<PAGE>
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the Quarterly Period Ended October 31, 1999
[ ] 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 000-25829
PORTAL SOFTWARE, INC.
(Exact Name of Registrant as Specified in Its Charter)
Delaware 77-0369737
-------- ----------
(State or Other Jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or Organization)
20883 Stevens Creek Boulevard
Cupertino, California 95014
----------------------------
(Address of Principal Executive Offices)
Registrant's Telephone Number, Including Area Code: (408) 343-4400
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. Yes X No ____
---
On November 30, 1999, 79,075,304 shares of the Registrant's Common Stock, $.001
par value, were outstanding.
<PAGE>
PORTAL SOFTWARE, INC.
FORM 10-Q
QUARTERLY PERIOD ENDED OCTOBER 31, 1999
INDEX
<TABLE>
<CAPTION>
Page
----
<S> <C>
Part I: Financial Information
Item 1: Financial Statements (Unaudited)
Condensed Consolidated Balance Sheets at January 31, 1999 and October 31, 1999 3
Condensed Consolidated Statements of Operations for the three and nine months 4
ended October 31, 1998 and 1999
Condensed Consolidated Statements of Cash Flows for the nine months 5
ended October 31, 1998 and 1999
Notes to Condensed Consolidated Financial Statements 6
Item 2: Management's Discussion and Analysis of Financial Condition and Results 14
of Operations
Item 3: Quantitative and Qualitative Disclosures About Market Risk 31
Part II: Other Information
Item 2: Changes in Securities and Use of Proceeds 32
Item 6: Exhibits and Reports on Form 8-K 33
Signature 34
Exhibit Index 35
</TABLE>
2
<PAGE>
ITEM 1: FINANCIAL STATEMENTS
PORTAL SOFTWARE, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands)
<TABLE>
<CAPTION>
January 31, October 31,
----------- -----------
1999 1999
---- ----
(unaudited)
<S> <C> <C>
Assets
Current assets:
Cash and cash equivalents..................................................... $ 11,809 $ 60,214
Short term investments........................................................ -- 141,397
Accounts receivable, net...................................................... 14,474 17,094
Restricted short-term investments............................................. -- 4,898
Other current assets.......................................................... 1,440 4,566
-------- --------
Total current assets......................................................... 27,723 228,169
Property and equipment, net.................................................... 4,417 9,079
Restricted long-term investments............................................... -- 5,861
Other assets................................................................... 204 3,503
-------- --------
$ 32,344 $246,612
======== ========
Liabilities and Stockholders' Equity (Net Capital Deficiency)
Current liabilities:
Accounts payable.............................................................. $ 2,567 $ 3,910
Accrued compensation.......................................................... 1,147 8,153
Other accrued liabilities..................................................... 5,214 4,186
Current portion of long-term debt............................................. 4,122 --
Current portion of capital lease obligations.................................. 479 735
Deferred revenue.............................................................. 23,344 26,221
-------- --------
Total current liabilities.................................................... 36,873 43,205
Long-term portion of capital lease obligations................................. 2,022 1,731
Stockholders' equity (net capital deficiency):
Convertible preferred stock................................................... 18,482 --
Common stock............................................................... 927 79
Additional paid-in capital.................................................... 16,753 245,749
Net unrealized loss on investments and other.................................. -- (221)
Notes receivable from stockholders............................................ (318) (359)
Deferred stock compensation................................................... (14,456) (7,644)
Accumulated deficit........................................................... (27,939) (35,928)
-------- --------
Stockholders' equity (net capital deficiency)................................ (6,551) 201,676
-------- --------
$ 32,344 $246,612
======== ========
</TABLE>
See accompanying notes.
3
<PAGE>
PORTAL SOFTWARE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts; unaudited)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
------------------ -----------------
October 31, October 31,
---------- -----------
1998 1999 1998 1999
---- ---- ---- ----
<S> <C> <C> <C> <C>
Revenues:
License fees................................................ $ 3,817 $18,076 $ 7,878 $ 39,791
Services.................................................... 3,414 9,976 7,706 24,236
-------- ------- --------- --------
Total revenues............................................. 7,231 28,052 15,584 64,027
-------- ------- --------- --------
Costs and expenses:
Cost of license fees........................................ 143 607 289 1,113
Cost of services............................................ 2,232 6,482 5,106 15,472
Research and development.................................... 3,148 6,757 7,815 17,213
Sales and marketing......................................... 4,016 11,795 9,157 27,952
General and administrative.................................. 1,439 3,845 3,426 8,999
Amortization of deferred stock compensation................. 537 1,801 867 6,812
-------- ------- --------- --------
Total costs and expenses................................... 11,515 31,287 26,660 77,561
-------- ------- --------- --------
Loss from operations......................................... ( 4,284) (3,235) ( 11,076) (13,534)
Interest income (expense) and other income, net.............. 300 1,956 451 2,951
One-time gain upon expiration of put option on common stock.. -- -- -- 3,810
-------- ------- --------- --------
Loss before income taxes..................................... ( 3,984) (1,279) ( 10,625) (6,773)
Provision for income taxes................................... (41) (400) (56) (1,216)
-------- ------- --------- --------
Net loss..................................................... $ (4,025) $(1,679) $ (10,681) $( 7,989)
======== ======= ========= ========
Basic and diluted net loss per share......................... $ (0.13) $ (0.02) $ (0.37) $ (0.14)
======== ======= ========= ========
Shares used in computing basic and diluted net loss per share 30,990 72,941 28,486 57,796
======== ======= ========= ========
Pro forma basic and diluted net loss per share (unaudited)... $ (0.07) $ (0.02) $ (0.19) $ (0.12)
======== ======= ========= ========
Shares used in computing pro forma basic and diluted
net loss per share (unaudited)............................. 59,643 72,941 57,005 68,476
======== ======= ========= ========
</TABLE>
See accompanying notes.
4
<PAGE>
PORTAL SOFTWARE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
<TABLE>
<CAPTION>
Nine Months Ended
-----------------
October 31,
-----------
1998 1999
---- ----
(unaudited)
<S> <C> <C>
OPERATING ACTIVITIES:
Net loss..................................................................................... $(10,681) $ (7,989)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
Depreciation and amortization............................................................... 649 1,552
Amortization of deferred stock compensation................................................. 866 6,812
One-time gain upon expiration of put option on common stock................................. -- (3,810)
Changes in operating assets and liabilities:
Accounts receivable, net................................................................... (3,783) (2,619)
Other current assets....................................................................... (312) (1,369)
Other assets............................................................................... (32) (252)
Accounts payable. (606) 1,343
Accrued compensation....................................................................... 956 7,005
Other accrued liabilities.................................................................. 1,672 (1,028)
Deferred revenue........................................................................... 2,668 2,876
-------- ---------
Net cash provided by (used in) operating activities....................................... (8,603) 2,521
-------- ---------
INVESTING ACTIVITIES
Purchases of short-term investments.......................................................... -- (147,316)
Purchases of long-term investments........................................................... -- (5,948)
Purchases of property and equipment.......................................................... -- (5,956)
-------- ---------
Net cash used in investing activities..................................................... -- (159,220)
-------- ---------
FINANCING ACTIVITIES:
Repayment of long-term debt.................................................................. -- (4,122)
Proceeds from line of credit................................................................. -- 1,000
Repayment of line of credit.................................................................. -- (1,000)
Principal payments under capital lease obligations........................................... (54) (371)
Proceeds from issuance of common stock, net of repurchases and issuance cost................. 375 209,619
Proceeds from issuance of preferred stock.................................................... 365 --
-------- ---------
Net cash from financing activities........................................................ 686 205,126
-------- ---------
Effect of exchange rate on cash and cash equivalents......................................... 4 (22)
Net increase (decrease) in cash and cash equivalents.......................................... (7,913) 48,405
Cash and cash equivalents at beginning of period.............................................. 14,646 11,809
-------- ---------
Cash and cash equivalents at end of period.................................................... $ 6,733 $ 60,214
======== =========
</TABLE>
See accompanying notes.
5
<PAGE>
PORTAL SOFTWARE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
(1) Significant Accounting Policies:
Nature of Business and Basis of Presentation
Portal Software, Inc. or Portal, formerly Portal Information Network, Inc.,
a California corporation, was incorporated in 1994. Portal markets and supports
real-time customer management and billing software, or CM&B software, for
providers of Internet-based services. Portal's software is a comprehensive
solution that is designed to meet the complex, mission-critical provisioning,
accounting, reporting and marketing needs of providers of Internet-based
services. Portal markets its products worldwide through a combination of a
direct sales force and distribution partners. Substantially all of Portal's
license revenues are derived from sales of its Infranet product.
Portal has incurred operating losses to date and, at October 31, 1999, had
an accumulated deficit of $35.9 million. Portal's activities have been primarily
financed through private placements and public offerings of equity securities.
Portal may need to raise additional capital through the issuance of debt or
equity securities. Such financing may not be available on terms satisfactory to
Portal, if at all.
The accompanying unaudited condensed consolidated financial statements include
the accounts of Portal and its wholly owned subsidiaries. All significant
intercompany balances and transactions have been eliminated in consolidation.
The balance sheet at October 31, 1999 and the statement of operations for the
three and nine months ended October 31, 1999 and cash flows for the nine months
ended October 31, 1998 and 1999 have been prepared without audit. In the
opinion of management, these financial statements reflect all adjustments that
are necessary for a fair presentation of the results for and as of the periods
shown. The results of operations for such periods are not necessarily
indicative of the results expected for the full fiscal year or for any future
period. The condensed consolidated financial statement information as of
January 31, 1999 is derived from audited financial statements as of that date.
These financial statements should be read in conjunction with the financial
statements and related notes included in the Company's final prospectus filed
with the Securities and Exchange Commission on May 6, 1999.
Revenue Recognition
License revenues are comprised of fees for multiyear or perpetual licenses,
which are primarily derived from contracts with corporate customers and
resellers. Revenue from license fees is recognized when persuasive evidence of
an agreement exists, delivery of the product has occurred, no significant Portal
obligations with regard to implementation remain, the fee is fixed or
determinable and collectibility is probable. For electronic delivery, the
software is considered to have been delivered when Portal has provided the
customer with the access codes that allow for immediate possession of the
software. If the fee due from the customer is not fixed or determinable, revenue
is recognized as payments become due from the customer. If collectibility is not
considered probable, revenue is recognized when the fee is collected. Revenue on
arrangements with customers who are not the ultimate users (primarily resellers)
is not recognized until the product is delivered to the end user.
Services revenues are primarily comprised of revenue from systems
integration or other consulting fees, maintenance agreements and training.
Arrangements that include software services are evaluated to determine whether
those services are essential to the functionality of other elements of the
arrangement. When software services are considered essential, revenue under the
arrangement is recognized using contract accounting. When software services are
not considered essential, the revenue allocable to the software services is
recognized as the services are performed. Maintenance agreements provide
technical support and include the right to unspecified upgrades on an if-and-
when-available basis. Maintenance revenue is deferred and recognized on a
straight-line basis as services revenue over the life of the related agreement,
which is typically one year. Customer advances and billed amounts due from
customers in excess of revenue recognized are recorded as deferred revenue.
6
<PAGE>
(1) Significant Accounting Policies (continued)
Revenue Recognition (continued)
Portal adopted Statement of Position 97-2, Software Revenue Recognition, or
SOP 97-2, and Statement of Position 98-4, Deferral of the Effective Date of a
Provision of SOP 97-2, Software Revenue Recognition, or SOP 98-4, as of February
1, 1998. SOP 97-2 and SOP 98-4 provide guidance for recognizing revenue on
software transactions and supersede SOP 91-1, Software Revenue Recognition. The
adoption of SOP 97-2 and SOP 98-4 did not have a material impact on Portal's
financial results. However, full implementation guidelines for this standard
have not yet been issued. Once available, the current revenue accounting
practices may need to change and such changes could affect Portal's future
revenues and results of operations.
In December 1998, the American Institute of Certified Public Accountants or
AICPA issued Statement of Position 98-9, Modification of SOP 97-2, Software
Revenue Recognition, With Respect to Certain Transactions, or SOP 98-9. SOP 98-9
amends SOP 98-4 to extend the deferral of the application of certain passages of
SOP 97-2 provided by SOP 98-4 through fiscal years beginning on or before March
15, 1999. All other provisions of SOP 98-9 are effective for transactions
entered into in fiscal years beginning after March 15, 1999. Portal does not
expect the final adoption of SOP 98-9 to have a material impact on its future
revenues or results of operations.
Concentration of Credit Risk
Portal sells its software and services to customers consisting mainly of
North American and European Internet service providers and enhanced service
developers. Portal performs ongoing credit evaluations of its customers and does
not require collateral. Portal maintains an allowance for potential credit
losses and such losses historically have been within management's expectations.
Two customers accounted for a combined 27% of total revenues during the
three months ended October 31, 1999 and one customer accounted for 18% of total
revenues during the three months ended October 31, 1998. No other individual
customers accounted for more than 10% of total revenue for the three-month
periods ended October 31, 1999 and 1998. No individual customer accounted for
greater than 10% of total revenue for the nine-month periods ended October 31,
1999 and 1998.
Segment Information
In June 1997, the Financial Accounting Standards Board or FASB issued
Statement of Financial Accounting Standards No. 131, "Disclosures About
Segments of an Enterprise and Related Information," or FAS 131, effective for
financial statements for periods beginning after December 15, 1997. FAS 131
establishes standards for the way that public business enterprises report
financial and descriptive information about reportable operating segments in
annual financial statements and interim financial reports issued to
stockholders. Portal adopted FAS 131 effective February 1, 1998. Portal operates
solely in one segment, the development and marketing of CM&B software, and
therefore Portal is not impacted by the adoption of FAS 131. Portal's foreign
offices consist of sales, marketing and support activities through its foreign
subsidiaries and an overseas reseller network. Operating losses generated by the
foreign operations of Portal and their corresponding identifiable assets were
not material in any period presented.
Portal's export revenue represented 21% and 38% of total revenues for the
three months ended October 31, 1998 and 1999 and 18% and 34% for the nine months
ended October 31, 1998 and 1999. All of the export sales to date have been
denominated in U.S. dollars and were derived from sales to Europe and Asia-
Pacific. Total export revenues for the three months ended October 31, 1998 and
1999 were $0.7 million and $8.7 million to customers in Europe and $0.8 million
and $1.9 million to customers in the Asia-Pacific region. Total export revenues
for the nine months ended October 31, 1998 and 1999 were $1.6 million and $17.2
million to customers in Europe and $1.2 million and $4.3 million to customers in
the Asia-Pacific region.
7
<PAGE>
(1) Significant Accounting Policies (continued)
Cash, Cash Equivalents, Short-Term and Long-Term Investments
Portal considers all highly liquid, low-risk debt instruments with an
original maturity at the date of purchase of three months or less to be cash
equivalents. Through January 31, 1999, Portal maintained cash and cash
equivalents in money market accounts with major financial institutions for which
the carrying amount approximated its fair value. Upon completion of the initial
public offering in May 1999 and the secondary offering in October 1999 (see Note
4), Portal received additional cash which is available for investment. At
October 31, 1999, cash equivalents and short-term investments consist primarily
of commercial paper, other debt instruments and money market funds. All short-
term investments have maturity dates from three to 24 months.
Portal classifies, at the date of acquisition, its cash equivalents and
short-term investments as available-for-sale in accordance with the provisions
of the FASB's Statement of Financial Accounting Standards No.115, "Accounting
for Certain Investments in Debt and Equity Securities" ("FAS 115").
Currently, Portal classifies its securities as available-for-sale, which are
reported at fair market value, with the related unrealized gains and losses
included in stockholders' equity. Unrealized gains and losses were not material
at January 31, 1999. At October 31, 1999, unrealized losses were $201,000. The
amortized cost of debt securities is adjusted for amortization of premiums and
accretion of discounts to maturity, both of which are included in interest
income. Realized gains and losses are recorded using the specific identification
method.
The following schedule summarizes the estimated fair value of our cash,
cash equivalents and short-term investments (in thousands)
January 31, October 31,
1999 1999
---- ----
(unaudited)
Cash and cash equivalents:
Cash.......................................... $ 4,359 $ 4,207
Money market funds............................ 7,450 43,251
Commercial paper.............................. -- 12,756
------- -------
$11,809 $60,214
======= =======
Short-term investments at October 31, 1999 (unaudited):
Gross Unrealized
----------------
Cost Gain Loss Fair Value
---- ---- ---- ----------
Commercial paper................. $ 25,555 $ -- $ (16) $ 25,539
Corporate notes.................. 55,400 -- (152) 55,248
U.S. Government securities....... 65,536 -- (28) 65,508
Restricted investments........... (4,898) -- -- (4,898)
-------- ------ ------ --------
$141,593 $ -- $ (196) $141,397
======== ====== ====== ========
The estimated fair value of cash, cash equivalents and short-term
investments classified by date of maturity is as follows (in thousands):
January 31, October 31,
1999 1999
---- ----
(unaudited)
Due within one year....................... $11,809 $160,643
Due within two years...................... -- 45,866
Restricted short-term investments......... -- (4,898)
------- --------
$11,809 $201,611
======= ========
8
<PAGE>
(1) Significant Accounting Policies (continued)
Cash, Cash Equivalents, Short-Term and Long-Term Investments (continued)
In accordance with FAS 115, Portal classifies all non-restricted short-term
investments as available-for-sale since these securities are available to
support current operations. Restricted short-term investments of $4,898,000
represents collateral for a surety bond required by a customer contract that
expires in January of 2000 and collateral for a letter of credit issued to a
landlord to guarantee payment of tenant improvements. The restricted short-term
investments are not available to support current operations and are consequently
classified as held-to-maturity. As a result, unrealized gains and losses are not
recorded. At October 31, 1999, amortized cost approximated fair value.
Restricted long-term investments of $5,861,000 represent collateral for two
letters of credit totaling $5,250,000 issued in lieu of a security deposit for a
new facility lease and consist of corporate bonds maturing over a period of one
to three years. The restricted long-term investments are classified as held-to-
maturity. As a result, unrealized gains and losses are not recorded. At October
31, 1999, amortized cost approximated fair value.
Realized gains and losses from sales of each type of security were
immaterial for all periods presented.
Other Assets
Other assets consisted of the following (in thousands):
January 31, October 31,
1999 1999
---- ----
(unaudited)
Prepaid services - long term portion (see Note 3)...... $ -- $3,048
Deposits and other..................................... 204 455
------ ------
$ 204 $3,503
====== ======
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ materially from those estimates.
Net Loss Per Common Share
Basic net loss per common share and diluted net loss per common share are
presented in conformity with the FASB's Statement of Financial Accounting
Standards No. 128, "Earnings Per Share", or FAS 128, for all periods
presented. Following the guidance given by the Securities and Exchange
Commission Staff Accounting Bulletin No. 98, common stock and convertible
preferred stock that has been issued or granted for nominal consideration prior
to the anticipated effective date of the initial public offering must be
included in the calculation of basic and diluted net loss per common share as if
these shares had been outstanding for all periods presented. To date, Portal has
not issued or granted shares for nominal consideration.
In accordance with FAS 128, basic and diluted net loss per share has been
computed using the weighted-average number of shares of common stock outstanding
during the period, less shares subject to repurchase. Pro forma basic and
diluted net loss per common share, as presented in the consolidated statements
of operations, has been computed for the three and nine-month periods ended
October 31, 1998 and 1999 as described above, and also gives effect to the
conversion of the convertible preferred stock (using the if-converted method)
from the original date of issuance.
9
<PAGE>
(1) Significant Accounting Policies (continued)
Net Loss Per Common Share (continued)
The following table presents the calculation of basic and diluted and pro
forma basic and diluted net loss per share (in thousands, except per share data;
unaudited):
<TABLE>
<CAPTION>
Three months ended Nine months ended
October 31, October 31,
---------- -----------
1998 1999 1998 1999
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net loss.................................................... $(4,025) $(1,679) $(10,681) $(7,989)
======= ======= ======== =======
Basic and diluted:
Weighted-average shares of common stock outstanding........ 39,556 76,544 38,698 62,306
Less: Weighted-average shares subject to repurchase........ (8,566) (3,603) (10,212) (4,510)
------- ------- -------- -------
Weighted-average shares used in computing basic and
diluted net loss per share................................ 30,990 72,941 28,486 57,796
======= ======= ======== =======
Basic and diluted net loss per share........................ $ (0.13) $ (0.02) $ (0.37) $ (0.14)
======= ======= ======== =======
Pro forma:
Net loss................................................... $(4,025) $(1,679) $(10,681) $(7,989)
======= ======= ======== =======
Shares used above.......................................... 30,990 72,941 28,486 57,796
Pro forma adjustment to reflect weighted effect of assumed
conversion of convertible preferred stock................. 28,653 -- 28,519 10,680
------- ------- -------- -------
Shares used in computing pro forma basic and diluted net
loss per share............................................ 59,643 72,941 57,005 68,476
======= ======= ======== =======
Pro forma basic and diluted net loss per share............. $ (0.07) $ (0.02) $ (0.19) $ (0.12)
======= ======= ======== =======
</TABLE>
Portal has excluded all convertible preferred stock, warrants for
convertible preferred stock, outstanding stock options, and shares subject to
repurchase from the calculation of diluted loss per common share because all
such securities are antidilutive for all periods presented. The total numbers of
shares excluded from the calculations of diluted net loss per share was
39,650,643 and 8,135,199 for the three months ended October 31, 1998 and 1999
and 40,687,026 and 6,524,628 for the nine months ended October 31, 1998 and
1999. Such securities, had they been dilutive, would have been included in the
computations of diluted net loss per share using the treasury stock method.
Comprehensive Loss
As of January 1, 1998, Portal adopted SFAS 130, "Reporting Comprehensive
Income." SFAS 130 establishes new rules for the reporting and display of
comprehensive net income and its components. However, it has no impact on our
net loss or stockholders' equity as presented in our financial statements. SFAS
130 requires foreign currency translation adjustments and changes in the fair
value of available for sale securities to be included in comprehensive net loss.
The components of comprehensive net loss are as follows (in thousands;
unaudited):
<TABLE>
<CAPTION>
Three months ended Nine months ended
October 31, October 31,
----------- -----------
1998 1999 1998 1999
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net loss.......................................... $(4,025) $(1,679) $(10,681) $(7,989)
Unrealized loss on marketable securities.......... --- (96) --- (201)
Change in cumulative translation adjustment....... (1) (59) 4 (20)
------- ------- -------- -------
Comprehensive net loss............................ $(4,026) $(1,834) $(10,677) $(8,210)
======= ======= ======== =======
</TABLE>
10
<PAGE>
(1) Significant Accounting Policies (continued)
Recently Issued Accounting Standards
In June 1998, the FASB issued Statement of Financial Accounting Standards
No. 133, "Accounting for Derivative Instruments and Hedging Activities", or
FAS 133. Portal is required to adopt FAS 133 for the year ending January 31,
2002. FAS 133 establishes methods of accounting for derivative financial
instruments and hedging activities related to those instruments as well as other
hedging activities. Because Portal currently holds no derivative financial
instruments and does not currently engage in hedging activities, adoption of FAS
133 is expected to have no material impact on Portal's financial condition or
results of operations.
In March 1998, the AICPA issued SOP 98-1, "Accounting for the Costs of
Computer Software Developed or Obtained for Internal Use", or SOP 98-1. SOP 98-
1 requires that entities capitalize certain costs related to internal use
software once certain criteria have been met. Portal is required to implement
SOP 98-1 for the year ending January 31, 2000. Portal adopted SOP No. 98-1 on
February 1, 1999 with no material impact on its financial position or results of
operations.
In April 1998, the AICPA issued SOP No. 98-5, "Reporting on the Costs of
Start-Up Activities," or SOP 98-5. SOP 98-5 requires that all start-up costs
related to new operations must be expensed as incurred. In addition, all start-
up costs that were capitalized in the past must be written off when SOP 98-5 is
adopted. Portal expects that the adoption of SOP 98-5 will not have a material
impact on its financial position or results of operations. Portal adopted SOP
No. 98-5 on February 1, 1999 with no material impact on its financial position
or results of operations.
(2) Long-Term Debt, Convertible Promissory Notes and Line of Credit
In July 1997, Portal entered into a $3.0 million note payable agreement
with a financial institution to finance working capital. The agreement was
subsequently amended in February 1999 to change the installment payment dates.
The note, bearing an interest rate at 10.75% per annum, is payable in three
installments of $1.5 million, $0.5 million, and $1.0 million on February 19,
1999, March 31, 1999, and April 30, 1999. In connection with these notes, Portal
issued warrants to the lender to purchase 130,098 shares of Series B preferred
stock at an exercise price of $1.50 per share. The note payable was paid on
schedule. As of April 30, 1999, the entire loan had been repaid.
In February through December 1995, Portal issued convertible promissory
notes in the aggregate principal amount of $0.8 million to private investors. In
April through June 1996, convertible notes in the amount of $0.5 million plus
accrued interest of $55,765 were exchanged for 3,616,590 shares of Series A
preferred stock at a price of $0.17 per share and convertible notes in the
amount of $0.3 million plus accrued interest of $16,163 were repaid.
Warrants to purchase 1,500,000 shares of common stock at an exercise price
of $0.001 per share were issued in connection with the original issuance of the
convertible notes in 1995. These warrants were exercised during the fiscal year
ended January 31, 1997. In December 1998, Portal entered into an agreement with
a customer to convert $1.1 million from a deposit into a note payable. The note,
bearing an interest rate of 10% per annum, was due on November 30, 1999. The
entire balance on the note was repaid in July 1999. On April 15, 1999, Portal
entered into a line of credit with a bank under which Portal may borrow up to $5
million. Amounts borrowed under this line of credit bear interest at a rate of
the bank's prime rate plus 0.5% and mature on April 13, 2000. On April 22, 1999,
Portal borrowed $1.0 million under the line of credit to repay the final
installment of the term loan that matured in April 1999. The entire balance on
the line of credit was repaid in May 1999.
(3) Agreement with Andersen Consulting LLC
On April 12, 1999, Portal agreed to enter into a strategic alliance with
Andersen Consulting LLC under which Andersen Consulting LLC will provide
services to Portal, the parties will expand their existing marketing alliance
and will work closely together to expand their customer service and marketing
relationship. Under this arrangement, Andersen Consulting LLC agreed to purchase
up to 400,000 shares of common stock from Portal in a private placement
concurrent with Portal's initial public offering at the initial public offering
price, less the underwriting discount.
11
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(3) Agreement with Andersen Consulting LLC (continued)
Under this agreement, Portal agreed to pay Andersen Consulting LLC for its
services a minimum services fee in cash of $2.8 million and a cash settled put
for 200,000 of the shares to be purchased by Andersen Consulting LLC. This put
guaranteed a closing value of $6.0 million at the end of the first day of
trading for 200,000 common shares sold to Andersen and required Portal to pay
Andersen Consulting LLC in cash for any differences between the closing value of
these shares and $6.0 million. Upon the date of the arrangement, Portal recorded
the fair value of the put of approximately $3.8 million. The value of the put
was determined using the Black-Scholes model using a risk-free interest rate of
6.3%, an expected life of one month and a volatility factor of 1.00.
Upon completion of the initial public offering (see Note 4), the put option
was settled. Based on the closing price of Portal's common stock at the end of
the first day of trading, the net cash settlement of the put was computed at a
value of zero. As a result, a gain upon remeasurement of the liability of $3.8
million was recorded as other income in the nine-month period ended October 31,
1999.
At October 31, 1999, the initial fair value of the put, approximately $3.8
million, has been classified as a prepaid service asset and will be amortized
systematically over the period of the service agreement, which is anticipated to
be between three and five years. Upon signing of the definitive agreement, the
service fee of $2.8 million will also be capitalized and amortized
systematically over the same period.
(4) Stockholders' Equity
Reincorporation and Stock Split
During February 1999, Portal's board of directors authorized the
reincorporation of the Company in the state of Delaware. This reincorporation
received shareholder approval on April 29, 1999. Portal is authorized to issue
250,000,000 shares of common stock, $0.001 par value and 5,000,000 shares of
undesignated preferred stock, $0.001 par value. The board of directors has the
authority to determine the price, rights, preferences, privileges and
restrictions of the preferred stock. In April 1999, Portal's board of directors
approved a three-for-one split of Portal's common and preferred stock. The stock
split took place on April 29, 1999. All share and per share amounts in the
accompanying consolidated financial statements have been adjusted retroactively.
Initial Public Offering
On May 11, 1999, Portal completed an initial public offering of its
Common Stock. All 4.6 million shares covered by Portal's Registration Statement
on Form S-1, including shares covered by an overallotment option that was
exercised, were sold by Portal at a price of $14.00 per share, less an
underwriting discount of $0.98 per share. In addition, on May 11, 1999, the
Company issued 380,184 shares of Common Stock to Andersen Consulting and 3.0
million shares of Common Stock to Cisco Systems, Inc. for $13.02 per share or an
aggregate purchase price of approximately $44.0 million. Net proceeds to the
Company from all shares sold were approximately $102.4 million. Upon the
consummation of Portal's initial public offering on May 11, 1999, all of the
then outstanding Series A Preferred Stock and Series B Preferred Stock
automatically converted into Common Stock.
Secondary Stock Offering
In October 1999, Portal completed a secondary offering of 5.75 million
shares of Portal common stock, including shares covered by an overallotment
option that was exercised. Of these shares, Portal offered 2.95 million primary
shares and selling stockholders offered 2.8 million shares. The shares were
issued at a price to the public of $38.00 per share, less an underwriting
discount of $1.84 per share. Net proceeds to the Company were approximately
$106.0 million after underwriting commissions and estimated expenses.
12
<PAGE>
(5) Income Taxes
Portal computes the provision for income taxes by applying the estimated
annual effective tax rate to recurring operations and other taxable items. The
$0.4 million and $1.2 million income tax provision for the three and nine months
ended October 31, 1999 is the result of foreign withholding taxes on revenue and
tax on earnings generated from operations in certain foreign jurisdictions.
13
<PAGE>
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Overview
Portal Software, Inc. develops, markets and supports real-time customer
management and billing software, known as CM&B software, for providers of
Internet-based services. In late 1993, Portal began focusing on developing and
marketing real-time CM&B software for the Internet. The first generally
available version of the product, named Infranet, was shipped in May 1996.
Beginning with fiscal year 1997, substantially all of Portal's revenues have
come from the license of Infranet, and from related services. Revenues consist
of Infranet license, consulting, training, support and maintenance fees. License
revenues are comprised of perpetual or multiyear license fees which are
primarily derived from contracts with corporate customers and resellers. Portal
believes that future license revenues will be generated from three sources:
. license fees from new customers;
. license fees for new products to existing customers; and
. growth in the subscriber base of its existing customers, which will lead
to increased revenue from subscriber-based licenses.
Portal has generated a substantial portion of its historical Infranet revenues
from approximately 160 customers. Portal has established a series of
partnerships with systems integrators and hardware platform, software and
service providers. Portal has derived, and anticipates that it will continue to
derive, a substantial portion of its revenues from customers that have
significant relationships with its market and platform partners.
RESULTS OF OPERATIONS
The following table sets forth the results of operations for the three and nine
months ended October 31, 1998 and 1999 expressed as a percentage of total
revenues.
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
October 31, October 31,
----------- ----------
1998 1999 1998 1999
----- ---- ---- ----
<S> <C> <C> <C> <C>
Revenues:
License fees.................................... 53 % 64 % 51 % 62 %
Services........................................ 47 36 49 38
---- ---- ---- ----
Total revenues............................... 100 100 100 100
---- ---- ---- ----
Costs and expenses:
Cost of license fees............................ 2 2 2 2
Cost of services................................ 31 23 33 24
Research and development........................ 43 24 50 27
Sales and marketing............................. 56 42 59 44
General and administrative...................... 20 14 22 14
Amortization of deferred stock compensation..... 7 7 5 10
---- ---- ---- ----
Total costs and expenses..................... 159 112 171 121
Loss from operations.............................. (59) (12) (71) (21)
Interest income (expense) and other income, net... 4 7 3 11
---- ---- ---- ----
Loss before income taxes.......................... (55) (5) (68) (10)
Provision for income taxes........................ (1) (1) (1) (2)
---- ---- ---- ----
Net loss.......................................... (56)% (6)% (69)% (12)%
==== ==== ==== ====
</TABLE>
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<PAGE>
Three and Nine Months Ended October 31, 1998 and 1999
Revenues
Total revenues were $28.1 million in the three months ended October 31, 1999, an
increase of approximately $20.8 million or 288% and $64.0 million in the nine
months ended October 31, 1999, an increase of approximately $48.4 million or
311% over the comparable periods in 1998. License fees revenues increased as a
percentage of total revenues in the three and nine months ended October 31, 1999
compared to the three and nine months ended October 31, 1998 primarily because
license fees revenue growth exceeded services revenue growth. This was due to
increased license sales as a result of the maturation of the Infranet product
and the expansion of the sales and marketing operations. During the quarter
ended October 31, 1999, Portal shipped Infranet 6.0, the most recent version of
Portal's customer management and billing software. Two customers accounted for a
combined 27% of total revenues during the three months ended October 31, 1999
and one customer accounted for 18% of total revenues during the three months
ended October 31, 1998. No customers accounted for more than 10% of total
revenue for the nine-month periods ended October 31, 1999 and 1998. Portal's
business strategy is to provide CM&B software that will meet the needs of
different Internet service business models. Consequently, because of the number
of different Internet service business models, Portal has received, and will
continue to receive, requests from customers to provide special features that do
not currently exist in its product but that Portal may agree to provide to the
customer in the future. It is Portal's expectation that certain customers will
continue to negotiate and require features that are not immediately available.
Customization of special features may in the future result in the deferral of
revenues until the features are delivered. However, as Infranet matures, Portal
expects that fewer orders will require features not yet available.
License fees totaled $18.1 million in the three months ended October 31, 1999,
an increase of approximately $14.3 million or 374% and $39.8 million in the nine
months ended October 31, 1999, an increase of approximately $31.9 million or
405% over the comparable periods in 1998. The increase in license fees was
primarily due to continued expansion in marketing activities and growth in
Portal's sales force as well as greater demand for and acceptance of Infranet.
Services revenues were $10.0 million in the three months ended October 31, 1999,
an increase of approximately $6.6 million or 192% and $24.2 million in the nine
months ended October 31, 1999, an increase of approximately $16.5 million or
215% over the comparable periods in 1998. The increase in services revenues
resulted from the increase in support and maintenance service fees related to
Portal's growing customer base and the renewal of maintenance contracts. In
addition, increased demand for Portal's consulting and training services to meet
the increasingly complex demands of Portal's customers and its expanding
customer base contributed to this increase.
<TABLE>
<CAPTION>
Three Months Nine Months
Ended October 31, Percent Ended October 31, Percent
---------------- -----------------
(in thousands) 1998 1999 Change 1998 1999 Change
---- ---- ------ ---- ---- ------
<S> <C> <C> <C> <C> <C> <C>
Geographical Revenues:
North America......................... $5,725 $17,530 206% $12,820 $42,494 231%
Percentage of total revenues....... 79% 62% 82% 66%
International
Europe............................... 724 8,657 1,096% 1,559 17,208 1,004%
Percentage of total revenues.. 10% 31% 10% 27%
Intercontinental..................... 782 1,865 138% 1,205 4,325 259%
Percentage of total revenues....... 11% 7% 8% 7%
------ ------- ----- ------- ------- ------
Total international.................. 1,506 10,522 599% 2,764 21,533 679%
Percentage of total revenues....... 21% 38% 18% 34%
------ ------- ------- ------- ------
Total revenues......................... $7,231 $28,052 288% $15,584 $64,027 311%
====== ======= ===== ======= ======= ======
</TABLE>
North American revenues, which are defined by Portal as revenues from the United
States and Canada, were $17.5 million in the three months ended October 31,
1999, an increase of approximately $11.8 million or 206% and $42.5 million in
the nine months ended October 31, 1999, an increase of approximately $29.7
million or 231% over the
15
<PAGE>
comparable periods in 1998. The increase in North American revenues was
primarily due to expanded marketing activities in North America and growth in
sales force as well as greater acceptance of Infranet.
International revenues for Europe and Intercontinental, which is defined by
Portal as Asia-Pacific, Japan and Latin America, totaled $10.5 million in the
three months ended October 31, 1999, an increase of approximately $9.0 million
or 599% and $21.5 million in the nine months ended October 31, 1999, an increase
of approximately $18.8 million or 679% over the comparable periods in 1998.
European revenues were $8.7 million in the three months ended October 31, 1999,
an increase of approximately $7.9 million or 1,096% and $17.2 million in the
nine months ended October 31, 1999, an increase of approximately $15.6 million
or 1,004% over the comparable periods in 1998. Intercontinental revenues were
$1.9 million in the three months ended October 31, 1999, an increase of
approximately $1.1 million or 138% and $4.3 million in the nine months ended
October 31, 1999, an increase of approximately $3.1 million or 259% over the
comparable period in 1998. The increase in international revenues was primarily
due to growth in Portal's direct sales force and increased marketing efforts
worldwide including the establishment of a sales presence in France, Germany,
Spain and Singapore during the period as well as the establishment of Portal's
European headquarters in the United Kingdom in April 1999.
International revenues represented 38% and 34% of total revenues for the three
and nine months ended October 31, 1999, compared with 21% and 18% in the three
and nine months ended October 31, 1998. In the three and nine months ended
October 31, 1999, revenues from Europe were 31% and 27% of total revenues and
revenues from Intercontinental were 7% of total revenues for both periods.
Expenses
Cost of License Fees
Cost of license fees consists of resellers' commission payments to systems
integrators and third-party royalty obligations. Cost of license fees was $0.6
million in the three months ended October 31, 1999, an increase of approximately
$0.5 million or 324% and $1.1 million in the nine months ended October 31, 1999,
an increase of approximately $0.8 million or 285% from the comparable periods in
1998. The increase in cost of license fees is primarily due to increased license
revenue and increased resellers' commissions resulting from Portal expanding its
base of systems integrator partners. Gross margin for license fees was
approximately 97% in both the three and nine months ended October 31, 1999
compared to approximately 96% in both of the comparable periods in 1998. Portal
did not incur any shipping, packaging or documentation costs, as its product was
delivered electronically over the Internet.
Cost of Services
Cost of services primarily consists of maintenance, consulting and training
expenses. Cost of services was $6.5 million in the three months ended October
31, 1999, an increase of approximately $4.3 million or 190% and $15.5 million in
the nine months ended October 31, 1999, an increase of approximately $10.4
million or 203% over the comparable periods in 1998. The increase in cost of
services is primarily due to an increase in the number of consulting and support
personnel necessary to support both the expansion of Portal's installed base of
customers and new installations. Gross margin for services was approximately 35%
and 36% in the three and nine months ended October 31, 1999 compared to
approximately 35% and 34% in the comparable periods in 1998. The increase in
gross margin was primarily due to a decrease in the use of higher cost third-
party personnel as a result of the hiring of additional consulting employees for
the nine months ended October 31, 1999. Portal expects cost of services to
increase substantially in the next few quarters as a result of the hiring of
additional personnel to meet the increased demand for services.
Research and Development Expenses
Research and development expenses consist primarily of personnel and related
costs for Portal's development efforts. Research and development expenses were
$6.8 million in the three months ended October 31, 1999, an increase of
approximately $3.6 million or 115% and $17.2 million in the nine months ended
October 31, 1999, an increase of approximately $9.4 million or 120% over the
comparable periods in 1998. The increase was primarily
16
<PAGE>
due to an increase in the number of research and development personnel necessary
to support both expanded functionality of Infranet and increases in Portal's
quality assurance and product publications operations. Portal currently believes
its investment in research and development will increase substantially during
the remainder of fiscal year 2000. Portal has not capitalized any software
development costs to date.
Sales and Marketing Expenses
Sales and marketing expenses consist of personnel and related costs for Portal's
direct sales force, marketing staff and marketing programs, including trade
shows, advertising and costs associated with Portal's recruitment of new and
maintenance of existing strategic partnerships. Sales and marketing expenses
were $11.8 million in the three months ended October 31, 1999, an increase of
approximately $7.8 million or 194% and $28.0 million in the nine months ended
October 31, 1999, an increase of approximately $18.8 million or 205% over the
comparable periods in 1998. The increase was due to a number of factors
including an increase in the number of sales and marketing personnel, the
opening of new sales offices in the United States, Europe and Hong Kong, the
establishment of a European headquarters in the United Kingdom, the costs of
establishing sales capabilities in China and expenses incurred in connection
with trade shows and additional marketing programs. Portal expects that sales
and marketing expenses will increase substantially over the next 12 months as
Portal hires additional sales and marketing personnel, increases spending on
advertising and marketing programs and establishes sales offices in additional
North American and international locations.
General and Administrative Expenses
General and administrative expenses consist primarily of personnel and related
costs for general corporate functions, including finance, accounting, legal and
human resources as well as facilities and information system expenses not
allocated to other departments. General and administrative expenses were $3.8
million in the three months ended October 31, 1999, an increase of approximately
$2.4 million or 167% and $9.0 million in the nine months ended October 31, 1999,
an increase of approximately $5.6 million or 163% over the comparable periods in
1998. The increase was primarily due to an increase in the number of general and
administrative personnel and an increase in legal and accounting costs incurred
in connection with business activities. Portal expects that general and
administrative expenses will increase substantially over the current fiscal year
as Portal hires additional general and administrative personnel and continues to
incur legal and accounting costs in connection with business activities.
Amortization of Deferred Stock Compensation
Portal recorded deferred stock compensation of approximately $16.8 million in
fiscal year 1999, representing the difference between the exercise prices of
options granted to acquire certain shares of common stock during fiscal year
1999 and the deemed fair value for financial reporting purposes of Portal's
common stock on their respective grant dates. Portal amortized deferred
compensation expense of approximately $1.8 million and $6.8 million during the
three and nine months ended October 31, 1999 as compared to $0.5 and $0.9
million incurred during the comparable periods in 1998. This compensation
expense relates to options awarded to individuals in all operating expense
categories. Total deferred compensation at October 31, 1999 of approximately
$7.6 million is being amortized over the vesting periods of the options using a
graded vesting method. The amortization of deferred compensation currently
recorded is estimated to be $8.2 million for the entirety of fiscal year 2000,
$3.7 million in fiscal year 2001, $1.9 million in fiscal year 2002 and $0.6
million in fiscal year 2003.
Interest Income (Expense) and Other Income, Net
Interest income (expense) and other income, net, includes interest and dividend
income from cash, cash equivalents short and long-term investments offset by
interest on capital leases. Interest income (expense) and other income, net, was
$2.0 and $6.8 million in the three and nine months ended October 31, 1999, as
compared to $0.3 million and $0.5 million in the comparable periods in 1998. The
increase was primarily due to the one-time, non-cash gain of $3.8 million upon
remeasurement of the put option granted to Andersen Consulting which was settled
upon completion of our initial public offering in May 1999, and interest income
from the investment of funds received upon completion of our initial and
secondary public offerings.
17
<PAGE>
Provision for Income Taxes
The $0.4 million and $1.2 million income tax provision shown for the three and
nine months ended October 31, 1999, compared with no significant provision for
income taxes for the comparable periods in 1998, is the result of foreign
withholding taxes on revenue and taxes on earnings generated from operations in
certain foreign jurisdictions. Under Statement of Financial Accounting Standards
No. 109 (FAS 109), deferred tax assets and liabilities are determined based on
differences between financial reporting and tax bases of assets and liabilities
and are measured using the enacted tax rates and laws that will be in effect
when the differences are expected to reverse. FAS 109 provides for the
recognition of deferred tax assets if realization of such assets are more likely
than not. Based on the weight of available evidence, the Company has provided a
valuation allowance against certain deferred tax assets. The Company will
continue to evaluate the realizability of the deferred tax assets on a quarterly
basis.
LIQUIDITY AND CAPITAL RESOURCES
Cash, cash equivalents and short-term investments totaled $206.5 million at
October 31, 1999, compared to a balance of $11.8 million at January 31, 1999.
Portal generated $2.5 million in cash from operations in the nine months ended
October 31, 1999, an increase of $11.1 million over the $8.6 million used in the
comparable period ended October 31, 1998. Amortization of deferred stock
compensation, which is included in the net loss line in the cash flow statement,
but does not require the use of cash, amounted to $6.8 million for the nine
months ended October 31, 1999 compared to $0.9 million for the nine months ended
October 31, 1998. Net cash from operations in the nine months period was
primarily comprised of a $8.0 million loss, a $2.6 million increase in accounts
receivable and a $1.4 million increase in other current assets, offset by a $2.9
million increase in deferred revenue and a combined increase in accounts payable
and accrued compensation of $8.3 million.
Portal has continued to make significant investments in equipment. During the
nine months ended October 31, 1999, Portal purchased computer servers,
workstations, networking equipment and other capital equipment amounting to
approximately $6.0 million, primarily to further expand its product capability,
increase internal network communication, product demonstration and service
capability. Of this amount, $0.3 million was funded from Portal's equipment
lease line facility.
Portal has raised equity capital from outside investors to fund its operations.
In fiscal year 1997, Portal raised approximately $2.4 million from the sale of
preferred stock. In fiscal year 1998, Portal raised approximately $15.0 million
from the sale of preferred stock. In fiscal year 1998 and fiscal year 1999,
Portal also raised an additional $0.1 million and $0.4 million, respectively,
from sales of common stock, primarily upon exercise of stock options by
employees and in fiscal year 1999 raised $0.4 million from the exercise of
warrants for preferred stock issued in connection with its capital lease line
facility and its term loan. In the nine months ended October 31, 1999, Portal
completed an initial public offering which raised approximately $102.4 million,
including sales of stock to Cisco Systems, Inc. and Andersen Consulting. Portal
also completed a secondary offering in October 1999, which raised approximately
$106.0 million, net of underwriting commissions and estimated expenses. During
the same period, Portal raised an additional $1.2 million from sales of common
stock upon the exercise of stock options by employees and warrants by third
parties, net of repurchases.
Historically, Portal has used debt and leases to partially finance its
operations and capital purchases. Portal has a $3.0 million capital lease line
facility with an equipment lessor, which it established in fiscal year 1998. The
lease line has a term of 48 months and bears interest at a rate of 8.5% per
annum. Separately, during the nine months ended October 31, 1999, Portal repaid
an outstanding $3.0 million term loan with a finance company. The term loan was
collateralized by substantially all of Portal's assets, with the exception of
new equipment purchased using funds provided by the capital lease line facility.
On April 15, 1999, Portal entered into a line of credit with a bank under which
Portal may borrow up to $5.0 million. Amounts borrowed under this line of credit
bear interest at a rate of the bank's prime rate plus 0.5% and mature on April
13, 2000. Portal had borrowed $1.0 million under the line of credit, which it
used to repay the remaining $1.0 million installment of the term loan which
matured in April 1999. The outstanding balance on the line of credit was repaid
in May 1999 from the proceeds of Portal's initial public offering. Portal also
converted a customer deposit for prepaid services into a $1.1 million short-term
liability in fiscal year 1999. This liability bore interest at a rate of 10% per
annum and was repaid in July 1999.
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<PAGE>
The capital lease line facility comprised the entire amount of the debt
obligations on Portal's balance sheet as of October 31, 1999. The capital lease
line facility includes certain covenants requiring minimum liquidity, tangible
net worth and profitability over time and becomes due immediately if Portal
fails to meet these covenants. Portal is currently, and has always been, in
compliance with these covenants.
On April 12, 1999, Portal agreed to enter into a strategic alliance with
Andersen Consulting under which Andersen Consulting will provide services to
Portal. The parties will expand their existing marketing alliance and will work
closely together to expand their customer service and marketing relationship.
Under this agreement, Portal will pay Andersen Consulting for its services a
minimum services fee in cash of $2.8 million and a cash settled put for 200,000
of the shares which were purchased by Andersen Consulting in a private placement
concurrent with Portal's initial public offering. This put guaranteed a closing
value of $6.0 million at the end of the first day of trading. Because the
closing value exceeded $6.0 million, Portal was not required to make any payment
with respect to this put.
In the normal course of business, Portal enters into leases for new or expanded
facilities in both domestic and international locations. In June 1999, Portal
entered into a lease for its worldwide headquarters that will expire in November
2010. In connection with the lease, Portal will make payments of $0.6 million,
$4.5 million, $4.6 million, $4.8 million and $4.9 million in the years ending
January 31, 2000, 2001, 2002, 2003 and 2004, respectively, and a total of $37.7
million thereafter until expiration of the lease. In connection with this lease,
Portal issued two letters of credit totaling $5,250,000 in lieu of a security
deposit for the facilities.
Portal's capital requirements depend on numerous factors, including market
acceptance of Portal's products, the resources Portal devotes to developing,
marketing, selling and supporting its products, the timing and extent of
establishing international operations, and other factors. Portal expects to
devote substantial capital resources to hire and expand its sales, support,
marketing and product development organizations, to expand marketing programs,
to establish additional facilities worldwide and for other general corporate
activities. Although Portal believes that its current cash balances and the net
proceeds from this offering will be sufficient to fund its operations for at
least the next 12 months, Portal may require additional financing within this
time frame. Additional funding, if needed, may not be available on terms
acceptable to Portal, or at all.
Year 2000 Readiness Disclosure
Many currently installed computer systems and software products are coded to
accept only two digit entries in the date code field. As a result, software that
records only the last two digits of the calendar year may not be able to
distinguish whether ``00'' means 1900 or 2000. This may result in software
failures or the creation of erroneous results.
Portal has conducted a limited review of the current version of Infranet and the
three immediately preceding releases. This review included a search of the
software code, and Portal believes that it has identified all instances where
date specific information is required. Based on this limited review, Portal
believes these Infranet releases, when configured, maintained (including the
installation of all Year 2000 and other maintenance releases and bug fixes) and
used in accordance with its documentation, correctly recognize and properly
process Year 2000 date code and function properly. Portal has no plans to
conduct further reviews of other releases of Infranet and products that are
scheduled for obsolescence prior to the end of the calendar year 1999.
Portal's software runs on several hardware platforms and operating systems,
including those provided by Compaq Computer Corporation, Hewlett-Packard
Company, Microsoft Corporation and Sun Microsystems, Inc. In addition, Portal's
software interfaces with third-party systems, such as credit card processing
services and customer-specific modifications that Portal service providers,
third-party integrators and customers have created to be used with Infranet.
Portal's software is, therefore, dependent upon the correct processing of dates
by these systems, interfaces and modifications.
Portal plans to contact all partners for which Portal provides integration as
part of Infranet's standard product configuration. In contacting these partners,
Portal has attempted to ascertain what release or releases of their products are
Year 2000 compliant. To date, Portal has received assurances from most of its
material partners and will continue obtaining such information from all
remaining partners. Portal may be unable to obtain compliance
19
<PAGE>
information from all of these partners. Moreover, Portal's partners may detect
errors in their products after previously indicating that their products are
Year 2000 compliant. Such revelations by Portal's partners have occurred in the
past and may occur in the future; and these revelations have caused and could
cause Portal to make changes in its products in response. In a test environment,
Portal will review Infranet and interfaces to partner products. Portal may not
identify all Year 2000 failures in partner products because not all failures are
within the scope of these tests.
Some of our customers elect to integrate Infranet with interfaces not ordinarily
supported by Portal. This integration, whether performed by Portal, the customer
or a third-party systems integrator, is not within the scope of Portal's in-
house testing efforts. Portal has advised all customers that they must
independently test these integrations for Year 2000 compliance.
Portal uses multiple software systems for its internal business purposes,
including accounting, human resources, e-mail, engineering development and
testing tools, customer service and support, professional services and sales
tracking applications. Portal has adopted a formal plan for determining the Year
2000 compliance of its major internal systems. Portal plans to obtain
verification of Year 2000 compliance for its major internal hardware equipment
and software systems before the end of 1999.
Portal has an ongoing process of assessing its Year 2000 readiness. To date, the
costs for conducting its assessment have not been material. Portal currently
estimates that the costs of ensuring that its products and internal systems are
Year 2000 compliant or remedying any Year 2000 problems will be approximately
$500,000 to $750,000. Portal is unable to predict to what extent its business
may be affected if its software or the systems that operate in conjunction with
its software or its internal systems experience a material Year 2000 failure.
Moreover, several customers, despite warnings regarding the use of non-Year 2000
certified versions of Infranet, are likely to continue to use such versions, and
decline to upgrade to certified versions or implement maintenance fixes or bug
releases made available to them. [Such non-certified versions are not Year 2000
compliant.] Known or unknown errors or defects that affect the operation of
Portal's software could result in delay or loss of revenue, interruption of
customer management and billing services, cancellation of customer contracts,
diversion of development resources, damage to Portal's reputation, increased
service and warranty costs and litigation costs, any of which could adversely
affect Portal's business, financial condition and results of operations. Year
2000 compliance is complex and is subject to various uncertainties, including
those described in this section and under "Risk Factors."
Portal does not have a contingency plan to remediate any Year 2000 problems that
may arise and affect its products or internal systems in the future. If such
problems arise, Portal will need to make the necessary expenditures to assess
and remedy such problems. The nature, timing and extent of such expenditures
cannot be estimated. Such expenditures, if required, may have a material adverse
effect on its business, financial condition and results of operations. Portal
believes that the following consequences are possible in a ``worst case'' Year
2000 scenario:
. a significant number of operational inconveniences and inefficiencies for
Portal and its customers that will divert management's time and attention;
and
. costly business disputes, litigation and claims for pricing adjustments,
product returns and warranty obligations.
RECENT ACCOUNTING PRONOUNCEMENTS
In March 1998, the American Institute of Certified Public Accountants or AICPA
issued Statement of Position No. 98-1, Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use. SOP No. 98-1 requires entities
to capitalize certain costs related to internal-use software once certain
criteria have been met. Portal adopted this statement on February 1, 1999 with
no material impact on its financial position or results of operations.
In April 1998, the AICPA issued SOP No. 98-5, Reporting on the Costs of Start-Up
Activities. SOP No. 98-5 requires that all start-up costs related to new
operations must be expensed as incurred. In addition, all start-up costs that
were capitalized in the past must be written off when SOP No. 98-5 is adopted.
Portal adopted this statement on February 1, 1999 with no material impact on its
financial position or results of operations.
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In June 1998, the Financial Accounting Standards Board issued FAS No. 133,
Accounting for Derivative Instruments and Hedging Activities. FAS No. 133
establishes methods for derivative financial instruments and hedging activities
related to those instruments, as well as other hedging activities. Because
Portal does not currently hold any derivative instruments and does not engage in
hedging activities, Portal expects that the adoption of FAS No. 133 will not
have a material impact on its financial position or results of operations.
Portal will be required to implement FAS No. 133 for fiscal year 2002.
In December 1998, the AICPA issued SOP 98-9, Modification of SOP 97-2, Software
Revenue Recognition, with Respect to Certain Transactions. SOP 98-9 amends SOP
98-4 to extend the deferral of the application of certain passages of SOP 97-2
provided by SOP 98-4 through fiscal years beginning on or before March 15, 1999.
All other provisions of SOP 98-9 are effective for transactions entered into in
fiscal years beginning after March 15, 1999. Portal does not expect the final
adoption of SOP 98-9 to have a material impact on its future revenues and
results of operations.
RISKS ASSOCIATED WITH PORTAL'S BUSINESS AND FUTURE OPERATING RESULTS
Portal's future operating results may vary substantially from period to
period. The price of our common stock will fluctuate in the future, and an
investment in our common stock is subject to a variety of risks, including but
not limited to the specific risks identified below. Inevitably, some investors
in our securities will experience gains while others will experience losses
depending on the prices at which they purchase and sell securities. Prospective
and existing investors are strongly urged to carefully consider the various
cautionary statements and risks set forth in this report.
This report contains forward-looking statements that are not historical
facts but rather are based on current expectations, estimates and projections
about our business and industry, our beliefs and assumptions. Words such as
"anticipates", "expects", "intends", "plans", "believes", "seeks", "estimates"
and variations of these words and similar expressions are intended to identify
forward-looking statements. These statements are not guarantees of future
performance and are subject to risks, uncertainties and other factors, some of
which are beyond our control, are difficult to predict and could cause actual
results to differ materially from those expressed or forecasted in the forward-
looking statements. These risks and uncertainties include those described in
this "Risks Associated With Portal's Business and Future Operating Results" and
elsewhere in this report. Forward-looking statements that were true at the time
made may ultimately prove to be incorrect or false. Readers are cautioned not to
place undue reliance on forward-looking statements, which reflect our
management's view only as of the date of this report. We undertake no obligation
to update these statements or publicly release the results of any revisions to
the forward-looking statements that we may make to reflect events or
circumstances after the date of this report or to reflect the occurrence of
unanticipated events.
It is difficult to predict our business because we have a limited history
operating as a provider of CM&B software
The results of operations for the three and nine months ended October 31,
1999 and 1998 contained in this report are not necessarily indicative of results
for fiscal year ending January 31, 2000 or any other future period. Moreover,
Portal has a relatively brief operating history as a provider of CM&B software
and had no meaningful license revenue until 1996. Therefore, Portal will
experience the risks and difficulties frequently encountered by early stage
companies in new and rapidly evolving markets, including those discussed in this
report. Our business strategy may not prove successful, and we may not
successfully address these risks.
We have not achieved profitability and expect to continue to incur net losses
for at least the next several quarters
In order to become profitable, we must increase our revenues. We may not be
able to increase or even maintain our revenues, and we may not achieve
sufficient revenues or profitability in any future period. We incurred net
losses of approximately $8.0 million for the nine months ended October 31, 1999,
$17.4 million for fiscal year 1999, $7.6 million for fiscal year 1998 and $2.3
million for fiscal year 1997. We have not achieved profitability and expect to
continue to incur net losses for at least the next several quarters even if
sales of our CM&B software continue to grow.
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In addition, we expect to significantly increase our sales and marketing,
product development and administrative expenses. As a result, we will need to
generate significant revenues from sales of Infranet to achieve and maintain
profitability. We expect that we will face increased competition that may make
it more difficult to increase our revenues. Even if we are able to increase
revenues, we may experience price competition which would lower our gross
margins and our profitability. Another factor that will lower our gross margins
is any increase in the percentage of our revenues that is derived from indirect
channels and from services, both of which have lower margins. If we do achieve
profitability, we cannot be certain that we can sustain or increase
profitability on a quarterly or annual basis.
Our quarterly operating results may fluctuate in future periods and we may fail
to meet expectations
Our revenues and operating results may vary significantly from quarter to
quarter due to a number of factors. In future quarters, our operating results
may be below one or more of the expectations of public market analysts and
investors, and the price of our common stock may fall. Failure by technology
companies to meet or exceed analyst expectations or any resulting changes in
analyst recommendations or ratings frequently results in substantial decreases
in the market value of the stock of such companies. Factors that could cause
quarterly fluctuations include:
. variations in demand for our products and services;
. the timing and execution of individual contracts, particularly large
contracts that would materially affect our operating results in a given
quarter;
. the timing of sales of our products and services;
. our ability to develop and attain market acceptance of enhancements to
Infranet and new products and services;
. delays in introducing new products and services;
. new product introductions by competitors;
. changes in our pricing policies or the pricing policies of our
competitors;
. the mix of products and services sold;
. the mix of sales channels through which our products and services are
sold;
. the mix of domestic and international sales;
. costs related to acquisitions of technologies or businesses;
. the timing of releases of new versions of third-party software and
hardware products that work with our products;
. our ability to attract, integrate, train, retain and motivate a
substantial number of sales and marketing, research and development,
technical support and other management personnel;
. our ability to expand our operations;
. the amount and timing of expenditures related to expansion of our
operations; and
. global economic conditions generally, as well as those specific to ISPs
and other providers of Internet-based services.
We have difficulty predicting the volume and timing of orders. For example,
substantially all of our future revenues will come from licenses of Infranet and
related services, and the market for this product is in its early stages of
development and is therefore unpredictable. In any given quarter, our sales have
involved, and we expect will continue to involve, large financial commitments
from a relatively small number of customers. As a result, the cancellation or
deferral of even a small number of licenses of Infranet would reduce our
revenues, which would adversely affect our quarterly financial performance.
Also, we have often booked a large amount of our sales in the last month of the
quarter and often in the last week of that month. Accordingly, delays in the
closing of sales near
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the end of a quarter could cause quarterly revenue to fall substantially short
of anticipated levels. Significant sales may also occur earlier than expected,
which could cause operating results for later quarters to compare unfavorably
with operating results from earlier quarters.
We record as deferred revenue fees from contracts that do not meet our
revenue recognition policy requirements. While a portion of our revenues each
quarter is recognized from deferred revenue, our quarterly performance will
depend primarily upon entering into new contracts to generate revenues for that
quarter. New contracts that we enter into may not result in revenue in the
quarter in which the contract was signed, and we may not be able to predict
accurately when revenues from these contracts will be recognized.
We plan to significantly increase our operating expenses to expand our
sales and marketing operations, broaden our customer support capabilities,
develop new distribution channels and fund greater levels of research and
development. We determine our operating expenses largely on the basis of
anticipated revenue trends and a high percentage of our expenses are fixed in
the short term. As a result, a delay in generating or recognizing revenue could
cause significant variations in our operating results from quarter-to-quarter
and could result in substantial operating losses.
It is difficult to predict the timing of individual orders because Infranet has
a long and variable sales cycle
To date, the sales cycle for Infranet has been three to nine months or
more. The long sales and implementation cycles for Infranet may cause license
revenues and operating results to vary significantly from period to period.
Along with systems integrators and our other distribution partners, we spend
significant time educating and providing information to our prospective
customers regarding the use and benefits of Infranet. Even after purchase, our
customers tend to deploy Infranet slowly and deliberately, depending on the
specific technical capabilities of the customer, the size of the deployment, the
complexity of the customer's network environment, and the quantity of hardware
and the degree of hardware configuration necessary to deploy Infranet.
Our business depends on the commercial acceptance of Infranet, and it is
uncertain to what extent the market will accept this product
Our future growth depends on the commercial success of Infranet.
Substantially all of our licensing revenues are derived from Infranet. Our
business will be harmed if our target customers do not adopt and purchase
Infranet. The market for Internet-based CM&B software is in its early stages of
development. Our future financial performance will also depend on the successful
development, introduction and customer acceptance of new and enhanced versions
of Infranet. We are not certain that our target customers will widely adopt and
deploy Infranet as their CM&B solution. In the future we may not be successful
in marketing Infranet or any new or enhanced products or services. Our future
revenues will also depend on our customers licensing software for additional
applicants or for additional subscribers. Their failure to do so could harm our
business.
Significant technical challenges arise in our business because many of our
customers purchase and implement Infranet in phases, deploy Infranet across a
variety of computer hardware platforms and integrate it with a number of legacy
systems, third-party software applications and programming tools. Implementation
currently requires participation by our professional services group, which has
significantly limited resources. Some customers may also require us to develop
costly customized features or capabilities, which increase our costs and consume
our limited customer service and support resources. Also, revenues we derive
from our services business have a significantly lower margin than revenues
derived from licensing Infranet. If new or existing customers have difficulty
deploying our products or require significant amounts of our professional
services support, our operating margins could be harmed.
We must hire and retain qualified sales personnel to sell Infranet
Our financial success and our ability to increase revenues in the future
depend considerably upon the growth and productivity of our direct sales force
that has historically generated a majority of Portal's license revenues. This
productivity and growth will depend to a large degree on our success in
recruiting, training and retaining additional direct salespeople. There is a
shortage of direct sales personnel with the skills and expertise necessary to
sell our
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products. Our business will be harmed if we fail to hire or retain qualified
sales personnel, or if newly hird salespeople fail to develop the necessary
sales skills or develop these skills more slowly than we anticipated.
In addition, because we currently rely on indirect sales for a significant
portion of our market opportunities, we may miss sales opportunities that are
available through other sales distribution methods and other sources of leads,
such as domestic and foreign resellers. In the future, we intend to augment our
indirect sales distribution methods through additional third-party distribution
arrangement. However, there is no guarantee that we will successfully augment
these arrangements or that the expansion of indirect sales distribution methods
will increase revenues. We may be at a serious competitive disadvantage if we
fail to enhance these indirect sales channels.
We also use systems integrators and other strategic relationships to implement
and sell Infranet
We have entered into relationships with third-party systems integrators, as
well as with hardware platform and software applications developers and service
providers. We have derived, and anticipate that we will continue to derive, a
significant portion of our revenues from customers that have significant
relationships with our market and platform partners. We could lose sales
opportunities if we fail to work effectively with these parties or fail to grow
our base of market and platform partners.
Many of these partners also work with competing software companies, and our
success will depend on their willingness and ability to devote sufficient
resources and efforts to marketing our products versus the products of others.
We may not be able to enter into additional, or maintain our existing, strategic
relationships on commercially reasonable terms, or at all. Our agreements with
these parties typically are in the form of nonexclusive referral fee or reseller
agreements that may be terminated by either party without cause or penalty and
with limited notice. Therefore, there is no guarantee that any single party will
continue to market our products. If these relationships fail, we will have to
devote substantially more resources to the distribution, sales and marketing,
implementation and support of Infranet than we would otherwise, and our efforts
may not be as effective as those of our partners, either of which would harm our
business.
Our quarterly revenue is generated from a limited number of customers and our
customer base is concentrated and the loss of one or more of our customers could
cause our business to suffer
A substantial portion of our license and services revenues in any given
quarter has been, and is expected to continue to be, generated from a limited
number of customers with large financial commitments. For example, two customers
accounted for 27% of total revenues for the quarter ended October 31, 1999. As a
result, if a large contract is cancelled or deferred or an anticipated contract
does not materialize, our business would be harmed. We have initially targeted
large ISPs, including on-line divisions of telecommunications carriers and other
providers of Internet-based services. Some of the industries we have targeted
are consolidating, which could reduce the number of potential customers
available to us.
Our business will suffer dramatically if we fail to successfully manage our
growth
Our ability to successfully offer Infranet and new products and services in
a rapidly evolving market requires an effective planning and management process.
We continue to increase the scope of our operations domestically and
internationally and have grown our headcount substantially. Our business will
suffer dramatically if we fail to effectively manage this growth. On October 31,
1999, we had 496 employees, compared to a total of 242 employees on January 31,
1999. We expect to continue to hire new employees at a rapid pace. This growth
has placed, and our anticipated future operations will continue to place, a
significant strain on our management systems and resources and on our internal
training capabilities. We expect that we will need to continue to improve our
financial and managerial controls and reporting systems and procedures, and will
need to continue to expand, train and manage our work force worldwide. Although
we have entered into a lease for new facilities for our headquarters in
Cupertino, California, we expect that we will also have to expand our
facilities, and we may face difficulties and significant expenses identifying
and moving into suitable office space.
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Our significant international operations and our planned expansion of our
international operations make us much more susceptible to risks from
international operations
For the nine months ended October 31, 1999 and the year ended January 31,
1999, we derived approximately 34% and 27% of our revenue, respectively, from
sales outside North America. As a result, we face risks from doing business on
an international basis, including, among others:
. reduced protection for intellectual property rights in some countries;
. licenses, tariffs and other trade barriers;
. difficulties in staffing and managing foreign operations;
. longer sales and payment cycles;
. greater difficulties in collecting accounts receivable;
. political and economic instability;
. seasonal reductions in business activity;
. potentially adverse tax consequences;
. compliance with a wide variety of complex foreign laws and treaties;
and
. variance and unexpected changes in local laws and regulations.
We currently have offices in a number of foreign locations including
Australia, France, Germany, Hong Kong, Japan, Spain and the United Kingdom and
plan to establish additional facilities in other parts of the world. The
expansion of our existing international operations and entry into additional
international markets will require significant management attention and
financial resources. We cannot be certain that our investments in establishing
facilities in other countries will produce desired levels of revenue. In
addition, we have sold Infranet internationally for only a few years and we have
limited experience in developing localized versions of Infranet and marketing
and distributing them internationally.
Further, our international revenues are denominated in U.S. dollars.
Therefore, a strengthening of the dollar versus other currencies could make our
products less competitive in foreign markets or collection of receivables more
difficult. We do not currently engage in currency hedging activities.
To the extent that we are unable to successfully manage expansion of our
business into international markets due to any of the foregoing factors, our
business could be adversely affected.
Our proprietary rights may be inadequately protected, and there is a risk of
infringement
Our success and ability to compete depend substantially upon our internally
developed technology, which we protect through a combination of patent,
copyright, trade secret and trademark law. Despite our efforts to protect our
proprietary rights, unauthorized parties may attempt to copy or otherwise obtain
and use our products or technology or to develop products with the same
functionality as our products. Policing unauthorized use of our products is
difficult, and we cannot be certain that the steps we have taken will prevent
misappropriation of our technology, particularly in foreign countries where the
laws may not protect our proprietary rights as fully as in the United States.
Others may develop technologies that are similar or superior to our technology.
Moreover, as the number of competitors in our industry segments grow and the
functionality of products in different industry segments overlaps, we expect
that our software products may in the future become subject to third-party
infringement claims. Some of our competitors in the market for CM&B software may
have filed or may intend to file patent applications covering aspects of their
technology upon which they may claim our technology infringes. Any litigation,
brought by us or by others, could be time-consuming and costly and could divert
the attention of our technical and management personnel. In addition, litigation
could cause product shipment delays or require us to develop non-infringing
technology or enter into royalty or licensing agreements. Such royalty or
licensing agreements, if required, may not be available on acceptable terms, or
at all, and could have a material and adverse impact on our gross margins and
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profitability. If a successful claim of product infringement were made against
us, our business could be significantly harmed.
Our business will suffer if our software contains significant errors or our
product development is delayed
We face possible claims and higher costs as a result of the complexity of
our products and the potential for undetected errors. Due to the "mission
critical" nature of Infranet, undetected errors are of particular concern.
Complex software, such as ours, always contains undetected errors. The
implementation of Infranet, which we accomplish through our services division
and with our partners, typically involves working with sophisticated software,
computing and communications systems. If we experience difficulties with an
implementation or do not meet project milestones in a timely manner, we could be
obligated to devote more customer support, engineering and other resources to a
particular project and to provide these services at reduced or no cost. If our
software contains significant undetected errors or we fail to meet our
customers' expectations or project milestones in a timely manner we could
experience:
. loss of or delay in revenues and loss of market share;
. loss of customers;
. failure to achieve market acceptance;
. diversion of development resources;
. injury to our reputation;
. increased service and warranty costs;
. legal actions by customers against us; and
. increased insurance costs.
Our licenses with customers generally contain provisions designed to limit
our exposure to potential product liability claims, such as disclaimers of
warranties and limitations on liability for special, consequential and
incidental damages. In addition, our license agreements generally cap the
amounts recoverable for damages to the amounts paid by the licensee to us for
the product or service-giving rise to the damages. However, these contractual
limitations on liability may not be enforceable, particularly if the damages
relate to a Year 2000 problem, and we may be subject to claims based on errors
in our software or mistakes in performing our services including claims relating
to damages to our customers' internal systems. A product liability claim,
whether or not successful, could harm our business by increasing our costs,
damaging our reputation and distracting our management.
In the past we have failed to release certain new products and upgrades on
time. These delays may result in:
. customer dissatisfaction;
. cancellation of orders and license agreements;
. negative publicity;
. loss of revenues;
. slower market acceptance; or
. legal action by customers against us.
Our business may be harmed if we are unable to develop, license or acquire new
products or enhancements to Infranet on a timely and cost-effective basis, or if
these products or enhancements are not accepted by the market.
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Year 2000 issues present technological risks, could cause disruption to our
business and could harm sales of Infranet
Concern over, and problems associated with, the impact of the occurrence of
the year 2000 on Portal's software products, internal systems, customers,
suppliers and the overall software industry could affect our future operating
results in several ways. Errors or defects that affect the operation of our
software could result in:
. delay or loss of revenue;
. cancellation of customer contracts;
. diversion of development resources;
. damage to our reputation;
. increased service and warranty costs; and
. litigation costs.
We are still in the process of completing our Year 2000 readiness plans,
tests and analyses and face uncertainty as a result. Infranet operates in
complex network environments and directly and indirectly interacts with a number
of other hardware and software systems. Our software also interfaces with third-
party systems, such as credit card processing services and customer-specific
modifications that our service providers, third-party integrators and customers
have created to be used with Infranet. Despite preliminary investigation and
testing by us and our partners, Infranet and the underlying systems and
protocols running it may contain previously undetected errors or defects
associated with Year 2000 date functions. Furthermore, our testing to date has
been limited to the current version of Infranet and three prior releases of
Infranet. Moreover, several customers, despite warnings regarding the use of
non-Year 2000 certified versions of Infranet, are likely to continue to use such
versions, and decline to upgrade to certified versions or implement maintenance
fixes or bug releases made available to them. [Such non-certified versions are
not Year 2000 compliant.] We may not be able to identify all Year 2000 failures
in our partners' products. We have attempted to ascertain what release or
releases of our partners' products are Year 2000 compliant.
To date, Portal has received compliance information from most of its
material partners. However, Portal may be unable to obtain compliance
information from all of these partners. Moreover, our partners may detect errors
in their products after previously indicating that their products are Year 2000
compliant. Such revelations by our partners, have occurred in the past and may
occur in the future; and these revelations have and could cause us to make
changes in our products in response. In addition, some of our customers elect to
integrate Infranet with interfaces not ordinarily supported by Portal. This
integration, whether performed by Portal, the customer or a third party systems
integrator, is also not within the scope of Portal's in-house testing efforts.
Portal has advised all customers that they must independently test these
integrations for year 2000 compliance.
We also are in the process of evaluating and assessing the Year 2000
compliance of many of our internal systems. Accordingly, we are unable to
predict to what extent our business may be affected if our software, the systems
that operate in conjunction with our software or our internal systems experience
a material Year 2000 failure.
The purchasing patterns of our customers and potential customers based on
Year 2000 issues may make it difficult to predict future sales of Infranet. Many
companies are deferring software purchases until after January 1, 2000 which
could cause an increase in short-term demand from those customers and a possible
decrease in future demand.
We incorporate software licensed from third parties into Infranet and any
significant interruption in the availability of these third-party software
products or defects in these products could harm our business in the short-term
Portions of Infranet incorporate software developed and maintained by
third-party software vendors, such as operating systems, tools and database
vendors. We expect that we may have to incorporate software from third party
vendors and developers to a larger degree in our future products. Any
significant interruption in the availability of these third-party software
products or defects in these products or future products could harm our sales
unless and
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until we can secure another source. We may not be able to replace the
functionality provided by the third-party software currently offered with our
products if that software becomes obsolete, defective or incompatible with
future versions of our products or is not adequately maintained or updated. The
absence of, or any significant delay in, the replacement of that functionality
could result in delayed or lost sales and increased costs and could harm our
business in the short-term.
Our future success will depend on our ability to manage technological change
The market for CM&B software and services and Internet applications is
characterized by:
. rapid technological change;
. frequent new product introductions;
. changes in customer requirements; and
. evolving industry standards.
Future versions of hardware and software platforms embodying new
technologies and the emergence of new industry standards could render our
products obsolete. Our future success will depend upon our ability to develop
and introduce a variety of new products and product enhancements to address the
increasingly sophisticated needs of our customers.
Infranet is designed to work on a variety of hardware and software
platforms used by our customers. However, Infranet may not operate correctly on
evolving versions of hardware and software platforms, programming languages,
database environments, accounting and other systems that our customers use. We
must constantly modify and improve our products to keep pace with changes made
to these platforms and to back-office applications and other Internet-related
applications. This may result in uncertainty relating to the timing and nature
of new product announcements, introductions or modifications, which may harm our
business. If we fail to modify or improve our products in response to evolving
industry standards, our products could rapidly become obsolete, which would harm
our business.
The markets in which we sell our product are highly competitive and we may not
be able to compete effectively
We compete in markets that are new, intensely competitive, highly
fragmented and rapidly changing. We face competition from providers of
traditional CM&B software such as Amdocs Limited, Kenan Systems Corporation,
which was recently acquired by Lucent Technologies, Inc., LHS Group Inc. and
Saville Systems PLC, which was recently acquired by ADC Telecommunications;
emerging providers of Internet-specific billing software, such as Belle Systems
S/A, Solect Technology Group and TAI Corporation, which was recently acquired by
Convergys Corportation; and proprietary systems developed by providers of
Internet-based services. We also compete with systems integrators and with
internal MIS departments of larger telecommunications carriers. We are aware of
numerous other major ISPs, software developers and smaller entrepreneurial
companies that are focusing significant resources on developing and marketing
products and services that will compete with Infranet. We anticipate continued
growth and competition in the on-line services and telecommunications industries
and the entrance of new competitors into the CM&B software market, and that the
market for our products and services will remain intensely competitive. We
expect that competition will increase in the near term and that our primary
long-term competitors may have not yet entered the market. Many of our current
and future competitors have significantly more personnel and greater financial,
technical, marketing and other resources than we do.
Our competitors may be able to respond more quickly to new or emerging
technologies and changes in customer requirements than we can. Also, current and
potential competitors have greater name recognition and more extensive customer
bases that they can use to compete more effectively. Increased competition could
result in price reductions, fewer customer orders, reduced gross margins and
loss of market share, any of which could harm our business.
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Our business substantially depends upon the continued growth of the Internet and
Internet-based services
We sell Infranet to organizations providing Internet-based services.
Consequently, our future revenues and profits, if any, substantially depend upon
the continued acceptance and use of the Internet as an effective medium of
commerce and communication. Rapid growth in the use of the Internet and on-line
services is a recent phenomenon and it may not continue. As a result, a broad
base of regular Internet users may not develop, and the market may not accept
recently introduced services and products that rely upon the Internet, such as
Infranet.
Future regulation of the Internet may slow its growth, resulting in decreased
demand for our products and services and increased costs of doing business
Due to the increasing popularity and use of the Internet, it is possible
that state and federal regulators could adopt laws and regulations that may
impose additional burdens on those companies conducting business on-line. The
growth and development of the market for Internet-based services may prompt
calls for more stringent consumer protection laws. The adoption of any
additional laws or regulations may decrease the expansion of the Internet or
impose additional burdens on those companies conducting business on-line. A
decline in the growth of the Internet could decrease demand for our products and
services and increase our cost of doing business, or otherwise harm our
business. Moreover, the applicability to the Internet of existing laws in
various jurisdictions governing issues such as property ownership, sales tax,
libel and personal privacy is uncertain and may take years to resolve. Our costs
could increase and our growth could be harmed by any new legislation or
regulation, the application of laws and regulations from jurisdictions whose
laws do not currently apply to our business, or the application of existing laws
and regulations to the Internet and other on-line services.
Our future success depends on our ability to attract and retain additional
personnel, particularly qualified sales persons
We intend to hire a significant number of additional sales, support,
marketing, administrative and research and development personnel in 1999 and
beyond. Competition for these individuals is intense, and we may not be able to
attract, assimilate or retain highly qualified personnel in the future. Our
business cannot continue to grow if we cannot attract qualified personnel. We
currently have a small customer service and support organization and will need
to increase our staff to support new customers and the expanding needs of our
existing customers. Hiring qualified customer service and support personnel, as
well as sales, marketing, administrative and research and development personnel,
is very competitive in our industry, particularly in the San Francisco Bay Area,
where Portal is headquartered, due to the limited number of people available
with the necessary technical skills and understanding of the Internet. We may
experience greater difficulty attracting these personnel with equity incentives
as a public company than we did as a privately held company. Our future success
also depends upon the continued service of our executive officers and other key
sales, marketing and support personnel in general, and on the services of John
E. Little, our President and Chief Executive Officer, and David S. Labuda, our
Chief Technology Officer, in particular. None of our officers or key employees
is bound by an employment agreement for any specific term. Our relationships
with these officers and key employees are at will.
Acquisitions of companies or technologies may result in disruptions to our
business and management due to difficulties in assimilating personnel and
operations
Although we have not done so in the past, we may make acquisitions or
investments in other companies, products or technologies in the future. If we
make any acquisitions, we will be required to assimilate the operations,
products and personnel of the acquired businesses and train, retain and motivate
key personnel from the acquired businesses. We may be unable to maintain uniform
standards, controls, procedures and policies if we fail in these efforts.
Similarly, acquisitions may cause disruptions in our operations and divert
management's attention from day-to-day operations, which could impair our
relationships with our current employees, customers and strategic partners. The
issuance of equity securities for any acquisition could be substantially
dilutive to our stockholders. In addition, our profitability may suffer because
of acquisition-related costs or amortization costs for acquired goodwill and
other intangible assets.
29
<PAGE>
The price of our common stock has been, and will be volatile
The trading price of our common stock has fluctuated in the past and will
fluctuate in the future. This future fluctuation could be a result of a number
of factors, many of which are outside our control. Some of these factors
include:
. quarter-to-quarter variations in our operating results;
. failure to meet the expectations of industry analysts;
. changes in earnings estimates by analysts;
. announcements and technological innovations or new products by us or
our competitors;
. increased price competition;
. developments or disputes concerning intellectual property rights; and
. general conditions in the Internet industry.
In addition, the stock market has experienced extreme price and volume
fluctuations, which have particularly affected the market prices of many
Internet and computer software companies, including ours, and which have often
been unrelated to the operating performance of these companies or our company.
Decreases in the trading prices of stocks of technology companies are often
precipitous.
Approximately 34,671,557 currently outstanding shares are subject to lock-
up agreements signed in connection with Portal's second public offering and will
be eligible for sale in the public market beginning December 28, 1999. If our
stockholders sell substantial amounts of our common stock, including shares
issued upon the exercise of outstanding options and warrants, in the public
market following the expiration of such restrictions, the market price of our
common stock could fall.
30
<PAGE>
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Short-Term Investment Portfolio
We do not hold derivative financial instruments in our short-term investment
portfolio. Our short- term investments consist of instruments that meet high
quality standards consistent with our investment policy. This policy dictates
that we diversify our holdings and limit our short-term investments to a maximum
of $5 million to any one issuer. Our policy also dictates that all short-term
investments mature in 24 months or less.
Impact of Foreign Currency Rate Changes
During fiscal year 1999, most local currencies of our international subsidiaries
weakened against the U.S. dollar. As of October 31, 1999, the currency of our
Asian subsidiary has strengthened and the currency of our other subsidiaries has
remained essentially stable since the end of our 1999 fiscal year. Because we
translate foreign currencies into U.S. dollars for reporting purposes, currency
fluctuations can have an impact, though generally immaterial, on our results. We
believe that historically our exposure to currency exchange fluctuation risk has
been minimal primarily due to the fact that all activities are denominated in
U.S. dollars. For the nine months ended October 31, 1999, there was an
immaterial currency exchange impact from our intercompany transactions. As of
October 31, 1999, we did not engage in foreign currency hedging activities.
31
<PAGE>
PART II: OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.
(a) Change in Certificate of Incorporation.
Upon the consummation of Portal's initial public offering on May 11, 1999, all
of the then outstanding Series A Preferred Stock and Series B Preferred Stock
automatically converted into Common Stock. Following that conversion, Portal
filed an Amended and Restated Certificate of Incorporation that reflects the
deletion of provisions relating to those series of preferred stock.
(c) Sales of Unregistered Securities.
During the three months ended April 30, 1999, following the exercise of options
to purchase shares of Common Stock that had been granted under the Company's
1995 Stock Option/ Stock Issuance Plan by 22 employees, the Company issued an
aggregate of 276,498 shares of Common Stock (adjusted for a three for one stock
split effected on April 29, 1999) for an aggregate purchase price of $185,696.
In addition, Portal issued to nine individuals in lieu of cash payment for
services rendered, an aggregate of 72,957 shares of Common Stock of which 68,957
were valued at $30.00 per share and 4,000 were valued at $8.00 per share. All
of the foregoing sales of Common Stock by the Company were made pursuant to the
exemption from the registration requirements of the Securities Act afforded by
Section 4(2) of the Securities Act or Rule 701 promulgated under the Securities
Act.
On May 11, 1999, concurrent with its initial public offering, the Company issued
380,184 shares of Common Stock to Anderson Consulting LLC and 3,000,000 shares
of Common Stock to Cisco Systems, Inc. for an aggregate purchase price of
$44,009,995. The sale of these shares was made pursuant to the exemption from
the registration requirements of the Securities Act afforded by Section 4(2) of
the Securities Act.
On October 19, 1999, Comdisco, Inc. purchased 97,119 shares of common stock
through the exercise of a warrant issued in 1997. The exercise price was paid by
means of a net exercise provision whereby the number of shares to be issued upon
exercise was reduced by a number of shares having a market value equal to
$149,998.50, the total exercise price of the warrant. The sale was made pursuant
to Section 4(2) of the Securities Act of 1933, as amended, as it was made to a
single sophisticated accredited investor in a private transaction not involving
a public offering.
(d) Use of Proceeds from Sales of Registered Securities.
On May 11, 1999, the Company completed an initial public offering of its Common
Stock, $0.001 par value. The managing underwriters in the offering were Goldman,
Sachs & Co., Credit Suisse First Boston, BancBoston Robertson Stephens and
Hambrecht & Quist (the "Underwriters"). The shares of Common Stock sold in the
offering were registered under the Securities Act of 1933, as amended, on a
Registration Statement on Form S-1 (the "Registration Statement") (Reg. No. 333-
72999) that was declared effective by the SEC on May 5, 1999. The offering
commenced on May 6, 1999 after all 4,600,000 shares of Common Stock registered
under the Registration Statement, including shares covered by an overallotment
option that was exercised, were sold at a price to the public of $14.00 per
share. The aggregate offering amount registered was $64,400,000. In connection
with the offering, the Company paid an aggregate of $4,508,000 in underwriting
discounts to the Underwriters. In addition, the following table sets forth an
estimate of all expenses incurred in connection with the offering, other than
underwriting discounts. All amounts shown are estimated except for the
registration fees of the SEC and the National Association of Securities Dealers,
Inc. ("NASD").
SEC Registration Fee $ 19,600
NASD Filing Fee 7,500
Nasdaq National Market Listing Fee 17,500
Printing and Engraving Expenses 200,000
Legal Fees and Expenses 500,000
Accounting Fees and Expenses 350,000
Blue Sky Fees and Expenses 1,000
32
<PAGE>
Transfer Agent Fees 12,000
Miscellaneous 142,400
----------
Total $1,250,000
After deducting the underwriting discounts and the estimated offering expenses
described above, the Company received net proceeds from the offering of
approximately $58,642,000. Of the net proceeds, the Company has used
approximately $2,846,000 for general corporate purposes, including working
capital and capital expenditures. Additionally, a portion of the net proceeds
were used to repay long-term debt and and line of credit obligations of
$5,122,000 and capital lease obligations of $200,000. The remaining $50,474,000
of the net proceeds are expected to be used for general corporate purposes,
including working capital, capital expenditures and product development. A
portion of the net proceeds may also be used to acquire or invest in
complementary business or products or to obtain the right to use complementary
technologies. The Company has no agreements or commitments with respect to any
such acquisition or investments and the Company is not currently engaged in any
material negotiations with respect to any such transaction. The amounts actually
expended for such purposes may vary significantly and will depend on a number of
factors, including the Company's future revenues and cash generated by
operations and the other factors described under "Factors That May Affect Future
Results". Accordingly, the Company retains broad discretion in the allocation of
the net proceeds of the offering. A portion of the net proceeds may also be used
to acquire or invest in complementary businesses, technologies or product
offerings; however, there are no current material agreements or commitments with
respect to any such activities.
None of the Company's net proceeds of the offering were paid directly or
indirectly to any director, officer, general partner of the Company or their
associates, persons owning 10% or more of any class of equity securities of the
Company, or an affiliate of the Company.
ITEM 6: EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
27 Financial Data Schedule
(b) Reports on Form 8-K:
No Form 8-K reports were filed during the quarter ended October 31,
1999.
33
<PAGE>
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.
December 14, 1999 PORTAL SOFTWARE, INC.
By /s/ JACK L. ACOSTA
-----------------------------
Jack L. Acosta
Vice President
and Chief Financial Officer
(Principal Financial Officer)
34
<PAGE>
EXHIBIT INDEX TO PORTAL SOFTWARE, INC.
QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTER ENDED OCTOBER 31, 1999
Exhibit Number Description
- -------------- -----------
27 Financial Data Schedule
35
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