<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 SEPTEMBER 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.
A CALIFORNIA CORPORATION I.R.S. EMPLOYER NO. 91-1788300
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 October 31, 2000, the company had outstanding 73,651,212 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................................... 18
Supplemental Pro Forma Financial Data (Unaudited)........... 40
Item 3. Quantitative and Qualitative Disclosures About Market
Risk........................................................ 41
PART II
Item 1. Legal Proceedings........................................... 42
Item 2. Changes in Securities and Use of Proceeds................... 42
Item 3. Defaults Upon Senior Securities............................. 42
Item 4. Submission of Matters to a Vote of Security Holders......... 42
Item 5. Other Information........................................... 42
Item 6. Exhibits and Reports on Form 8-K............................ 42
</TABLE>
i
<PAGE> 3
PART I
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
CRITICAL PATH, INC.
CONSOLIDATED BALANCE SHEET
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
ASSETS
<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER 30,
1999 2000
------------ -------------
(UNAUDITED)
<S> <C> <C>
Current assets
Cash and cash equivalents................................. $ 75,932 $ 242,458
Restricted cash........................................... 325 325
Accounts receivable, net.................................. 10,147 43,911
Other current assets...................................... 40,800 9,688
--------- ----------
Total current assets............................... 127,204 296,382
Investments................................................. 18,426 32,669
Notes receivable from officers.............................. 669 1,107
Property and equipment, net................................. 52,517 85,704
Intangible assets, net...................................... 474,297 1,498,578
Other assets................................................ 692 9,202
--------- ----------
Total assets....................................... $ 673,805 $1,923,642
========= ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities
Accounts payable.......................................... $ 35,621 $ 42,546
Accrued expenses.......................................... 7,120 14,529
Deferred revenue.......................................... 1,818 16,683
Capital lease and other obligations, current.............. 6,585 9,681
--------- ----------
Total current liabilities.......................... 51,144 83,439
Convertible subordinated notes payable...................... -- 300,000
Capital lease and other obligations, long-term.............. 5,669 5,958
--------- ----------
Total liabilities.................................. 56,813 389,397
--------- ----------
Minority interest in consolidated subsidiary................ -- 526
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 73,392 (net of
134 and 175 treasury shares at cost of $229 and $342,
respectively)......................................... 864,699 2,132,237
Notes receivable from shareholders........................ (1,154) (1,192)
Unearned compensation..................................... (124,906) (126,807)
Accumulated deficit, including other comprehensive loss... (121,647) (470,519)
--------- ----------
Total shareholders' equity......................... 616,992 1,533,719
Total liabilities and shareholders' equity......... $ 673,805 $1,923,642
========= ==========
</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 NINE MONTHS ENDED
------------------------------ ------------------------------
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
1999 2000 1999 2000
------------- ------------- ------------- -------------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C>
Net revenues
Licenses............................. $ -- $ 21,998 $ -- $ 46,965
Services............................. 4,913 22,977 7,968 56,058
-------- --------- -------- ---------
Total net revenues........... 4,913 44,975 7,968 103,023
-------- --------- -------- ---------
Cost of net revenues
Licenses............................. -- 634 -- 2,378
Services............................. 4,681 19,076 9,829 50,154
Amortization of purchased
technology........................ -- 4,434 -- 10,969
Acquisition-related retention
bonuses........................... 130 260 130 1,040
Stock-based expenses................. 2,712 381 3,901 1,257
-------- --------- -------- ---------
Total cost of net revenues... 7,523 24,785 13,860 65,798
-------- --------- -------- ---------
Gross profit (loss).................... (2,610) 20,190 (5,892) 37,225
-------- --------- -------- ---------
Operating expenses
Sales and marketing.................. 3,557 16,128 8,760 47,075
Research and development............. 1,895 7,635 4,705 23,171
General and administrative........... 3,678 6,491 7,919 20,589
Amortization of intangible assets.... 9,263 94,160 9,813 230,645
Acquisition-related retention
bonuses........................... 570 2,888 570 9,260
Stock-based expenses................. 5,425 10,388 25,244 29,033
Acquired in-process research and
development....................... -- 3,500 -- 3,700
Employee severance expenses.......... -- 6,695 -- 6,695
-------- --------- -------- ---------
Total operating expenses..... 24,388 147,885 57,011 370,168
-------- --------- -------- ---------
Loss from operations................... (26,998) (127,695) (62,903) (332,943)
Interest and other income (expense),
net.................................. 2,841 4,905 5,074 10,859
Interest expense....................... (167) (5,214) (411) (10,747)
Equity in net loss of joint venture.... -- (640) -- (640)
Minority interest in net income of
consolidated subsidiary.............. -- (201) -- (526)
-------- --------- -------- ---------
Loss before income taxes............... (24,324) (128,845) (58,240) (333,997)
Provision for income taxes............. -- (2,534) -- (4,333)
-------- --------- -------- ---------
Net loss............................... $(24,324) $(131,379) $(58,240) $(338,330)
======== ========= ======== =========
Net loss per share -- basic and
diluted.............................. $ (0.65) $ (2.13) $ (2.26) $ (5.94)
======== ========= ======== =========
Weighted average shares -- basic and
diluted.............................. 37,158 61,614 25,715 56,925
======== ========= ======== =========
</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>
NINE MONTHS ENDED
SEPTEMBER 30
----------------------
1999 2000
--------- ---------
(UNAUDITED)
<S> <C> <C>
Operations
Net loss.................................................. $ (58,240) $(338,330)
Provision for doubtful accounts........................... 135 1,169
Depreciation and amortization............................. 14,017 24,915
Amortization of intangible assets......................... -- 241,614
Amortization of stock-based costs and expenses............ 29,299 33,783
Acquired in-process research and development.............. -- 3,700
Minority interest in net income of consolidated
subsidiary............................................. -- 526
Equity in net loss of unconsolidated affiliate............ -- 640
Accounts receivable....................................... (1,562) (18,124)
Other assets.............................................. (3,997) (5,442)
Accounts payable.......................................... 2,928 1,413
Accrued expenses.......................................... 2,018 (3,162)
Deferred revenue.......................................... (438) (599)
--------- ---------
Net cash used in operating activities.................. (15,840) (57,897)
--------- ---------
Investing
Notes receivable from officers............................ (122) (371)
Property and equipment purchases.......................... (21,843) (39,939)
Investments in unconsolidated entities, net............... (4,500) (24,895)
Payments for acquisitions, net of cash acquired........... (78,223) (24,417)
Promissory note receivable................................ (15,000) 10,000
--------- ---------
Net cash used in investing activities.................. (119,688) (79,622)
--------- ---------
Financing
Proceeds from issuance of Preferred Stock, net............ 12,496 --
Proceeds from issuance of Common Stock, net............... 257,372 29,414
Proceeds from convertible debt offering, net.............. -- 289,221
Proceeds from payments of shareholder notes receivable.... 97 --
Principle payment to retire note payable.................. -- (8,000)
Principal payments on lease obligations................... (2,166) (4,711)
Purchase of treasury stock................................ (229) (113)
--------- ---------
Net cash provided by financing activities.............. 267,570 305,811
--------- ---------
Net change in cash and cash equivalents..................... 132,042 168,292
Effect of exchange rates on cash and cash equivalents....... -- (1,766)
Cash and cash equivalents at beginning of period............ 14,791 75,932
--------- ---------
Cash and cash equivalents at end of period.................. $ 146,833 $ 242,458
========= =========
</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 2000, the
shareholders approved the re-incorporation 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 that these changes will become effective in
the fourth 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.
Basis of presentation
The consolidated financial statements include the accounts of the Company,
its wholly-owned and majority-owned subsidiaries. All significant intercompany
balances and transactions have been eliminated in consolidation.
Cash equivalents and restricted cash
The Company considers all highly liquid investments with an original
maturity of three months or less to be cash equivalents. Cash equivalents
consist primarily of deposits in money market funds. Restricted cash is composed
of amounts held on deposit that are required as collateral for Company issued
credit cards.
Investments
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 charges for permanent declines in value, if any, on available-for-sale
securities will be reported in other income or expense as incurred. The equity
method is used to account for investments in unconsolidated entities if the
Company has the ability to exercise significant influence over financial and
operating matters, but does not have the ability to control such entities. The
cost method is used to account for equity investments in unconsolidated entities
where the Company does not have the ability to exercise significant influence
over financial and operating matters. The Company periodically evaluates these
investments for other-than-temporary impairment.
Concentration of credit risk
Financial instruments that potentially subject the Company to a
concentration of credit risk consist of cash and cash equivalents, restricted
cash, and accounts receivable. Cash and cash equivalents and restricted cash are
deposited with financial institutions that management believes are creditworthy.
The Company's accounts receivable are derived from product and service
transactions with geographically dispersed companies that operate in a number of
horizontal markets. At September 30, 2000, approximately 10% of the Company's
net accounts receivable were collectible from over 270 publicly-held and private
companies operating Internet portal and other on-line businesses. Approximately
8% of the Company's net accounts receivable were collectible from over 80
Internet service providers. Due to the large representative customer
4
<PAGE> 7
CRITICAL PATH, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
base, management does not believe that these industry concentrations expose the
Company to material credit risk. The Company performs ongoing credit evaluations
of its customers and maintains allowances for potential credit losses. To date,
such losses have been within management's expectations.
Fair value of financial instruments
The Company's financial instruments, including cash and cash equivalents,
restricted cash, accounts and notes receivable, accounts payable and capital
lease obligations, are carried at cost, which approximates fair value due to the
short maturity of these instruments.
Property and equipment
Property and equipment are stated at cost less accumulated depreciation.
Depreciation is computed using the straight-line method over the shorter of the
estimated useful lives of the assets, generally three to five years, or the
lease term, if applicable. Gains and losses on disposals are included in income
at amounts equal to the difference between the net book value of the disposed
assets and the proceeds received upon disposal. Expenditures for replacements
and improvements are capitalized, while expenditures for maintenance and repairs
are charged to operations as incurred.
Internally developed software
Statement of Position ("SOP") 98-1, "Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use," requires that certain costs
for the development of internal use software should be capitalized, including
the costs of coding, software configuration, upgrades and enhancements. SOP 98-1
provides guidance on capitalization of costs incurred for computer software
developed or obtained for internal use. The Company capitalizes internally
developed software costs in accordance with SOP 98-1; these costs primarily
include purchased software and external consulting fees. SOP 98-1 was adopted
during 1999, and did not have a material effect on the Company's 1999 financial
results.
Intangible assets
Identifiable intangible assets result from the application of the purchase
method of accounting for the Company's acquisitions and are composed of the
amounts allocated to the acquisition date fair value of assembled workforce,
customer base and acquired technology. The excess of the purchase price paid
over the fair value of tangible and identifiable intangible net assets acquired
is allocated to goodwill. Intangible assets are stated net of accumulated
amortization and are amortized on a straight-line basis over their expected
useful lives ranging from two to eight years. The Company periodically evaluates
the reasonableness of the remaining useful lives of intangible assets based upon
an analysis of current operating contributions and business plans.
Valuation of long-lived assets
In accordance with Statement of Financial Accounting Standards ("SFAS") No.
121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to be Disposed Of," the Company periodically evaluates the carrying value
of long-lived assets and certain identifiable intangibles for impairment, when
events and circumstances indicate that the carrying amount of an asset may not
be recoverable. An impairment loss is recognized whenever the evaluation
demonstrates that the carrying amount of a long-lived asset is not recoverable.
Since February 19, 1997 (inception) through September 30, 2000, no impairment
losses have been identified.
5
<PAGE> 8
CRITICAL PATH, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
Revenue recognition
The Company's revenue recognition policies are in compliance with all
applicable accounting standards and regulations, and subsequent amendments and
interpretations issued by the American Institute of Certified Public Accountants
("AICPA") and the Securities and Exchange Commission ("SEC"), including SOP
97-2, "Software Revenue Recognition," SOP 98-9 "Modification of SOP 97-2,
Software Revenue Recognition with Respect to Certain Transactions," and the
SEC's Staff Accounting Bulletin ("SAB") No. 101, "Revenue Recognition." SOP 97-2
provides guidance on generally accepted accounting principles for recognizing
revenue on software transactions. SOP 97-2 requires that revenue recognized from
software arrangements be allocated to each element of the arrangement based on
the relative fair values of the elements, such as software products, specified
upgrades and enhancements, post contract customer support, installation,
training or other services. Under SOP 97-2, the determination of fair value is
based on Company-specific objective evidence. If objective evidence of fair
value for each element of the arrangement does not exist, all revenue from the
arrangement is deferred until such time that evidence of fair value does exist
or until all elements of the arrangement are delivered.
License Revenue. License revenue is derived from perpetual and term
licenses for the Company's messaging, directory, collaborative and enterprise
application integration technologies. License revenues are recognized when
persuasive evidence of an arrangement exists, delivery of the licensed software
to the customer has occurred and the collection of a fixed or determinable
license fee is considered probable.
The Company also receives license fees from resellers under arrangements
that do not provide product return, exchange or upgrade rights. Revenue from
reseller agreements may include a nonrefundable, advance royalty which is
payable upon the signing of the contract and license fees based on the
contracted value of the Company's products purchased by the reseller. Guaranteed
license fees from resellers, where no right of return exists, are recognized
when persuasive evidence of an arrangement exists, delivery of the licensed
software has occurred and the collection of a fixed or determinable license fee
is considered probable. Non-guaranteed per-copy license fees from resellers are
initially deferred and are recognized when they are reported as sold to end
users by the reseller.
Service Revenue. The Company derives service revenues from the delivery of
hosted messaging and collaboration services, professional services associated
with both hosted services and licensed products and from post-contract customer
support agreements associated with product licenses. Fees for hosted messaging
services are primarily based upon monthly contractual per unit rates for the
services involved, which are recognized on a ratable monthly basis over the term
of the contract beginning with the month in which service delivery starts.
Amounts billed or received in advance of service delivery are initially deferred
and subsequently recognized on a ratable monthly basis over the term of the
contract beginning with the month in which service delivery starts.
Fees from with post-contract customer support agreements associated with
product licenses are recognized ratably over the term of the support contract,
generally one year. Other services revenue, composed primarily of training,
installation and configuration services, are recognized in the period in which
the services are performed.
Research and development
Research and development costs include expenses incurred by the Company to
develop and enhance its portfolio of secure messaging, directory, wireless, data
integration and collaboration solutions. Research and development costs,
including acquired in-process research and development costs, are recognized as
an expense as incurred.
6
<PAGE> 9
CRITICAL PATH, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
Advertising expense
Advertising and promotion costs are generally expensed as incurred. Costs
associated with the development of print or other media campaigns are deferred
until the period that includes the first commercial use of the media campaign.
Costs associated with industry trade shows and customer conferences are deferred
until the period that includes the applicable trade show or conference.
Stock-based compensation
The Company accounts for stock-based employee compensation arrangements in
accordance with the provisions of Accounting Principles Board ("APB") Opinion
No. 25, "Accounting for Stock Issued to Employees" and complies with the
disclosure provisions of Statement of Financial Accounting Standards ("SFAS")
No. 123, "Accounting for Stock-Based Compensation." Under APB No. 25,
compensation expense is based on the difference, if any, on the date of the
grant, between the fair value of the Company's stock and the exercise price of
the option. The Company accounts for equity instruments issued to non-employees
in accordance with the provisions of SFAS No. 123 and Emerging Issues Task Force
("EITF") 96-18, "Accounting for Equity Instruments That Are Issued to Other Than
Employees for Acquiring, or in Conjunction with Selling, Goods or Services."
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 was 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." The Company implemented the
provisions of FIN No. 44 in the quarter ended June 30, 2000. Management does not
believe that the adoption of FIN No. 44 will have a significant impact on future
results.
Income taxes
Income taxes are computed using an asset and liability approach, which
requires the recognition of taxes payable or refundable for the current year and
deferred tax assets and liabilities for the future tax consequences of events
that have been recognized in the Company's consolidated financial statements or
tax returns. The measurement of current and deferred tax assets and liabilities
are based on provisions of the enacted tax law; the effects of future changes in
tax laws or rates are not anticipated. The measurement of deferred tax assets is
reduced, if necessary, by the amount of any tax benefits that, based on
available evidence, are not expected to be realized.
Net loss per share
Net loss per share is calculated in accordance with SFAS No. 128, "Earnings
per Share" and SAB No. 98. Under the provisions of SFAS No. 128 and SAB No. 98,
basic net loss per share is computed by dividing the net loss available to
common shareholders for the period by the weighted average number of common
shares outstanding during the period. Shares subject to repurchase by the
Company and shares held in escrow in connection with certain acquisition
agreements, are excluded from the basic calculation. Diluted net loss per share
is computed by dividing the net loss for the period by the weighted average
number of common and potential common shares outstanding during the period if
the effect of each class of potential common shares is dilutive. Potential
common shares include restricted Common Stock, shares held in escrow, and
incremental Common and Preferred shares issuable upon the exercise of stock
options and warrants and upon conversion of Series A and Series B Convertible
Preferred Stock and the convertible notes.
7
<PAGE> 10
CRITICAL PATH, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
Comprehensive income
In accordance with SFAS No. 130, "Reporting Comprehensive Income" the
Company accounts for and reports comprehensive income or loss and its components
in its financial statements. Comprehensive income or loss, as defined, includes
the Company's net income or loss and all other changes in equity (net assets)
during the period from non-owner sources.
Foreign currency translation
Assets and liabilities recorded in foreign currencies are translated at the
exchange rate on the balance sheet date. Revenue and expenses are translated at
average rates of exchange prevailing during the period. Translation adjustments
are charged or credited to other comprehensive income, a component of
shareholders' equity. Realized gains and losses on foreign currency transactions
are included in "Interest and other income (expense), net."
Segment and geographic information
In June 1997, the Financial Accounting Standards Board issued SFAS No. 131,
"Disclosures about Segments of an Enterprise and Related Information." This
Statement establishes standards for the way companies report information about
operating segments in annual financial statements. It also establishes standards
for related disclosures about products and services, geographic areas and major
customers. In accordance with the provisions of SFAS No. 131, the Company has
determined that it does not have separately reportable operating segments. The
Company operates in one principle business segment across domestic and
international markets.
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 in-process research and development and
existing 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
legal and financial advisory services. 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 research and development ($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
research and development 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.
8
<PAGE> 11
CRITICAL PATH, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
The ISOCOR acquisition was recognized as follows:
<TABLE>
<CAPTION>
(IN THOUSANDS)
<S> <C>
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 $218.0 million, and other acquisition
related expenses of approximately $10.0 million, consisting primarily of
payments for legal and financial advisory services. Of the total purchase price,
approximately $7.1 million was allocated to net tangible liabilities and the
remainder was 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>
<CAPTION>
(IN THOUSANDS)
<S> <C>
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 fair value of
intangible assets was determined based upon an independent valuation using a
combination of methods, including cost and royalty savings approaches for the
value of the acquired existing technology, cost and income approaches for the
value of the customer base, and a cost approach for the value of the assembled
workforce.
9
<PAGE> 12
CRITICAL PATH, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
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
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 financial advisory services. 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 ($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>
<CAPTION>
(IN THOUSANDS)
<S> <C>
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 legal and financial advisory services. 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 ($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>
10
<PAGE> 13
CRITICAL PATH, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
PeerLogic, Inc.
On September 26, 2000, the Company acquired PeerLogic, Inc. ("PeerLogic"),
a vendor of directory and enterprise application integration software. 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 in-process research and development and existing
technologies and the customer base, and a replacement cost approach for the
value of the assembled workforce.
Upon consummation of the PeerLogic acquisition, the Company recognized $3.5
million representing the value attributable to acquired in-process research and
development in certain enterprise application integration software that had not
yet reached technological feasibility and had no alternative future use. The
value was determined using an income approach, by estimating the future net cash
flows of the acquired in-process research and development over its estimated
useful life and discounting the net cash flows back to their present value. The
discount rate included a factor that took into account the uncertainty
surrounding the successful development of the acquired in-process research and
development. The acquired in-process research and development is expected to
become commercially available in 2001.
The total purchase price of approximately $445.1 million consisted of
$374.7 million of the Company's Common Stock (6.4 million shares), assumed stock
options with a fair value of $63.4 million, other acquisition related expenses
of approximately $4.0 million, consisting primarily of payments for legal and
financial advisory services, and the Company's previous $3.0 million minority
investment in PeerLogic. Of the total purchase price, approximately $22.4
million was allocated to the net tangible liabilities, approximately $28.3
million was allocated to unearned compensation related to the unvested portion
of assumed stock options, and the remainder was allocated to intangible assets,
including acquired in-process research and development ($3.5 million), existing
technology ($30.3 million), assembled workforce ($7.4 million), customer base
($5.5 million), and goodwill ($392.5 million). The unvested portion of the
assumed stock options was capitalized and is being amortized over the estimated
remaining service period of two years. 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 PeerLogic acquisition was recognized as follows:
<TABLE>
<CAPTION>
(IN THOUSANDS)
<S> <C>
Fair value of assets acquired.......................... $ 475,524
Liabilities assumed.................................... (30,404)
Fair value of Common Stock, options and warrants
issued............................................... (438,120)
---------
Cash paid, including acquisition costs................. 7,000
Less: cash acquired.................................... 0
---------
Net cash paid.......................................... $ 7,000
=========
</TABLE>
11
<PAGE> 14
CRITICAL PATH, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
ProForma Results
The following unaudited pro forma information presents the Company's
consolidated results of operations for the nine months ended September 30, 1999
and 2000, as if the acquisitions 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>
NINE MONTHS ENDED
SEPTEMBER 30,
----------------------
1999 2000
--------- ---------
(IN THOUSANDS,
EXCEPT PER SHARE DATA)
<S> <C> <C>
Net revenues................................. $ 34,577 $ 121,752
Net loss..................................... (398,840) (536,528)
Net loss per share -- basic and diluted...... (9.12) (7.63)
</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.
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. During the three-and nine-month periods ended September 30, 2000,
the Company recorded equity in net loss of joint venture of $640,000.
NOTE 3 -- ACQUISITION-RELATED RETENTION BONUSES
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
twelve-month period commencing on the date the bonuses are granted.
As of September 30, 2000, the aggregate, adjusted eligible bonus amount was
$18.3 million, and the amount recognized as compensation expense was $3.1
million and $10.3 million during the three- and nine-month periods then ended,
respectively. Additionally, during the three-month period ended September 30,
2000, approximately $790,000 was recognized as employee severance expense,
resulting from acceleration of the required one year vesting period (Note 4).
Based on the functions of the employees scheduled to receive acquisition-related
retention bonuses, $260,000 and $1.0 million of the compensation charge was
allocated to cost of net revenues, and the remaining $2.9 million and $9.3
million was allocated to operating expenses, for the three-and nine-month
periods ended September 30, 2000, respectively. Acquisition-related retention
bonuses during both the three- and nine-month periods ended September 30, 1999,
amounted to $700,000.
12
<PAGE> 15
CRITICAL PATH, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
During the three- and nine-months ended September 30, 2000, of which $130,000
was allocated to cost of net revenues and the remaining $570,000 was allocated
to operating expenses.
NOTE 4 -- EMPLOYEE SEVERANCE EXPENSES
On July 19, 2000, the Company announced its plan to reduce its worldwide
employee headcount by approximately 13%. This employee reduction plan was
executed with the intent to realize various synergies gained through the nine
acquisitions the Company completed in 1999 and the first half of 2000. During
the quarter ended September 30, 2000, the Company recognized a one-time charge
for severance-related costs totaling $6.7 million, composed of $3.3 million in
cash charges and $3.4 million in stock-based compensation expense. During the
quarter ended September 30, 2000, the Company paid approximately $2.6 million
related to employee severance and expects to make the remaining severance
related payments in the quarter ending December 31, 2000. Any differences
between the amounts accrued and amounts actually incurred will be recognized in
the quarter ending December 31, 2000. The Company recognized stock-based
compensation expense resulting from the acceleration of certain employee stock
options in connection with the Company's employee reduction plan. These charges
totaled $3.4 million and have been included in employee severance expense for
the quarter ended September 30, 2000.
NOTE 5 -- INVESTMENTS
The Company's investments in unconsolidated entities consist of the
following:
<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER 30,
1999 2000
------------ -------------
(IN THOUSANDS)
<S> <C> <C>
Marketable securities.............................. $10,926 $ 2,201
Non-marketable securities, at cost................. 7,500 23,600
Investments, at equity............................. -- 6,868
------- -------
Total Investments........................ $18,426 $32,669
======= =======
</TABLE>
The Company made strategic equity investments totaling $13.1 million during
the three months ended September 30, 2000 in four private entities, which are
being accounted for using the cost method of accounting. See Subsequent
Events -- Note 13.
NOTE 6 -- INTANGIBLE ASSETS
<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER 30,
1999 2000
------------ -------------
(IN THOUSANDS)
<S> <C> <C>
Goodwill........................................... $475,368 $1,615,513
Customer base...................................... 12,800 42,950
Assembled workforce................................ 6,960 22,960
Existing technology................................ 9,940 89,540
Patent license..................................... 1,488 1,488
-------- ----------
506,556 1,772,451
Less: accumulated amortization..................... (32,259) (273,873)
-------- ----------
Intangible assets, net................... $474,297 $1,498,578
======== ==========
</TABLE>
Amortization of intangible assets totaled $98.6 million and $241.6 million
during the three- and nine-month periods ended September 30, 2000, respectively.
During the three- and nine-month periods ended September 30, 1999, amortization
of intangible assets totaled $9.3 million and $9.8 million, respectively.
13
<PAGE> 16
CRITICAL PATH, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
Based on the functionality of the purchased technology, amortization expense for
the three- and nine-month periods ended September 30, 2000, of $4.4 million and
$11.0 million, respectively, was allocated to cost of net revenues. The
remaining $94.2 million and $230.6 million was allocated to operating expenses.
NOTE 7 -- BORROWINGS
On September 26, 2000, in connection with the PeerLogic acquisition, the
Company assumed an $8.0 million unsecured convertible note payable to
International Computers Limited ("ICL") (the "ICL Note Payable"). The ICL Note
Payable was issued by PeerLogic in April 1999, accrued interest at a rate of
7.5% per annum and was payable in equal, principal and interest, monthly
installments commencing on August 1, 1999 until June 30, 2002, when the balance
of the unpaid principal and accrued interest shall be due and payable in full.
On September 29, 2000, the Company retired the ICL Note Payable through the
payment of $8.7 million in principal ($8.0 million) and interest ($700,000) to
ICL.
On March 30, 2000, the Company issued $300.0 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.
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 8 -- 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.
14
<PAGE> 17
CRITICAL PATH, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
In the ordinary course of business, the Company has issued letters of
credit and refundable security deposits totaling $1.7 million associated
primarily with operating leases for office facilities.
NOTE 9 -- MINORITY INTEREST IN SUBSIDIARY
The Company owns a 72.87% interest in CP Italia, a consolidated subsidiary.
In addition, in the event certain performance levels are achieved, the Company
has agreed to purchase the remaining 27.13% minority interest it doesn't own on
or before January 31, 2001, for a purchase price ranging from $2.7 million to
$4.2 million, based upon the achievement of future performance milestones.
NOTE 10 -- 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 $798,000 and $5.9 million were recorded
during the three-month periods ended September 30, 1999 and 2000, respectively,
and $12.2 million and $13.6 million were recorded during the nine-month periods
ended September 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.
On September 8, 2000, AOL executed a net exercise of warrants to purchase
766,674 shares related to the attainment of the first of five milestones (the
related gross number of warrants to purchase shares of the Company's Common
Stock were 814,254 shares). On September 18, 2000, AOL executed a net exercise
of warrants to purchase 1,441,067 shares related to the attainment of the
remaining four milestones (the related gross number of warrants to purchase
shares of the Company's Common Stock were 1,628,512 shares).
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 September 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
nine-month periods ended September 30, 2000, $1.9 million and $5.6 million,
respectively, was charged to stock-based expense related to the 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
15
<PAGE> 18
CRITICAL PATH, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
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 September 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 September 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 September 30, 2000, closing price of the Company's Common
Stock of $60.75, resulting in a revised fair value of the warrants of $17.6
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 nine-month periods
ended September 30, 2000, no amount was recognized as stock-based expense
related to these warrants.
NOTE 11 -- COMPREHENSIVE LOSS
The components of comprehensive loss, net of tax, are as follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------- ---------------------
1999 2000 1999 2000
-------- --------- -------- ---------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Net loss...................................... $(24,324) $(131,379) $(58,240) $(338,330)
Unrealized investment gains (losses).......... (7,475) (3,117) 7,014 (9,233)
Foreign currency translation adjustments...... -- (1,177) -- (1,308)
-------- --------- -------- ---------
Comprehensive loss............................ $(31,799) $(135,673) $(51,226) $(348,871)
======== ========= ======== =========
</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.
16
<PAGE> 19
CRITICAL PATH, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
NOTE 12 -- NET LOSS PER SHARE
Net loss per share is calculated as follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------- ---------------------
1999 2000 1999 2000
-------- --------- -------- ---------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C>
Net loss...................................... $(24,324) $(131,379) $(58,240) $(338,330)
Weighted average shares outstanding........... 39,990 64,405 28,768 60,061
Weighted average shares subject to repurchase
agreements.................................. (2,574) (1,214) (2,967) (1,637)
Weighted average shares held in escrow related
to acquisitions............................. (258) (1,577) (86) (1,499)
-------- --------- -------- ---------
Shares used in computation of basic and
diluted net loss per share.................. 37,158 61,614 25,715 56,925
======== ========= ======== =========
Net loss per share -- basic and diluted....... $ (0.65) $ (2.13) $ (2.26) $ (5.94)
======== ========= ======== =========
</TABLE>
For the three- and nine-month periods ended September 30, 1999,
approximately 19.2 million and 16.9 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 nine-month periods ended September 30, 2000,
approximately 18.4 million and 19.4 million potential common shares,
respectively, were excluded.
NOTE 13 -- SUBSEQUENT EVENT
In October 2000 the Company made a strategic equity investment totaling
$600,000 in a private entity and is committed to increase this investment to
$4.2 million upon the investee's attainment of certain future performance
milestones.
17
<PAGE> 20
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, failure to expand our sales and marketing activities, unplanned system
interruptions and capacity constraints that could reduce our ability to provide
messaging services and harm our business and our reputation, potential
difficulties associated with strategic relationships and investments, ability to
respond to rapid technological change of the Internet messaging industry,
competition, foreign currency fluctuations, failure to maintain or reduce
operating expense levels, delays in customer orders, recognition of revenue from
customers, problems related to managing the Company's expected growth, including
the ability to maintain or improve upon cost efficiencies, and the failure to
realize savings due to perceived synergies of acquired businesses, including
PeerLogic, 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 Inc. is a leading global provider of Internet messaging
infrastructure products and services. The Company is a single resource that
provides solutions to manage the flow of mission-critical information through an
integrated portfolio of secure messaging, directory, wireless, data integration
and collaboration solutions. Critical Path was founded in 1997, and is
headquartered in San Francisco with offices in eleven countries throughout the
world.
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 in-process research and
development and existing 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
legal and financial advisory services. 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 research and development ($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
research and development 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.
18
<PAGE> 21
CRITICAL PATH, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
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 $218.0 million, and other acquisition
related costs of approximately $10.0 million, consisting primarily of payments
for legal and financial advisory services. 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 existing
technology ($21.5 million), assembled workforce ($500,000), 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 fair value of intangible assets was determined based upon
an independent valuation using a combination of methods, including cost and
royalty savings approaches for the value of the acquired existing technology,
cost and income approaches for the value of the customer base, and a cost
approach for the value of the assembled workforce.
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, consisting primarily of payments for legal and financial
advisory services. Of the total purchase price, approximately $7.8 million 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 ($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 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 legal and financial advisory services. 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 ($28.3 million). The fair value of the
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CRITICAL PATH, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
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.
PeerLogic, Inc. On September 26, 2000, the Company acquired PeerLogic, Inc.
("PeerLogic"), a vendor of directory and enterprise application integration
software. 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 in-process research and development and
existing technologies and the customer base, and a replacement cost approach for
the value of the assembled workforce.
Upon consummation of the PeerLogic acquisition, the Company recognized $3.5
million representing the value attributable to acquired in-process research and
development in certain enterprise application integration software that had not
yet reached technological feasibility and had no alternative future use. The
value was determined using an income approach, by estimating the future net cash
flows of the acquired in-process research and development over its estimated
useful life and discounting the net cash flows back to their present value. The
discount rate included a factor that took into account the uncertainty
surrounding the successful development of the acquired in-process research and
development. The acquired in-process research and development is expected to
become commercially available in 2001.
The total purchase price of approximately $445.1 million consisted of
$374.7 million of the Company's Common Stock (6.4 million shares), assumed stock
options with a fair value of $63.4 million, other acquisition related expenses
of approximately $4.0 million, consisting primarily of payments for legal and
financial advisory services, and the Company's previous $3.0 million minority
investment in PeerLogic. Of the total purchase price, approximately $22.4
million was allocated to the net tangible liabilities, approximately $28.3
million was allocated to unearned compensation related to the unvested portion
of assumed stock options, and the remainder was allocated to intangible assets,
including acquired in-process research and development ($3.5 million), existing
technology ($30.3 million), assembled workforce ($7.4 million), customer base
($5.5 million), and goodwill ($392.5 million). The unvested portion of the
assumed stock options was capitalized and is being amortized over the estimated
remaining service period of two years. 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.
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. During the three- and nine-month periods ended
September 30, 2000, the Company recorded equity in net loss of joint venture of
$640,000.
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.
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CRITICAL PATH, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
As of April 9, 2000, all five milestones had been attained. Aggregate
charges to stock-based expenses of $798,000 and $5.9 million were recorded
during the three-month periods ended September 30, 1999 and 2000, respectively,
and $12.2 million and $13.6 million were recorded during the nine-month periods
ended September 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.
On September 8, 2000, AOL executed a net exercise of warrants to purchase
766,674 shares related to the attainment of the first of five milestones (the
gross number of warrants to purchase shares of the Company's Common Stock
amounted to 814,254 shares). On September 18, 2000, AOL executed a net exercise
of warrants to purchase 1,441,067 shares related to the attainment of the
remaining four milestones (the gross number of warrants to purchase shares of
the Company's Common Stock amounted to 1,628,512 shares).
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 September 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
nine-month periods ended September 30, 2000, $1.9 million and $5.6 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 September 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 September 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 September 30, 2000, closing price of the Company's Common
Stock of $60.75, resulting in a revised fair value of the warrants of $17.6
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
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CRITICAL PATH, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
benefit of the strategic relationship. During the three-and nine-month periods
ended September 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 September 30, 2000, the Company had 1,028 employees, in
comparison with 488 employees at December 31, 1999 and 369 at September 30,
1999. The Company does not believe that its historical growth rates for revenue,
expenses, or personnel are indicative of future results.
Net Revenues
The Company's revenue recognition policies are in compliance with all
applicable accounting standards and regulations, and subsequent amendments and
interpretations issued by the American Institute of Certified Public Accountants
("AICPA") and the Securities and Exchange Commission ("SEC"), including SOP
97-2, "Software Revenue Recognition," SOP 98-9 "Modification of SOP 97-2,
Software Revenue Recognition with Respect to Certain Transactions," and the
SEC's Staff Accounting Bulletin ("SAB") No. 101, "Revenue Recognition." SOP 97-2
provides guidance on generally accepted accounting principles for recognizing
revenue on software transactions. SOP 97-2 requires that revenue recognized from
software arrangements be allocated to each element of the arrangement based on
the relative fair values of the elements, such as software products, specified
upgrades and enhancements, post contract customer support, installation,
training or other services. Under SOP 97-2, the determination of fair value is
based on Company-specific objective evidence. If objective evidence of fair
value for each element of the arrangement does not exist, all revenue from the
arrangement is deferred until such time that evidence of fair value does exist
or until all elements of the arrangements are delivered.
License Revenue. License revenue is derived from perpetual and term
licenses for the Company's messaging, directory, collaborative and enterprise
application integration technologies. License revenues are recognized when
persuasive evidence of an arrangement exists, delivery of the licensed software
to the customer has occurred and the collection of a fixed or determinable
license fee is considered probable.
The Company also receives license fees from resellers under arrangements
that do not provide product return, exchange or upgrade rights. Revenue from
reseller agreements may include a nonrefundable, advance royalty which is
payable upon the signing of the contract and license fees based on the
contracted value of the Company's products purchased by the reseller. Guaranteed
license fees from resellers, where no right of return exist, are recognized when
persuasive evidence of an arrangement exists, delivery of the licensed software
to the customer has occurred and the collection of a fixed or determinable
license fee is considered probable. Non-guaranteed per-copy license fees from
resellers are initially deferred and are recognized when they are reported as
sold to end users by the reseller.
Service Revenue. The Company derives service revenues from the delivery of
hosted messaging and collaboration services, professional services associated
with both hosted services and licensed products and from post-contract customer
support agreements associated with product licenses. Fees for hosted messaging
services
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CRITICAL PATH, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
are primarily based upon monthly contractual per unit rates for the services
involved, which are recognized on a ratable monthly basis over the term of the
contract beginning with the month in which service delivery starts. Amounts
billed or received in advance of service delivery are initially deferred and
subsequently recognized on a ratable monthly basis over the term of the contract
beginning with the month in which service delivery starts.
Fees from post-contract customer support agreements associated with product
licenses are recognized ratably over the term of the support contract, generally
one year. Other services revenue, composed primarily of training, installation
and configuration services, are recognized in the period in which the services
are performed.
License. The Company recognized $22.0 million and $47.0 million in license
revenues during the three-and nine-month periods ended September 30, 2000,
respectively, as compared to no license revenues in the first three quarters of
1999. These increases over 1999 levels were attributed to the introduction of
new product offerings as a result of several acquisitions and to increasing
demand for the Company's messaging, directory, meta-directory and calendar
applications.
Service. The Company recognized $23.0 million and $56.1 million in services
revenues during the three-and nine-month periods ended September 30, 2000,
respectively, as compared to $4.9 million and $8.0 million during the three- and
nine-months ended September 30, 1999. These increases over 1999 levels were
attributed to the introduction of new product offerings as a result of several
acquisitions, continued penetration of the hosted messaging services market,
including continued increases in the number of email boxes hosted and the number
of new hosted enterprise customers, and continued 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 43% and
42% of net revenues during the three-and nine-month periods ended September 30,
2000, respectively. Revenues from international operations were insignificant in
1999.
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. During the
quarter ended September 30, 2000, cost of license revenues benefited from the
elimination of a royalty agreement for directory technology with PeerLogic,
Inc., which was acquired on September 26, 2000. Royalties incurred under the
then existing agreement for the three months ended June 30, 2000, approximated
$700,000.
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 September 30, 2000, total cost of
net revenues was $24.8 million, or 55% of net revenues, in comparison with costs
of $7.5 million, or 153% of net revenues, for the comparable period of 1999. For
the nine months ended September 30, 2000, total cost of net revenues was $65.8
million, or 64% of net revenues, in comparison with costs of $13.9 million, or
174% of net revenues in the comparable period of 1999. The Company added 15 new
hosted messaging clusters to its data centers during the first three quarters of
2000, expanding the capacity of its hosting network to manage current customer
requirements and anticipated growth. Additional costs were incurred during the
first three quarters of 2000 to add technology platforms for new service
offerings. As a result of these significant acquisitions of equipment and
related support resources,
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CRITICAL PATH, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
depreciation and other costs and expenses during the first three 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 ten acquisitions completed during 1999 and the first three quarters of
2000, and through its continued efforts to enhance its portfolio of secure
messaging, directory, data integration and collaboration solutions. Operations,
customer support, and professional services staff increased from 102 employees
at September 30, 1999, to 338 employees at September 30, 2000.
During the three- and nine-month periods ended September 30, 2000, the
Company recognized charges associated with amortization of acquired technology
in the amounts of $4.4 million and $11.0 million, respectively. Additionally,
the Company recognized charges related to acquisition-related retention bonuses
and stock-based charges associated with employee stock options in cost of net
revenues. During the three- and nine-month periods ended September 30, 2000,
acquisition-related retention bonuses were $260,000 and $1.0 million,
respectively. During both the three- and nine-month periods ended September 30,
1999, acquisition-related retention bonuses were $130,000. Additionally, for the
three- and nine-month periods ended September 30, 2000, the Company recognized
stock-based charges associated with employee stock options in the amounts of
$381,000 and $1.3 million, respectively. For the three- and nine-month periods
ended September 30, 1999, the Company recognized stock-based charges of $2.7
million and $3.9 million, 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 nine-month periods ended September 30,
2000, amounted to $16.1 million, or 36% of net revenues, and $47.1 million, or
46% of net revenues, respectively, in comparison with approximately $3.6
million, or 72% of net revenues, and $8.8 million, or 110% 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 resulted in the
increase in sales and marketing expenses. Sales and marketing staff increased
from 120 employees to 298 employees at September 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 $7.6
million, or 17% of net revenues, and $23.2 million, or 23% of net revenues
during the three- and nine-month periods ended September 30, 2000, respectively,
in comparison with approximately $1.9 million, or 39% of net revenues, and $4.7
million, or 59% 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 portfolio of secure
messaging, directory, wireless, data integration and collaboration solutions.
Research and development staff increased from 109 employees to 239 employees at
September 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 $6.5 million, or 14% of net
revenues, and $20.6 million, or 20% of net revenues, during the three- and
nine-month periods ended September 30, 2000,
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CRITICAL PATH, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
respectively, in comparison with approximately $3.7 million, or 75% of net
revenues, and $7.9 million, or 99% of net revenues, during the comparable
periods of 1999, respectively.
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 38 employees to 153
employees at September 30, 1999 and 2000, respectively.
Acquisition-Related Retention Bonuses
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 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
twelve-month period commencing on the date the bonuses are granted.
As of September 30, 2000, the aggregate, adjusted eligible bonus amounted
to $18.3 million, and the amount recognized as compensation expense was $3.1
million and $10.3 million during the three- and nine-month periods ended
September 30, 2000, respectively. Based on the functions of the employees
scheduled to receive acquisition-related retention bonuses, for the three months
ended September 30, 2000, $260,000 of the compensation charge was allocated to
cost of net revenues and the remaining $2.9 million was allocated to operating
expenses. During the nine months ended September 30, 2000, $1.0 million of the
compensation charge was allocated to cost of net revenues and the remaining $9.3
million was allocated to operating expenses. Additionally, during the
three-month period ended September 30, 2000, approximately $790,000, in
acquisition-related retention bonuses, was recognized as employee severance
expense, resulting from the acceleration of certain employees' required one year
vesting period. These accelerations resulted from the Company's employee
reduction plan, which was executed in the third quarter of 2000. Compensation
charges recognized related to acquisition-related retention bonuses during the
three- and nine-month periods ended September 30, 1999, amounted to $700,000.
During the three- and nine-months ended September 30, 2000, $130,000 of the
compensation charge was allocated to cost of net revenues and the remaining
$570,000 was allocated to operating expenses.
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, Netmosphere and PeerLogic, 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, in-process technology and existing
technology. The aggregate amortization of these intangibles was $98.6 million
and $241.6 million during the three- and nine- month periods ended September 30,
2000. Amortization expense for the three-and nine-month periods ended September
30, 2000, of $4.4 million and $11.0 million, respectively, was allocated to cost
of net revenues and the remaining $94.2 million and $230.6 million was allocated
to operating expenses. There were no acquisitions during the first quarter of
1999 and charges to operating expenses related
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CRITICAL PATH, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
to amortization of intangibles amounted to $9.3 million and $9.8 million for the
three- and nine-month periods ended September 30, 1999.
The Company anticipates that future amortization of intangible assets
associated with its acquisitions which occurred in 1999 and the first three
quarters of 2000 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.
Acquired In-Process Research and Development
In connection with the acquisitions of ISOCOR and PeerLogic, the Company
recognized $200,000 and $3.5 million, respectively, representing the value
attributable to acquired in-process research and development that had not yet
reached technological feasibility and had no alternative future use. These
values were determined by estimating the future net cash flows of the acquired
in-process research and development over their respective estimated useful life
and discounting the net cash flows back to their present value.
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 nine-month periods ended
September 30, 2000, totaled approximately $3.0 million and $11.0 million,
respectively. Approximately $381,000 and $2.6 million of amortized unearned
compensation was allocated to cost of net revenues, and the remaining $1.3
million and $9.7 million was amortized to operating expenses for the three- and
nine-month periods ended September 30, 2000, respectively. In addition, during
the three- and nine-month periods ended September 30, 1999, amortization expense
totaled $6.7 million and $15.2 million, respectively. Approximately $2.7 million
and $3.9 million of amortized unearned compensation was allocated to cost of net
revenues, and the remaining $4.0 million and $11.3 million was amortized to
operating expenses for the three- and nine-month periods ended September 30,
1999, respectively.
The Company incurred stock-based expenses for warrants the Company granted
to ICQ, Qwest, Telco, i2, 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 $1.4 million and $7.8
million for the three-month periods ended September 30, 1999 and 2000,
respectively. During the nine-month periods ended September 30, 1999 and 2000,
approximately $13.9 million and $19.3 million was recognized as stock-based
expenses as a result of these warrants.
Employee Severance Expenses
On July 19, 2000, the Company announced its plan to reduce its worldwide
employee headcount by approximately 13%. This employee reduction plan was
executed with the intent to realize various synergies gained through the nine
acquisitions the Company completed in 1999 and the first half of 2000. During
the quarter ended September 30, 2000, the Company recognized a one-time charge
for severance-related costs totaling $6.7 million, composed of $3.3 million in
cash charges and $3.4 million in stock-based compensation expense. During the
quarter ended September 30, 2000, the Company paid approximately $2.6 million
related to employee severance and expects to make the remaining severance
related payments in the quarter ending December 31, 2000. Any differences
between the amounts accrued and amounts actually incurred will be recognized in
the quarter ending December 31, 2000. The Company recognized stock-based
compensation
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CRITICAL PATH, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
expense resulting from the acceleration of certain employee stock options in
connection with the Company's employee reduction plan. These charges totaled
$3.4 million and have been included in employee severance expense for the
quarter ended September 30, 2000.
Interest and Other Income (Expense) and Interest Expense
Interest and other income (expense) 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 $2.8 million and $4.0 million during the three-month
periods ended September 30, 1999 and 2000, respectively, and $5.1 million and
$9.9 million for the nine-month periods ended September 30, 1999 and 2000,
respectively. The Company recognized a net realized gain from foreign exchange
transactions associated with its international operations in the amount of
$884,000 and $963,000 during the three- and nine-month periods ended September
30, 2000. There was no foreign exchange transaction gain or loss during the
nine-month period ended September 30, 1999.
Interest expense consists primarily of the interest related to the Notes
and the amortization of related issuance costs. The Company incurred
approximately $4.3 million and $8.6 million in interest on the Notes, and
approximately $540,000 and $1.1 million related to amortization of debt issuance
costs for the three- and nine-month periods ended September 30, 2000,
respectively. Additionally, during the three- and nine-month periods ended
September 30, 2000, the Company incurred interest expense of $327,000 and
$975,000, respectively, comprised of interest on capital lease obligations,
stock-based charges, and interest on other long-term debt obligations. For the
three- and nine-month periods ended September 30, 2000, amortization of
stock-based charges was $16,000 and $48,000, respectively, and interest charges
on capital lease obligations amounted to $311,000 and $927,000, respectively.
For the three- and nine-month periods ended September 30, 1999, amortization of
stock-based charges was $16,000 and $48,000, respectively, and interest charges
on capital lease obligations amounted to $151,000 and $363,000, respectively.
Minority Interest in Net Income of Consolidated Subsidiary
The Company owns a 72.87% interest in CP Italia, a consolidated subsidiary.
During the three- and nine-month periods ended September 30, 2000, the Company
recorded minority interest in net income of consolidated subsidiary of $201,000
and $526,000, respectively.
Provision for Income Taxes
No provision for U.S. federal or state income taxes has been recorded as
the Company has incurred net operating losses from its inception through
September 30, 2000. The Company recognized a provision for foreign income taxes
during the three- and nine-month periods ended September 30, 2000 in the amount
of $2.5 million and $4.3 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 U.S.
federal and state net operating loss carryforwards, which expire in varying
amounts through 2019 and 2005, 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.
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CRITICAL PATH, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
At December 31, 1999, the Company also had research and development credit
carryforwards of approximately $1.2 million and $717,000 for U.S. federal and
state, respectively. These research and development credit carryforwards begin
to expire in varying amounts through 2019 for U.S. federal purposes, and do not
expire for U.S. state purposes. There is significant doubt as to whether the
Company will realize any benefit from these deferred tax assets, and
accordingly, the Company has established a full valuation allowance as of
December 31, 1999, and September 30, 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 nine months
ended September 30, 2000, cash and cash equivalents increased $166.5 million to
$242.5 million.
For the nine months ended September 30, 2000, the Company used $57.9
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 and depreciation, and approximately $11.5
million in one-time severance and acquisition-related retention bonus payments
made in the third quarter of 2000. For the nine months ended September 30, 1999,
the Company used $15.8 million to fund operating activities.
Cash used in investing activities during the nine months ended September
30, 2000, was approximately $79.6 million. During the nine months ended
September 30, 2000, the Company disbursed $39.9 million to purchase property and
equipment, consisting of approximately $30.7 million in expenditures related to
customer network infrastructure and approximately $9.2 million related to the
Company's general operations. 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 messaging infrastructure to
support our customers' new and existing business initiatives. In addition, the
Company completed its acquisitions of ISOCOR, docSpace, RemarQ, Netmosphere and
PeerLogic during the first nine months of 2000, and as a result, expended
approximately $24.4 million, net of cash received. Furthermore, the Company made
strategic investments totaling $17.4 million in several private entities and
made an initial capital contribution of $7.5 million to fund its interest in the
Critical Path Pacific joint venture. The Company also advanced approximately
$371,000 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 nine months of 1999, the
Company issued $122,000 in notes to certain officers of the Company, net of
repayments, advanced $15.0 million to two strategic partners, made capital
expenditures which totaled $21.8 million, completed investments in two privately
held strategic corporate partners totaling $4.5 million and expended
approximately $78.2 million in net cash proceeds and other acquisition costs
related to the acquisitions of Fabrik, dotOne and Amplitude.
Cash from financing activities during the nine months ended September 30,
2000, totaled $305.8 million. The Company received $289.2 million in net
proceeds from the sale of its $300.0 million Notes, as well as approximately
$29.4 million from the exercise of employee stock options. These increases were
offset by a payment of $8.0 million to retire a note payable assumed in the
PeerLogic acquisition, payments totaling $4.7 million to retire principal on
capital lease obligations and $113,000 to purchase treasury stock. During the
nine months ended September 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 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
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CRITICAL PATH, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
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 $2.2
million to retire principal on capital lease obligations and $229,000 to
purchase treasury stock. These payments were offset by the repayment of $97,000,
by a shareholder, on a previously outstanding note receivable.
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 $15.0 million during the
remaining three months of 2000 to purchase network infrastructure equipment and
to develop and implement its automated billing application. In October 2000 the
Company made a strategic equity investment, totaling $600,000, in a private
entity and is committed to increase this investment to $4.2 million, upon the
investee's attainment of certain future performance milestones.
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 nine months of 2000, the Company completed its acquisitions of ISOCOR,
docSpace, RemarQ, Netmosphere and PeerLogic and as a result, expended
approximately $60.2 million in cash consisting of approximately $33.0 million in
acquisition consideration and $27.2 million for other acquisition costs,
consisting primarily of financial advisory and other professional services. 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.
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 products and 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.
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CRITICAL PATH, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
WE HAVE A HISTORY OF LOSSES, EXPECT CONTINUING LOSSES AND MAY NEVER ACHIEVE
PROFITABILITY.
As of September 30, 2000, we had an accumulated deficit of approximately
$470.5 million. We have not achieved profitability in any period, and expect to
continue to incur net losses in accordance with generally accepted accounting
principles 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-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
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CRITICAL PATH, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
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 ten companies for
an aggregate consideration consisting of cash, Common Stock and the assumption
of stock options and warrants totaling approximately $1.8 billion.
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 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 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 reduced
employee headcount in order to eliminate duplicative positions totaling
approximately 13% of our worldwide workforce that were created by our
acquisitions. The elimination was 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.
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CRITICAL PATH, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
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
1,028 on September 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. 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. However, in the third quarter of 2000, we eliminated
approximately 13% of our worldwide employees to operational synergies that were
observed due to the acquisitions we have completed. If we cannot manage growth
effectively, our business and operating results could suffer.
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
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CRITICAL PATH, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
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 nine months ended September 30, 2000 we
derived approximately 42% 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;
- 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!, Aether Systems, and Brightmail, 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
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CRITICAL PATH, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
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 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
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CRITICAL PATH, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
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 Lotus
Development Corporation and Microsoft. We believe that competition will increase
and that companies such as Software.com, 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.
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.
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CRITICAL PATH, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
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.
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 Financial Officer has joined us
within the past eight 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
36
<PAGE> 39
CRITICAL PATH, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
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 twelve 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 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.
37
<PAGE> 40
CRITICAL PATH, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
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 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.
38
<PAGE> 41
CRITICAL PATH, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
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 October 31, 2000, we had approximately 73.7 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 which we filed in July of 2000 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 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.
39
<PAGE> 42
CRITICAL PATH, INC.
SUPPLEMENTAL PRO FORMA FINANCIAL DATA
(UNAUDITED)
The following supplemental pro forma financial information presents the
Company's condensed consolidated results of operations for the three- and
nine-month periods ended September 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, (iii)
stock-based compensation associated with outstanding options and warrants, (iv)
in-process research and development associated with purchase business
combinations, and (v) employee severance expenses associated with workforce
reductions. 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 NINE MONTHS ENDED
------------------------------ ------------------------------
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
1999 2000 1999 2000
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Net revenues
Licenses............................. $ -- $21,998 $ -- $ 46,965
Services............................. 4,913 22,977 8,074 56,058
------- ------- -------- --------
Total net revenues........... 4,913 44,975 8,074 103,023
------- ------- -------- --------
Cost of net revenues
Licenses............................. -- 634 -- 2,378
Services............................. 4,681 19,076 9,829 50,154
------- ------- -------- --------
Total cost of net revenues... 4,681 19,710 9,829 52,532
------- ------- -------- --------
Gross profit (loss).................... 232 25,265 (1,755) 50,491
------- ------- -------- --------
Operating expenses
Sales and marketing.................. 3,557 16,128 8,760 47,075
Research and development............. 1,895 7,635 4,705 23,171
General and administrative........... 3,678 6,491 7,919 20,589
------- ------- -------- --------
Total operating expenses..... 9,130 30,254 21,384 90,835
------- ------- -------- --------
Loss from operations................... (8,898) (4,989) (23,139) (40,344)
Interest and other income (expense),
net.................................. 2,841 4,905 5,074 10,859
Interest expense....................... (151) (5,198) (363) (10,699)
Equity in net loss of joint venture.... -- (640) -- (640)
Minority interest in net income of
consolidated subsidiary.............. -- (201) -- (526)
------- ------- -------- --------
Loss before income taxes............... (6,208) (6,123) (18,428) (41,350)
Provision for income taxes............. -- (2,534) -- (4,333)
------- ------- -------- --------
Net Loss............................... $(6,208) $(8,657) $(18,428) $(45,683)
======= ======= ======== ========
Net loss per share -- basic and
diluted.............................. $ (0.17) $ (0.14) $ (0.71) $ (0.80)
======= ======= ======== ========
Weighted average shares -- basic and
diluted.............................. 37,158 61,614 25,715 56,925
======= ======= ======== ========
</TABLE>
40
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CRITICAL PATH, INC.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
As of September 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 September 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.
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<PAGE> 44
PART 2 -- OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
See Footnote 8, "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
None.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
<TABLE>
<S> <C>
27.1 Financial Data Schedule
</TABLE>
(b) Reports on Form 8-K
On August 8, 2000, the Company filed a report on Form 8-K announcing the
expected acquisition of PeerLogic, Inc.
On October 2, 2000, the Company filed a report on Form 8-K announcing that
Paul Gigg, Executive Vice President and Chief Operating Officer, would be
leaving Critical Path.
On October 6, 2000, the Company filed a report on Form 8-K announcing the
completion of its acquisition of PeerLogic, Inc.
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<PAGE> 45
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: November 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)
43
<PAGE> 46
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<S> <C>
27.1 Financial Data Schedule
</TABLE>
44
