companies that develop and
maintain in-house solutions, we compete with email service providers, such as
USA.NET, Inc. and mail.com, and with product-based companies, such as
Software.com, Inc. and Lotus Development Corporation. We believe that
competition will increase and that companies such as Microsoft, which currently
offers email products primarily to Internet service providers that provide
access to the Internet; web hosting companies; web sites intended to be major
starting sites for users when they connect to the Internet, commonly referred to
as web portals; and corporations may leverage their existing relationships and
capabilities to offer email services.
We believe competition will increase as current competitors increase the
sophistication of their offerings and as new participants enter the market. Many
current and potential competitors have longer operating histories, larger
customer bases, greater brand recognition and significantly greater financial,
marketing and other resources than we do and may enter into strategic or
commercial relationships with larger, more established and better-financed
companies. Further, any delays in the general market acceptance of the email
hosting concept would likely harm our competitive position. Any delay would also
allow competitors additional time to improve their service or product offerings,
and provide time for new competitors to develop email service solutions and
solicit prospective customers within our target markets. Increased competition
could result in pricing pressures, reduced operating margins and loss of market
share, any of which could cause our business to suffer.
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CRITICAL PATH, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS (CONTINUED)
IF WE DO NOT SUCCESSFULLY ADDRESS SERVICE DESIGN RISKS, OUR REPUTATION COULD BE
DAMAGED AND OUR BUSINESS AND OPERATING RESULTS COULD SUFFER.
We must accurately forecast the features and functionality required by
target customers. In addition, we must design and implement service enhancements
that meet customer requirements in a timely and efficient manner. We may not
successfully determine customer requirements and may be unable to satisfy
customer demands. Furthermore, we may not be able to design and implement a
service incorporating desired features in a timely and efficient manner. In
addition, if customers and end-users do not favorably receive any new service we
launch, our reputation could be damaged. If we fail to accurately determine
customer feature requirements or service enhancements or to market services
containing such features or enhancements in a timely and efficient manner, our
business and operating results could suffer materially.
WE NEED TO UPGRADE OUR SYSTEMS AND INFRASTRUCTURE TO ACCOMMODATE INCREASES IN
MESSAGING TRAFFIC.
We must continue to expand and adapt our network infrastructure as the
number of users and the amount of information we wish to transmit increases, and
as their requirements change. The expansion and adaptation of our network
infrastructure will require substantial financial, operational and management
resources. Due to the limited deployment of services to date, the ability of our
network to connect and manage a substantially larger number of customers at high
transmission speeds is unknown, and we face risks related to the network's
ability to operate with higher customer levels while maintaining expected
performance.
As the frequency and complexity of messaging increases, we will need to
make additional investments in our infrastructure, which may be expensive. In
addition, we may not be able to accurately project the rate or timing of
messaging traffic increases or upgrade our systems and infrastructure to
accommodate future traffic levels, which may cause service degradation or
outages. We may also not be able to achieve or maintain a sufficiently high
capacity of data transmission as customer usage increases. Customer demand for
our services could be greatly reduced if we fail to maintain high capacity data
transmission. In addition, as we upgrade our network infrastructure to increase
capacity available to customers, we are likely to encounter equipment or
software incompatibility that may cause delays in implementations. We may not be
able to expand or adapt our network infrastructure to meet additional demand or
customers' changing requirements in a timely manner or at all.
BECAUSE WE PROVIDE MESSAGING AND COLLABORATION SERVICES OVER THE INTERNET, OUR
BUSINESS COULD SUFFER IF EFFICIENT TRANSMISSION OF DATA OVER THE INTERNET IS
INTERRUPTED.
The recent growth in the use of the Internet has caused frequent
interruptions and delays in accessing the Internet and transmitting data. To
date we have not experienced a significant adverse effect from these
interruptions. However, because we provide messaging and collaboration services
over the Internet, interruptions or delays in Internet transmissions will
adversely affect customers' ability to send or receive their messages. We rely
on the speed and reliability of the networks operated by third parties.
Therefore, our market depends on improvements being made to the entire Internet
infrastructure to alleviate overloading and congestion.
We depend on telecommunications network suppliers such as Level 3, Qwest,
Exodus and TeleHouse to transmit messages across their networks. In addition, to
deliver our services, we rely on a number of public and private peering
interconnections, which are arrangements among access providers to carry one
another's traffic. If these providers were to discontinue these arrangements,
and alternative providers did not emerge or were to increase the cost of
providing access, our ability to transmit messaging traffic would be reduced. If
we were to increase our current prices to accommodate any increase in the cost
of providing access, it could negatively impact sales. If we did not increase
prices in response to rising access costs, margins would be negatively affected.
Furthermore, if additional capacity is not added as traffic increases, our
ability to distribute content rapidly and reliably through these networks will
be adversely affected.
27
<PAGE> 30
CRITICAL PATH, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS (CONTINUED)
IF WE ENCOUNTER SYSTEM FAILURES, WE MAY NOT BE ABLE TO PROVIDE ADEQUATE SERVICE
AND OUR BUSINESS AND REPUTATION COULD BE DAMAGED.
Our ability to successfully receive and send messages and provide
acceptable levels of customer service largely depends on the efficient and
uninterrupted operation of computer and communications hardware and network
systems. Our systems and operations are vulnerable to damage or interruption
from fire, flood, earthquake, power loss, telecommunications failure and similar
events. The occurrence of any of the foregoing risks could subject us to
contractual monetary penalties if we fail to meet minimum performance standards,
and could have a material adverse effect on business and operating results and
damage our reputation.
WE MUST RECRUIT AND RETAIN OUR KEY EMPLOYEES TO EXPAND OUR BUSINESS.
Our success depends on the skills, experience and performance of senior
management and other key personnel, many of whom have worked together for only a
short period of time. For example, our Chief Operating Officer and Chief
Financial Officer have joined us within the past three months. The loss of the
services of any senior management or other key personnel, including the
President, David Thatcher, and Chief Executive Officer, Douglas Hickey, could
materially and adversely affect business results. We do not have long-term
employment agreements with any executive officers and other key personnel. Our
success also depends on our ability to recruit, retain and motivate other highly
skilled sales and marketing, technical and managerial personnel. Competition for
these people is intense, and we may not be able to successfully recruit, train
or retain qualified personnel. In particular, we may not be able to hire a
sufficient number of qualified software developers.
UNKNOWN SOFTWARE DEFECTS COULD DISRUPT SERVICES, WHICH COULD HARM OUR BUSINESS
AND REPUTATION.
Our service offerings depend on complex software, both internally developed
and licensed from third parties. Complex software often contains defects,
particularly when first introduced or when new versions are released. We may not
discover software defects that affect new or current services or enhancements
until after they are deployed. Although we have not experienced any material
software defects to date, it is possible that, despite testing, defects may
occur in the software. These defects could cause service interruptions, which
could damage our reputation or increase service costs, cause us to lose revenue,
delay market acceptance or divert development resources, any of which could
cause business to suffer.
WE MAY NEED ADDITIONAL CAPITAL AND RAISING ADDITIONAL CAPITAL MAY DILUTE
EXISTING SHAREHOLDERS.
We believe that existing capital resources will enable us to maintain
current and planned operations for at least the next 12 months. However, we may
be required to raise additional funds due to unforeseen circumstances. If
capital requirements vary materially from those current planned, we may require
additional financing sooner than anticipated. Such financing may not be
available in sufficient amounts or on terms acceptable to us and may be dilutive
to existing shareholders.
WE MAY NOT BE ABLE TO PROTECT INTELLECTUAL PROPERTY AND PROPRIETARY RIGHTS.
We regard our copyrights, service marks, trademarks, trade secrets and
similar intellectual property as critical to our success, and we rely on
trademark and copyright law, trade secret protection and confidentiality and/or
license agreements with employees, customers and partners to protect proprietary
rights. Despite these precautions, unauthorized third parties may infringe or
copy portions of our services or reverse engineer or obtain and use information
that we regard as proprietary. End-user license provisions protecting against
unauthorized use, copying, transfer and disclosure of the licensed program may
be unenforceable under the laws of certain jurisdictions and foreign countries.
The status of United States patent protection in the software industry is not
well defined and will evolve as the U.S. Patent and Trademark Office grants
additional patents. We have several patents pending in the United States and may
seek additional patents in the future. We do
28
<PAGE> 31
CRITICAL PATH, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS (CONTINUED)
not know if the patent application or any future patent application will be
issued with the scope of the claims sought, if at all, or whether any patents
received will be challenged or invalidated. In addition, the laws of some
foreign countries do not protect proprietary rights to the same extent as do the
laws of the United States. Our means of protecting proprietary rights in the
United States or abroad may not be adequate and competitors may independently
develop similar technology.
Third parties may infringe or misappropriate copyrights, trademarks and
similar proprietary rights belonging to us. In addition, other parties have
asserted and may assert infringement claims against us. For example, a company
that we acquired is a party to a lawsuit involving alleged infringement of a
third party's patent. The recently acquired company has denied the allegations
of infringement and has made counterclaims. Although we have not received notice
of any other alleged patent infringement, we cannot be certain that our products
do not infringe issued patents that may relate to our products. In addition,
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. We may be subject to legal proceedings and claims from time
to time in the ordinary course of business, including claims of alleged
infringement of trademarks and other intellectual property rights of third
parties. Intellectual property litigation is expensive and time-consuming and
could divert management's attention away from operating our business.
WE MAY NEED TO LICENSE THIRD-PARTY TECHNOLOGIES AND WE FACE RISKS IN DOING SO.
We intend to continue to license certain technology from third parties,
including web server and encryption technology. The market is evolving and we
may need to license additional technologies to remain competitive. We may not be
able to license these technologies on commercially reasonable terms or at all.
In addition, we may fail to successfully integrate any licensed technology into
our services. These third-party in-licenses may expose us to increased risks,
including risks related to the integration of new technology, the diversion of
resources from the development of proprietary technology, and an inability to
generate revenues from new technology sufficient to offset associated
acquisition and maintenance costs. An inability to obtain any of these licenses
could delay product and service development until equivalent technology can be
identified, licensed and integrated. Any such delays in services could cause our
business and operating results to suffer.
THE TRADING PRICES AND VOLUMES OF OUR STOCK HAVE BEEN VOLATILE AND WE EXPECT
THAT THIS VOLATILITY WILL CONTINUE.
Our stock price and trading volumes have been highly volatile since our
initial public offering on March 29, 1999. We expect that this volatility will
continue in the future due to factors such as:
- Actual or anticipated fluctuations in results of operations;
- Changes in or failure to meet securities analysts' expectations;
- Announcements of technological innovations and acquisitions;
- Introduction of new services by us or our competitors;
- Developments with respect to intellectual property rights;
- Conditions and trends in the Internet and other technology industries;
and
- General market conditions.
In addition, the stock market has from time to time experienced significant
price and volume fluctuations that have affected the market prices for the
common stocks of technology companies, particularly Internet companies. These
broad market fluctuations may result in a material decline in the market price
of our common stock. In the past, following periods of volatility in the market
price of a particular company's
29
<PAGE> 32
CRITICAL PATH, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS (CONTINUED)
securities, securities class action litigation has often been brought against
that company. We may become involved in this type of litigation in the future.
Litigation is often expensive and diverts management's attention and resources,
which could have a material adverse effect on our business and operating
results.
GOVERNMENTAL REGULATION AND LEGAL UNCERTAINTIES COULD IMPAIR THE GROWTH OF THE
INTERNET AND DECREASE DEMAND FOR OUR SERVICES OR INCREASE OUR COST OF DOING
BUSINESS.
Although there are currently few laws and regulations directly applicable
to the Internet and messaging services, 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
messaging services may prompt calls for more stringent consumer protection laws
that may impose additional burdens on those companies conducting business
online. The adoption of any additional laws or regulations may impair the growth
of the Internet or commercial online services which could decrease the demand
for our services and increase our cost of doing business, or otherwise harm
business and operating results. Moreover, the applicability to the Internet of
existing laws in various jurisdictions governing issues such as property
ownership, sales and other taxes, libel and personal privacy is uncertain and
may take years to resolve.
WE MAY HAVE LIABILITY FOR INTERNET CONTENT AND WE MAY NOT HAVE ADEQUATE
LIABILITY INSURANCE.
As a provider of messaging services, we face potential liability for
defamation, negligence, copyright, patent or trademark infringement and other
claims based on the nature and content of the materials transmitted via our
services. We do not and cannot screen all of the content generated by our users,
and we could be exposed to liability with respect to this content. Furthermore,
some foreign governments, such as Germany, have enforced laws and regulations
related to content distributed over the Internet that are more strict than those
currently in place in the United States.
Although we carry general liability and umbrella liability insurance, our
insurance may not cover claims of these types or may not be adequate to
indemnify us for all liability that may be imposed. There is a risk that a
single claim or multiple claims, if successfully asserted against us, could
exceed the total of our coverage limits. There is also a risk that single claim
or multiple claims asserted against us may not qualify for coverage under our
insurance policies as a result of coverage exclusions that are contained within
these policies. Should either of these risks occur, capital contributed by our
stockholders may need to be used to settle claims. Any imposition of liability,
particularly liability that is not covered by insurance or is in excess of
insurance coverage could have a material adverse effect on our reputation and
business and operating results, or could result in the imposition of criminal
penalties.
FUTURE SALES OF OUR COMMON STOCK MAY DEPRESS THE PRICE OF OUR COMMON STOCK.
As of July 31, 2000, we had approximately 63.9 million shares of Common
Stock outstanding. Sales of a substantial number of shares of Common Stock in
the public market could cause the market price of our Common Stock to decline.
Up to 2.9 million shares may be issued upon the conversion of our Convertible
Subordinated Notes and will become eligible for sale under an S-3 registration
statement that we will file to meet our registration rights obligations in
connection with our sale of Convertible Subordinated Notes. Certain of our
shareholders and warrant holders have registration rights with respect to the
Common Stock and Common Stock issuable under the warrants.
OUR DIRECTORS, EXECUTIVE OFFICERS AND PRINCIPAL SHAREHOLDERS WILL BE ABLE TO
EXERT SIGNIFICANT INFLUENCE OVER US.
As a result of our offerings, our directors, executive officers and
principal shareholders will beneficially own a substantial portion of our
outstanding Common Stock. These shareholders, if they vote together, will be
able to exercise significant influence over all matters requiring shareholder
approval, including the election of
30
<PAGE> 33
CRITICAL PATH, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS (CONTINUED)
directors and approval of significant corporate transactions. This concentration
of ownership may also delay or prevent a change in control of our company.
OUR ARTICLES OF INCORPORATION AND BYLAWS CONTAIN PROVISIONS THAT COULD DELAY OR
PREVENT A CHANGE IN CONTROL.
Our Articles of Incorporation and Bylaws contain provisions that could
delay or prevent a change in control of our company. These provisions could
limit the price that investors might be willing to pay in the future for shares
of our Common Stock. Some of these provisions:
- Authorize the issuance of preferred stock that can be created and issued
by the board of directors without prior stockholder approval, commonly
referred to as "blank check" preferred stock, with rights senior to those
of Common Stock;
- Prohibit shareholder action by written consent; and
- Establish advance notice requirements for submitting nominations for
election to the board of directors and for proposing matters that can be
acted upon by shareholders at a meeting.
31
<PAGE> 34
CRITICAL PATH, INC.
SUPPLEMENTAL PRO FORMA FINANCIAL DATA (UNAUDITED)
The following supplemental pro forma financial information presents the
Company's consolidated results of operations for the three- and six-month
periods ended June 30, 1999 and 2000, excluding the impact of certain special
charges consisting of (i) amortization of intangible assets associated with
purchase business combinations, (ii) accruals for employee retention bonuses
associated with purchase business combinations, and (iii) stock-based
compensation associated with outstanding options and warrants. This supplemental
presentation is for informational purposes only, and is not intended to replace
the condensed consolidated operating results prepared and presented in
accordance with generally accepted accounting principles.
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
-------------------- --------------------
JUNE 30, JUNE 30, JUNE 30, JUNE 30,
1999 2000 1999 2000
-------- -------- -------- --------
<S> <C> <C> <C> <C>
(In thousands, except per share amounts)
Net revenues
Licenses....................................... $ -- $ 13,897 $ -- $ 24,967
Services....................................... 2,006 19,598 3,055 33,081
------- -------- -------- --------
Total net revenues..................... 2,006 33,495 3,055 58,048
------- -------- -------- --------
Cost of net revenues
Licenses....................................... -- 737 -- 1,744
Services....................................... 3,234 16,738 5,148 31,078
------- -------- -------- --------
Total cost of net revenues............. 3,234 17,475 5,148 32,822
------- -------- -------- --------
Gross profit (loss).............................. (1,228) 16,020 (2,093) 25,226
------- -------- -------- --------
Operating expenses
Sales and marketing............................ 3,219 17,342 5,203 30,947
Research and development....................... 1,430 9,213 2,809 15,536
General and administrative..................... 2,691 7,332 4,241 14,098
------- -------- -------- --------
Total operating expenses............... 7,340 33,887 12,253 60,581
------- -------- -------- --------
Loss from operations............................. (8,568) (17,867) (14,346) (35,355)
------- -------- -------- --------
Interest and other income (expense), net......... 1,882 4,697 2,233 5,954
Interest expense................................. (164) (5,244) (212) (5,501)
Minority interest in net income of consolidated
subsidiary..................................... -- (325) -- (325)
------- -------- -------- --------
Loss before income taxes......................... (6,850) (18,739) (12,325) (35,227)
Provision for income taxes....................... -- (1,439) -- (1,799)
------- -------- -------- --------
Net Loss......................................... $(6,850) $(20,178) $(12,325) $(37,026)
======= ======== ======== ========
Net loss per share -- basic and diluted.......... $ (0.21) $ (0.34) $ (0.62) $ (0.68)
======= ======== ======== ========
Weighted average shares -- basic and diluted..... 32,977 58,592 19,994 54,581
======= ======== ======== ========
</TABLE>
32
<PAGE> 35
CRITICAL PATH, INC.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
As of June 30, 2000, the Company did not have any derivative financial
instruments. However, the Company is exposed to interest rate risk. The Company
employs established policies and procedures to manage its exposure to changes in
the market risk of its marketable securities, which are classified as
available-for-sale as of June 30, 2000.
The Company's capital lease obligations and $300 million five-year, 5.75%
Convertible Subordinated Notes due April 2005, have fixed interest rates and
fixed redemption amounts. The fair value of these instruments is affected by
changes in market interest rates. The Company believes that the market risk
arising from holdings of its financial instruments is not material.
A substantial portion of the Company's worldwide operations has a
functional currency other than the United States Dollar. In particular, the
Company maintains substantial development operations in Ireland, where the
functional currency is the Irish Pound; Germany, where the functional currency
is the German Mark; and Italy, where the functional currency is the Italian
Lira. In addition, a significant portion of the Company's revenue is also
denominated in currencies other than the United States Dollar. Fluctuations in
exchange rates may have a material adverse effect on the Company's results of
operations and could also result in exchange losses. The impact of future
exchange rate fluctuations cannot be predicted adequately. To date, the Company
has not sought to hedge the risks associated with fluctuations in exchange
rates, but may undertake such transactions in the future. There can be no
assurance that any hedging techniques implemented by the Company would be
successful or that the Company's results of operations will not be materially
adversely affected by exchange rate fluctuations.
33
<PAGE> 36
PART 2 -- OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
See Footnote 7, "Commitments and Contingencies", in the Notes to
Consolidated Financial Statements.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
See Footnote 2, "Acquisitions and Joint Venture", in the Notes to
Consolidated Financial Statements.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On June 13, 2000, an Annual Meeting of the Shareholders of Critical Path,
Inc., was held at the Park Hyatt Hotel, 333 Battery Street, San Francisco,
California.
At the Annual Meeting, the following persons were elected by the
Shareholders of Critical Path, Inc. as directors to serve until the next annual
meeting: David Hayden, Douglas Hickey, Christos Cotsakos, Lisa Gansky, Kevin
Harvey, James Smith and George Zachary.
The following table sets forth the number of votes cast for, against, and
withheld, including abstentions and broker non-votes, for the persons standing
for election as a director:
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
VOTES
----------------------------------------------------------------------
PERSON FOR AGAINST ABSTAIN
<S> <C> <C> <C>
-----------------------------------------------------------------------------------------------
Christos M. Cotsakos 39,054,352 179,860 122,550
-----------------------------------------------------------------------------------------------
Lisa A. Gansky 39,221,435 3,277 122,550
-----------------------------------------------------------------------------------------------
Kevin R. Harvey 39,232,731 1,481 122,550
-----------------------------------------------------------------------------------------------
David C. Hayden 39,230,977 3,235 122,550
-----------------------------------------------------------------------------------------------
Douglas T. Hickey 39,223,666 10,546 122,550
-----------------------------------------------------------------------------------------------
James A. Smith 38,926,842 307,370 122,550
-----------------------------------------------------------------------------------------------
George Zachary 39,224,305 9,907 122,550
-----------------------------------------------------------------------------------------------
</TABLE>
The following items were approved at the Annual Meeting by the Shareholders
of Critical Path, Inc.:
1. A proposal to change the state of incorporation of Critical Path, Inc.
from California to Delaware;
2. A proposal to increase the number of authorized shares of Common Stock
from 150,000,000 to 500,000,000;
3. A proposal to reserve an additional 8,000,000 shares of Common Stock for
issuance under Critical Path's 1998 Stock Plan;
4. A proposal to amend Critical Path's 1998 Stock Plan to reduce the annual
increase in shares of Common Stock authorized to be issued thereunder
from 5% of Critical Path's authorized shares to 2% of Critical Path's
authorized shares, subject to the increase in the number of authorized
shares to 500,000,000; and
5. The appointment of PricewaterhouseCoopers LLP as Critical Path's
independent accounts for the 2000 fiscal year.
34
<PAGE> 37
The following table sets forth the number of votes cast for, against, and
withheld, including abstentions and broker non-votes, for each proposal outlined
above:
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
VOTES
------------------------------------------------------------------------------
PROPOSAL FOR AGAINST ABSTAIN NOT-VOTED
<S> <C> <C> <C> <C>
-----------------------------------------------------------------------------------------------------
Proposal 1 29,390,568 4,845,513 10,902 5,109,779
-----------------------------------------------------------------------------------------------------
Proposal 2 33,609,280 5,718,597 28,884 1
-----------------------------------------------------------------------------------------------------
Proposal 3 27,329,399 6,816,606 100,978 5,109,779
-----------------------------------------------------------------------------------------------------
Proposal 4 36,398,379 2,882,894 48,988 35,501
-----------------------------------------------------------------------------------------------------
Proposal 5 39,301,299 12,983 41,480
-----------------------------------------------------------------------------------------------------
</TABLE>
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
27.1 Financial Data Schedule
(b) Reports on Form 8-K
None.
35
<PAGE> 38
SIGNATURE
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 duly authorized.
Date: August 14, 2000
CRITICAL PATH, INC.
By: /s/ MARK J. RUBASH
--------------------------------------
Mark J. Rubash
Executive Vice President,
Chief Financial Officer
(Duly Authorized Officer and Principal
Financial and Accounting Officer)
36
<PAGE> 39
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<C> <S>
27.1 Financial Data Schedule
</TABLE>
