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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended November 30, 1999
Commission File Number 000-26565
LIBERATE TECHNOLOGIES
(Exact name of registrant as specified in its charter)
Delaware 94-3245315
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
2 Circle Star Way, San Carlos, California 94070-6200
(Address of principal executive office) (Zip Code)
(650) 701-4000
(Registrant's telephone number, including area code)
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 [ ]
83,603,312 * shares of the Registrant's common stock were outstanding
as of December 31, 1999.
- --------------------------------------------------------------------------------
* SHARE AMOUNTS SHOWN HAVE BEEN RETROACTIVELY RESTATED TO GIVE EFFECT TO A
TWO-FOR-ONE STOCK SPLIT DECLARED ON DECEMBER 21, 1999, WHICH WILL BE EFFECTIVE
AFTER JANUARY 14, 2000.
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LIBERATE TECHNOLOGIES
FORM 10-Q
For The Quarter Ended November 30, 1999
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PART I. FINANCIAL INFORMATION Page
----
<S> <C>
Item 1. Financial Statements
Condensed Consolidated Balance Sheets at November 30, 1999
and May 31, 1999............................................................... 1
Condensed Consolidated Statements of Operations and Comprehensive Loss
for the Three Months and Six Months Ended November 30, 1999 and 1998........... 2
Condensed Consolidated Statements of Cash Flows for the Six Months Ended
November 30, 1999 and 1998..................................................... 3
Notes to Condensed Consolidated Financial Statements............................... 4
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations............................................ 8
Item 3. Quantitative and Qualitative Disclosure About Market Risk........................... 27
PART II. OTHER INFORMATION
Item 1. Legal Proceedings................................................................... 28
Item 2. Changes in Securities and Use of Proceeds........................................... 28
Item 3. Defaults in Securities.............................................................. 29
Item 5. Other Information................................................................... 29
Item 6. Exhibits and Reports on Form 8-K.................................................... 29
Signature................................................................................... 30
</TABLE>
<PAGE>
Part I. Financial Information
Item 1. Financial Statements
LIBERATE TECHNOLOGIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands)
Unaudited
<TABLE>
<CAPTION>
November 30, May 31,
1999 1999
----------- -----------
<S> <C> <C>
ASSETS
CURRENT ASSETS
Cash and cash equivalents .................... $ 40,947 $ 33,657
Short-term investments ....................... 84,829 19,751
Accounts receivable, net ..................... 2,031 644
Receivable from affiliate, net ............... 753 482
Prepaid warrants ............................. 2,600 1,504
Prepaid expenses and other current assets .... 3,061 1,911
--------- ---------
Total current assets ....................... 134,221 57,949
Property and equipment, net ..................... 6,106 2,269
OTHER ASSETS
Advanced royalties ........................... 676 279
Purchased intangibles, net ................... 4,563 7,606
Restricted cash .............................. 8,788 --
Other ........................................ 79 79
--------- ---------
Total assets ............................. $ 154,433 $ 68,182
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable ............................. $ 1,316 $ 1,643
Accrued payroll and related expenses ......... 2,639 2,248
Accrued liabilities .......................... 9,766 8,911
Short-term portion of capital leases ......... 239 --
Note payable to affiliate .................... 52 52
Deferred revenues ............................ 34,350 38,787
--------- ---------
Total current liabilities ................ 48,362 51,641
Long-term portion of capital leases ............. 486 --
Long-term debt .................................. -- 4,315
COMMITMENTS AND CONTINGENCIES (NOTE 5)
STOCKHOLDERS' EQUITY
Convertible preferred stock .................. -- 330
Common stock ................................. 836 12
Contributed and paid-in capital .............. 282,885 166,973
Deferred stock compensation .................. (6,858) (6,579)
Warrants ..................................... 3,687 1,522
Stockholder notes receivable ................. (198) (348)
Accumulated other comprehensive income ....... (25) 28
Accumulated deficit .......................... (174,742) (149,712)
--------- ---------
Total stockholders' equity ............... 105,585 12,226
--------- ---------
Total liabilities and stockholders' equity $ 154,433 $ 68,182
========= =========
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS. COMMON STOCK AND CONTRIBUTED AND PAID-IN CAPITAL HAVE BEEN
RETROACTIVELY RESTATED TO GIVE EFFECT TO A TWO-FOR-ONE STOCK SPLIT DECLARED ON
DECEMBER 21, 1999, WHICH WILL BE EFFECTIVE AFTER JANUARY 14, 2000.
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LIBERATE TECHNOLOGIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE LOSS
(in thousands, except per share data)
Unaudited
<TABLE>
<CAPTION>
Three months ended Six months ended
November 30, November 30,
--------------------------- ---------------------------
1999 1998 1999 1998
------------- ------------- ------------ --------------
<S> <C> <C> <C> <C>
REVENUES
License and royalty ............................ $ 2,000 $ 1,398 $ 3,482 $ 2,537
Service ........................................ 4,074 3,003 7,880 5,172
-------- -------- -------- --------
Total revenues ............................... 6,074 4,401 11,362 7,709
-------- -------- -------- --------
COST OF REVENUES
License and royalty ............................ 586 716 1,108 1,316
Service ........................................ 5,131 1,672 10,693 2,871
-------- -------- -------- --------
Total cost of revenues ....................... 5,717 2,388 11,801 4,187
-------- -------- -------- --------
Gross margin ................................. 357 2,013 (439) 3,522
-------- -------- -------- --------
OPERATING EXPENSES
Research and development ....................... 6,300 4,014 11,642 8,055
Sales and marketing ............................ 3,702 3,258 6,918 5,403
General and administrative ..................... 1,756 794 3,180 1,608
Amortization of purchased intangibles .......... 1,521 1,521 3,042 3,042
Amortization of warrants ....................... 710 -- 1,069 --
Amortization of deferred stock compensation .... 525 104 1,029 111
-------- -------- -------- --------
Total operating expenses ..................... 14,514 9,691 26,880 18,219
-------- -------- -------- --------
Loss from operations ......................... (14,157) (7,678) (27,319) (14,697)
Interest and other income, net .................... 1,641 68 2,338 149
-------- -------- -------- --------
Loss before income tax (provision) benefit ... (12,516) (7,610) (24,981) (14,548)
Income tax (provision) benefit .................... (8) 287 (49) 558
-------- -------- -------- --------
Net loss ..................................... (12,524) (7,323) (25,030) (13,990)
Foreign currency translation adjustment ........... (38) (1) (53) (1)
-------- -------- -------- --------
Comprehensive loss ........................... $(12,562) $ (7,324) $(25,083) $(13,991)
======== ======== ======== ========
Basic and diluted net loss per share .............. $ (0.15) $ (15.38) $ (0.46) $ (30.81)
======== ======== ======== ========
Shares used in computing basic and diluted net loss
per share ...................................... 83,204 476 54,780 454
======== ======== ======== ========
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS. BASIC AND DILUTED NET LOSS PER SHARE AND SHARES USED IN
COMPUTING BASIC AND DILUTED NET LOSS PER SHARE HAVE BEEN RETROACTIVELY RESTATED
TO GIVE EFFECT TO A TWO-FOR-ONE STOCK SPLIT DECLARED ON DECEMBER 21, 1999, WHICH
WILL BE EFFECTIVE AFTER JANUARY 14, 2000.
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LIBERATE TECHNOLOGIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
Unaudited
<TABLE>
<CAPTION>
Six months ended
November 30,
----------------------------
1999 1998
------------ ------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss ............................................................... $ (25,030) $ (13,990)
Adjustment to reconcile net loss to net cash used in operating activities
Depreciation and amortization ........................................ 3,868 3,693
Amortization of warrants ............................................. 1,069 --
Provision for doubtful accounts ...................................... 203 180
Loss on disposal of property and equipment ........................... 600 --
Non-cash compensation expense ........................................ 1,029 111
Changes in operating assets and liabilities
Increase in accounts receivable .................................... (1,590) (338)
Increase in receivable from affiliate, net ......................... (271) (1,378)
Increase in prepaid expenses and other current assets .............. (1,150) (209)
(Increase) decrease in other assets ................................ (397) 118
Increase in restricted cash ........................................ (8,788) --
Decrease in accounts payable ....................................... (327) (158)
Increase in accrued liabilities .................................... 855 1,195
Increase (decrease) in accrued payroll and related expenses ........ 391 (575)
Increase (decrease) in deferred revenues ........................... (4,437) 4,855
Increase in interest payable ....................................... -- 100
--------- ---------
Net cash used in operating activities ............................ (33,975) (6,396)
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of property and equipment .................................... (4,474) (455)
Purchase of short-term investments ..................................... (65,078) --
--------- ---------
Net cash used in investing activities ........................... (69,552) (455)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from initial public offering, net ............................. 97,970 --
Proceeds from private placement, net ................................... 12,125 --
Proceeds from exercise of stock options ................................ 838 85
Principal payments on capital lease obligations ........................ (63) --
--------- ---------
Net cash provided by financing activities ........................ 110,870 85
--------- ---------
Effect of exchange rates on cash .......................................... (53) (1)
--------- ---------
Net increase (decrease) in cash and cash equivalents ...................... 7,290 (6,767)
Cash and cash equivalents, beginning of period ............................ 33,657 12,138
--------- ---------
Cash and cash equivalents, end of period ........................ $ 40,947 $ 5,371
========= =========
SUPPLEMENTAL NON-CASH ACTIVITIES
Conversion of debt and accrued interest to equity ...................... $ 4,343 $ --
========= =========
Issuance of warrants for common stock in connection with network
operator agreements ................................................... $ 2,165 $ --
========= =========
Deferred stock compensation ............................................ $ 1,307 $ 2,530
========= =========
Stockholder notes receivable ........................................... $ 23 $ 5
========= =========
Equipment under capital leases ......................................... $ 788 $ --
========= =========
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS.
3
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LIBERATE TECHNOLOGIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Unaudited
NOTE 1. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements
include the accounts of Liberate Technologies ("Liberate" or "the Company") and
its wholly owned subsidiary. All intercompany accounts and transactions have
been eliminated. These financial statements have been prepared by Liberate,
without audit, and reflect all adjustments, which in the opinion of management
are necessary to present fairly the financial position and the results of
operation for the interim periods. These financial statements have been prepared
in accordance with the rules and regulations of the Securities and Exchange
Commission. However, they omit certain information and footnote disclosures
necessary to conform to generally accepted accounting principles. These
statements should be read in conjunction with the audited consolidated financial
statements and notes to consolidated financial statements included in Liberate's
Form S-1/A and subsequent reports on Form 10-Q filed with the Securities and
Exchange Commission since July 27, 1999. 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.
NOTE 2. OFFERINGS OF COMMON STOCK
On August 2, 1999, Liberate completed an initial public offering in
which it sold 12,500,000 shares of common stock at $8 per share. Liberate sold
an additional 902,100 shares of common stock at $8 per share related to the
exercise of the underwriters' overallotment. The total aggregate proceeds from
these transactions were $107.2 million. Underwriters' discounts and other
related costs were $9.2 million, resulting in net proceeds of $98.0 million. The
net proceeds were predominately held in cash equivalents, short-term investments
and restricted cash at November 30, 1999. Shortly before the offering, Liberate
recorded a one-for-six reverse stock split of its outstanding preferred and
common stock. Upon the close of the offering, all of Liberate's preferred stock,
par value $0.01 per share, automatically converted into 66,178,670 shares of
common stock. Immediately following the closing of the offering, Liberate sold
1,627,604 shares of common stock in a private placement to Lucent Technologies
for an aggregate of $12.1 million. In addition, following the closing of the
offering, the Company issued 843,880 shares of common stock to Middlefield
Ventures, an affiliate of Intel, in connection with the cancellation of a
convertible promissory note in the amount of $4.0 million payable by Liberate to
Middlefield. Related to this transaction, the accrued interest on the
convertible promissory note was charged to additional paid-in capital. During
the six months ended November 30, 1999, the Company issued 520,528 shares of
common stock to employees, external consultants and other service providers for
the exercise of stock options.
NOTE 3. SEGMENT INFORMATION
In June 1997, the Financial Accounting Standards Board issued SFAS No.
131, "Disclosures about Segments of an Enterprise and Related Information." SFAS
131 changes the way companies report selected segment information in annual
financial statements and requires companies to report selected segment
information in interim financial reports to stockholders. SFAS 131 was effective
for the Company's year ending May 31, 1999. The Company operates solely in one
segment -- the development, manufacturing and sale of information appliance
software for consumer, corporate and educational marketplaces. As of November
30, 1999, the Company's long-term assets were located primarily in the United
States.
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The Company's revenues by geographic area are as follows:
<TABLE>
<CAPTION>
Three months ended Six months ended
November 30, November 30,
-------------------------- --------------------------
(IN THOUSANDS) 1999 1998 1999 1998
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
United States....................... $3,122 $1,779 $ 5,904 $3,467
Japan............................... 1,015 1,473 1,812 2,255
England............................. 1,207 485 2,167 852
Canada.............................. 293 83 346 443
Other............................... 437 581 1,133 692
------------ ------------ ------------ ------------
Total revenues...................... $6,074 $4,401 $11,362 $7,709
============ ============ ============ ============
</TABLE>
International revenues consist of sales to customers incorporated in
foreign countries. International revenues were 49% and 60% of total revenues for
each of the three months ended November 30, 1999 and 1998. For each of the six
months ended November 30, 1999 and 1998 international revenues were 48% and 55%
of total revenues.
NOTE 4. CALCULATION OF NET LOSS PER SHARE
Shares used in computing basic and diluted net loss per share are based
on the weighted average shares outstanding in each period. The effect of
outstanding stock options and warrants are excluded from the calculation of
diluted net loss per share, as their inclusion would be antidilutive. Previously
issued preferred stock, which converted to common stock, is weighted from the
time the shares were converted. At November 30, 1999, options to purchase
14,324,842 shares of common stock and warrants to purchase 749,998 shares of
common stock were outstanding and were excluded from the calculation of net loss
per share.
<TABLE>
<CAPTION>
Three months ended Six months ended
November 30, November 30,
----------------------- -----------------------
(IN THOUSANDS, EXCEPT PER SHARE DATA) 1999 1998 1999 1998
----------- ----------- ---------- -----------
<S> <C> <C> <C> <C>
Net loss.................................... $(12,524) $(7,323) $(25,030) $(13,990)
=========== =========== ========== ===========
Weighted average shares of
common stock outstanding.................. 83,204 476 54,780 454
=========== =========== ========== ===========
Basic and diluted net loss per share........ $ (0.15) $(15.38) $ (0.46) $ (30.81)
=========== =========== ========== ===========
</TABLE>
NOTE 5. COMMITMENTS AND CONTINGENCIES
CAPITAL LEASES. In August 1999, the Company signed a master lease
agreement for office furniture. In October 1999, the Company initiated the
master agreement by leasing certain furniture and equipment under a
non-cancelable three-year lease agreement. This agreement is accounted for as a
capital lease and is secured by the related furniture and equipment. The Company
is required to maintain liability and property damage insurance for the leased
assets. As of November 30, 1999, furniture and equipment totaling $788,000 has
been recorded as leased property and equipment and accumulated amortization of
approximately $44,000 is included in depreciation expense.
COMMITMENTS. In April 1999, Liberate and General Instrument entered
into a manufacturer's agreement whereby General Instrument will develop hardware
using Liberate's software. Under the manufacturer's agreement, Liberate will pay
General Instrument $10.0 million for development over a three-year period.
Amounts expensed under this agreement were approximately $960,000 and $1.8
million for the three months and six months ended November 30, 1999.
During the first quarter of fiscal 2000, the Company signed an
amendment to the Technology License and Distribution Agreement with Sun
Microsystems. This amendment called for Liberate to pay
5
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certain minimum royalties in exchange for the right to certain Sun technology
and to maintain the status as a preferred vendor of Sun. Minimum guaranteed
royalties of approximately $3.8 million are to be paid to Sun through the period
ended December 31, 2004. Approximately $225,000 of expense related to this
contract was recorded for the six months ended November 30, 1999.
The Company previously leased its headquarters, furniture and equipment
from Oracle. By mutual consent, the Company's Redwood Shores, California office
lease, furniture and equipment lease and service agreement was terminated
without penalty in September 1999.
In September 1999, the Company relocated their headquarters to a new
facility of approximately 78,000 square feet in San Carlos, California. The
lease provides for monthly rent payments of approximately $202,000 with annual
increases of three percent and terminates in February 2010. Over the term of the
lease, total payments will be approximately $35.5 million. At the lease signing,
Oracle Corporation provided a $10.0 million guarantee to the Company's landlord.
Oracle's guarantee was subsequently replaced with a security deposit provided by
Liberate in the form of an Irrevocable Letter of Credit for approximately $2.5
million. The letter of credit is secured by a Certificate of Deposit in an
amount equal to the letter of credit.
Simultaneous with the relocation, Liberate exercised its option to
lease additional space of approximately 103,000 square feet in a building under
construction on an adjacent property. The initial monthly rent will be
approximately $268,000, with annual increases of three percent. Over the term of
the lease for this new facility, total payments are expected to be approximately
$45.3 million. The lease will end ten years from the date of occupancy, which is
estimated to be in the first quarter of calendar 2000. The Company's security
deposit increased to $8.8 million for both buildings and is provided for in the
form of an Irrevocable Letter of Credit for the same amount. This letter of
credit is secured by Certificates of Deposit in amounts equal to the letter of
credit.
LITIGATION. In December 1998, one of our former employees filed an
action in the California Superior Court for the County of San Mateo against
us for, among other things, unpaid commissions of approximately $1.5 million,
constructive employment termination, intentional misrepresentation and
negligent misrepresentation. In October 1999, the plaintiff amended his
complaint against us, adding claims for damages for failure to pay wages
under the California Labor Code and common law retaliation, and sought to
impose a constructive trust on the allegedly withheld commissions and any
enhancement in value of that money. We have conducted extensive discovery on
these claims, which we believe to be without merit. In December 1999, we
filed a motion for summary judgment/summary adjudication to dismiss all of
the claims brought by the plaintiff. In January 2000, the Court dismissed
eight of the ten claims brought against us leaving only the claims of
intentional and negligent misrepresentation for trial. We continue to believe
that these claims are without merit and that we have strong defenses to them.
We intend to continue to vigorously defend this action as to the remaining
claims.
NOTE 6. SUBSEQUENT EVENTS
WARRANTS. In April and May 1999, the Company entered into agreements
with several network operators that require Liberate to issue warrants to
purchase up to an aggregate of 4,599,992 shares of common stock if those
network operators satisfy commercial milestones. In December 1999, warrants
to purchase 866,664 shares of common stock at $6.90 per share were issued to
two network operators under the terms of those agreements in connection with
prepaid royalty fees. The fair market value of these warrants is
approximately $100.0 million. Of these warrants, 466,664 warrants are fully
vested with the remaining warrants vesting as these network operators satisfy
certain commercial milestones, but no later than May 31, 2003. A portion of
these fully-vested warrants, valued at approximately $27.5 million, were
exercised in January 2000.
STOCK SPLIT. On December 21, 1999, the Company announced a
two-for-one stock split in the form of a stock dividend, effective after
January 14, 2000. The stock split will increase the number of shares of
Liberate's common stock outstanding to approximately 83,600,000 shares. All
share and per share amounts
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related to common stock, stock options and warrants herein have been restated to
reflect the effects of this split.
SUBLEASES. In December 1999, the Company signed an
agreement with a third party to sublease approximately 27,000 square feet in
the Company's headquarters building located in San Carlos, California. The
sublease is for 18 months and is estimated to begin upon completion of
the building construction in March 2000. This contract is pending final
approval of Liberate's landlord.
ACQUISITIONS. In January 2000, the Company entered into a Merger
Agreement and Plan of Reorganization to acquire via merger certain assets and
technology of SourceSuite LLC for approximately 1,772,000 shares of
Liberate's common stock. These shares have been retroactively restated to
give effect to a two-for-one stock split declared on December 21, 1999, which
will be effective after January 14, 2000. The acquisition will be accounted
for as a purchase. As a part of this transaction, the Company would hire
certain employees who provide services to SourceSuite. Also in connection
with the acquisition, the Company expects to write off between $2.0 million
and $4.0 million of acquired in-process research and development, which in
the opinion of management, had not reached technological feasibility and had
no alternative future use. The Company expects to record goodwill and other
intangibles of between $175.0 million to $200.0 million to be amortized over
an estimated economic life of 36 months.
In connection with this acquisition, the Company has agreed to enter
into a Preferred Content Provider Agreement with a subsidiary of Source Media
and Insight Communications. The Company will use commercially reasonable
efforts to introduce the subsidiary's products to the Company's multiple
network operator customers using the technology purchased pursuant to the
Agreement and Plan of Reorganization. In addition, various incentive credits
are provided to both parties if the network operators select the subsidiary's
products. The Company has also agreed to a Programming Services Agreement
with the subsidiary where the Company would continue to develop certain
products for the subsidiary.
OTHER. In January 2000, negotiations involving Liberate's proposed
acquisition of another company terminated. Expenses related to this
terminated acquisition are currently estimated to range from approximately
$700,000 to $1.3 million and will be recorded in the third quarter of fiscal
2000.
7
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Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
This document contains forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933, as amended, and Section 23E of the
Securities Act of 1934, as amended. These statements relate to future events or
our future financial performance. Any statements contained in this document that
are not statements of historical fact may be deemed to be forward-looking
statements. In some cases, you can identify forward-looking statements by
terminology such as "may," "will," "should," "expect," "plan," "anticipate,"
"intend," "believe," "estimate," "predict," "potential" or "continue," or the
negative of such terms or other comparable terminology. These statements are
only predictions. Actual events or results may differ materially.
Although we believe that the expectations reflected in the
forward-looking statements are reasonable, we cannot guarantee future results,
levels of activity, performance or achievements. Moreover, neither we, nor any
other person, assume responsibility for the accuracy and completeness of the
forward-looking statements. We are under no obligation to update any of the
forward-looking statements after the filing of this Form 10-Q to conform such
statements to actual results or to changes in our expectations.
The following discussion should be read in conjunction with our
financial statements, related notes and the other financial information
appearing elsewhere in this Form 10-Q. Readers are also urged to carefully
review and consider the various disclosures made by us which attempt to advise
interested parties of the factors which affect our business, including without
limitation, the disclosures made under the caption "Risk Factors," and the
factors and risks discussed in our Registration Statement on Form S-1/A and
subsequent reports on Form 10-Q filed with the Securities and Exchange
Commission since July 27, 1999.
OVERVIEW
Liberate is a leading provider of software for delivering enhanced
Internet content, services and applications to information appliances, such as
television set-top boxes and game consoles. Our Internet-based client and server
software allows network operators, such as telecommunications companies, cable
and satellite television operators and Internet service providers to provide
consumers with access to network operator-branded applications and services. We
began operations as a division of Oracle in December 1995 to develop server and
client software for the consumer, corporate and educational markets. In April
1996 we were incorporated in Delaware. In August 1997, we acquired Navio
Communications, a development-stage company involved in designing Internet
application and server software for the consumer market.
We began shipping our initial products and generating revenues in the
last quarter of fiscal 1997. We generate revenues by licensing our server and
client products and providing related services to network operators and
information appliance manufacturers. Network operators generally pay up-front
license fees for our server software. We recognize server license revenues upon
final delivery of the licensed product, when collection is probable and when the
fair market value and the fee for each element of the transaction are fixed and
determinable. We also generate service revenues from maintenance provided in
connection with server licenses. Maintenance fees typically represent a
percentage of associated license fees.
We license our client software and provide related services to both
network operators and information appliance manufacturers. Information appliance
manufacturers pay us royalties on a per unit basis. Typically, we recognize
these royalty fees upon shipment of the device by the manufacturer. Network
operators also pay per-subscriber royalty fees when information appliance owners
activate the operators' service. Generally, network operators pay these royalty
fees upon activation, either in the form of an up-front payment or on a
subscription basis. Up-front royalty fees are recognized when a network operator
reports to us that a user has activated the service. These network operators pay
an additional per-subscriber maintenance fee typically on an annual basis for
the duration of the activation period. Subscription-based royalty fees are
recognized quarterly when reported by the network operators. A portion of this
subscription-based royalty fee is allocated to service revenues as maintenance
and is also recognized quarterly.
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In addition to the maintenance services we offer with our software
licenses, which include upgrades and technical support, we also provide
comprehensive consulting, engineering and training services to network operators
and information appliance manufacturers. Revenues generated from these services
generally are recognized as the services are performed while maintenance fees
are recognized ratably over the term of the maintenance contract.
Deferred revenues consist primarily of payments received from customers
for prepaid license and royalty fees and prepaid services for undelivered
product and services. Deferred revenues decreased from $38.8 million at May 31,
1999, to $34.4 million at November 30, 1999. This decrease resulted primarily
from recognition of previously deferred revenue, as well as a conscious effort
to de-emphasize customer prepayments of future licenses and royalties.
For both the three months and six months ended November 30, 1999, two
customers each provided for 10% or more of our total revenues - Wind River and
Cable & Wireless. For the three months ended November 30, 1998, four customers
each provided over 10% or more of our total revenues - Wind River, NEC, Nintendo
and NTL. For the six months ended November 30, 1998, Wind River and Nintendo
each provided for 10% or more of our total revenues.
International revenues accounted for approximately 49% and 60% of our
total revenues for the three months ended November 30, 1999 and 1998. For the
six months ended November 30, 1999 and 1998, international revenues accounted
for approximately 48% and 55% of our total revenues. We anticipate international
revenues to continue to represent a significant portion of total revenues.
In January 2000, we entered into a Merger Agreement and Plan of
Reorganization to acquire via merger certain assets and technology of
SourceSuite LLC for approximately 1,772,000 shares of our common stock. These
shares have been retroactively restated to give effect to a two-for-one stock
split declared on December 21, 1999, which will be effective after January
14, 2000. The acquisition will be accounted for as a purchase. As part of
this transaction, Liberate would hire certain employees who provide services
to SourceSuite. Also in connection with the acquisition, we expect to write
off between $2.0 million and $4.0 million of acquired in-process research and
development, which in the opinion of our management, had not reached
technological feasibility and had no alternative future use. We also expect
to record goodwill and other intangibles of between $175.0 million to $200.0
million to be amortized over an estimated economic life of 36 months.
In January 2000, negotiations involving our proposed acquisition of
another company terminated. Expenses related to this terminated acquisition
are currently expected to range from approximately $700,000 to $1.3 million
and will be recorded in the third quarter of fiscal 2000.
On December 21, 1999, we announced a two-for-one stock split in the
form of a stock dividend, effective after January 14, 2000. The stock split
will increase the number of shares of our common stock outstanding to
approximately 83,600,000 shares. All share and per share amounts related to
common stock, stock options and warrants herein have been restated to reflect
the effects of this split.
9
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RESULTS OF OPERATIONS
THREE MONTHS ENDED NOVEMBER 30, 1999 AND 1998.
REVENUES
Total revenues were approximately $6.1 million for the three months
ended November 30, 1999, an increase of $1.7 million or 38%, compared to
approximately $4.4 million for the same three months ended November 30, 1998.
License and royalty revenues grew approximately $602,000 or 43% in the
second quarter of fiscal 2000 to $2.0 million. This increase was primarily
related to increased royalty revenues reflecting an increase in our customer
base, including certain customers entering the trial and deployment phases.
License and royalty revenues comprised 33% of total revenues in the second
quarter of fiscal 2000 compared to 32% in fiscal 1999.
Service revenues grew approximately $1.1 million or 36%, to $4.1
million for the three months ended November 30, 1999, as a direct result of the
continued expansion of our professional services organization created in the
beginning of fiscal 1999. Also contributing to the growth in service revenues
was the overall increases in both maintenance fees and the level of billable
custom development projects. Service revenues comprised 67% of total revenues in
the second quarter of fiscal 2000, compared to 68% in the second quarter of
fiscal 1999.
COST OF REVENUES
Total cost of revenues was approximately $5.7 million and $2.4 million
for the three months ended November 30, 1999 and 1998, representing 94% and 54%
of total revenues in each of the three-month periods. We anticipate that total
cost of revenues will increase in absolute dollars in future periods as we
provide continued services to support customer implementations and as we
experience higher third party license costs as deployments increase.
Cost of license and royalty revenues consists primarily of license
and support fees paid to third parties for technology incorporated into our
products. Cost of license and royalty revenues decreased approximately
$130,000 or 18% to $586,000 in the second quarter of fiscal 2000, primarily
due to the full amortization of certain prepaid inbound licenses. In the
second quarter of fiscal 2000 and fiscal 1999, cost of license and royalty
revenues was 29% and 51% of license and royalty revenues. We anticipate cost
as a percentage of related revenues will fluctuate in future periods, but
follow an overall decreasing trend. Amortization of certain third party costs
will have the effect of decreasing costs as a percentage of related revenues
as these revenues increase. However, introduction of new third party
technology may offset the effect of the amortized costs or increase cost as a
percentage of related revenues.
Cost of service revenues consists of employee compensation and related
overhead, as well as payments to external consultants. Cost of service revenues
increased approximately $3.5 million or 207%, to $5.1 million for the three
months ended November 30, 1999. The increase in cost of service revenues was
primarily due to the expansion of the professional service organization, as well
as an increase in the level of billable custom development projects, which were
necessary to meet the growth in customer installation, training and deployment
of our products. We expect cost of service revenues to continue to increase in
absolute dollars to the extent existing and new customers install and deploy our
products. For the second quarter of fiscal 2000 and fiscal 1999, cost of service
revenues was 126% and 56% of service revenues. The increase in cost as a
percentage of related revenues was a result of our continued investment in this
portion of our business. We expect cost of service revenues to increase in
absolute dollars to the extent existing and new customers install and deploy our
products. We also expect the cost of service revenues as a percentage of service
revenues to fluctuate in future periods. These costs may increase in the
near-term due to continued expansion of services as existing and new customers
install and deploy our products and we continue to provide and support limited
trial installations of our products at discounted prices to network operators in
order to continue to increase our market share.
10
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RESEARCH AND DEVELOPMENT EXPENSES
Research and development expenses consist primarily of salary and other
related costs for personnel and external consultants, as well as costs related
to outsourced development projects to support product development. Research and
development expenses increased approximately $2.3 million or 57%, to $6.3
million for the three months ended November 30, 1999. The increase is primarily
due to an increase in staffing and related expenses, as well as more outsourced
development projects, in particular a project with General Instrument. This was
offset by an increase in the level of custom development projects, which when
billable to customers, the related costs are classified as cost of service
revenues. The classification of costs between research and development and cost
of service revenues may fluctuate between categories depending on the level of
projects that are billable at any point in time. Research and development
expenses were 104% and 91% of total revenues for the second quarter of fiscal
2000 and fiscal 1999. We believe that continued investment in research and
development is critical to attaining our strategic objectives. Consequently, we
expect research and development expenses to increase significantly in absolute
dollars in future periods. However, over the long-term as revenues increase, we
anticipate that research and development expenses as a percentage of total
revenues will decline.
SALES AND MARKETING EXPENSES
Sales and marketing expenses consist primarily of salaries and other
related costs for sales and marketing personnel, sales commissions, travel,
facilities for regional offices, public relations, marketing materials and
tradeshows. Sales and marketing expenses increased approximately $444,000 or 14%
to $3.7 million in the second quarter of fiscal 2000. The increase in sales and
marketing expenses was primarily due to the growth in salary and related
personnel costs, including travel and facilities, offset by a decrease in
commissions. Sales and marketing expenses were 61% and 74% of total revenues for
the second quarter of fiscal 2000 and fiscal 1999. We believe sales and
marketing expenses will increase in absolute dollars in future periods as we
expand our direct sales and marketing efforts domestically and abroad. However,
over the long term, as revenues increase, we anticipate that these costs will
generally continue to decrease as a percentage of total revenues.
GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative expenses consist primarily of salaries and
other related costs for legal, corporate development, human resource and finance
employees, as well as legal and other professional fees. General and
administrative expenses increased approximately $962,000 or 121%, to $1.8
million for the second quarter of fiscal 2000. The increase was primarily due to
increased staffing, including the formation of our corporate development
organization, as well as increased spending for legal and accounting services.
In the second quarter of fiscal 2000, we also began to incur expenses
attributable to being a public company. General and administrative expenses were
29% and 18% of total revenues for the second quarter of fiscal 2000 and fiscal
1999. We believe these expenses will increase in absolute dollars as we continue
to add personnel to support our expanding operations and assume the
responsibilities of a public company. However, over the long term, as revenues
increase we anticipate that these costs will generally begin to decrease as a
percentage of total revenues.
AMORTIZATION OF PURCHASED INTANGIBLES
Purchased intangibles represent the purchase price of Navio in excess
of identified tangible and intangible assets and is amortized over three years.
In August 1997, we recorded approximately $18.3 million of purchased
intangibles, which is being amortized on a straight-line basis over an estimated
useful life of three years. We recorded $1.5 million of amortization expense in
both the second quarters of fiscal 2000 and fiscal 1999.
11
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AMORTIZATION OF DEFERRED STOCK COMPENSATION
Deferred stock compensation represents the difference between the
estimated fair value of our common stock for accounting purposes and the option
exercise price of such options at the grant date. In fiscal 1999, we began
recording deferred stock compensation for stock options granted to employees and
others. These amounts are amortized on a straight-line basis over the 48-month
vesting period of such options. Amortization of deferred stock compensation
increased to $525,000 in the second quarter of fiscal 2000, compared to $104,000
in fiscal 1999. The majority of the stock option grants being amortized were
granted in the latter half of fiscal 1999. We anticipate that deferred stock
compensation expense will remain relatively stable from quarter to quarter, with
decreases resulting from the effect of employee terminations. Beginning in
fiscal 2003, we expect deferred stock compensation expense to decrease ratably
from quarter to quarter through the first quarter of fiscal 2004.
AMORTIZATION OF WARRANTS
Warrant expense represents the amortization of warrants based on
their estimated fair value, as determined using the Black-Scholes model, at
the earlier of the grant date or the date it becomes probable that the
warrants will be earned. In accordance with the Emerging Issues Task Force
No. 96-18, certain warrants will continue to be revalued in situations where
they are granted before establishment of a performance commitment. In April
and May 1999, we entered into agreements with several network operators that
require us to issue warrants to purchase up to an aggregate of 4,599,992
shares of common stock if those network operators satisfy commercial
milestones. These warrants are expensed over their respective amortization
periods. No additional warrants to purchase common stock were recorded as
being earned in the three months ended November 30, 1999. Amortization
expense for the quarter ended November 30, 1999, was approximately $710,000
and no amortization expense was recorded during the three months ended
November 30, 1998. As of the end of the second fiscal quarter, approximately
$3.7 million of prepaid warrants have been recorded on the consolidated
balance sheet, net of accumulated amortization of $1.1 million. We expect
amortization expense for warrants to increase ratably as additional warrants
are earned.
INTEREST AND OTHER INCOME, NET
Net interest and other income includes interest income (net of
expenses) earned on Liberate's cash, cash equivalents and short-term
investments, as well as bank charges and losses on disposals of fixed assets.
Net interest and other income was $1.6 million in the second quarter of fiscal
2000, compared to $68,000 in the second quarter of fiscal 1999. Interest income
on proceeds from our private placement offerings in the last quarter of fiscal
1999 and initial public offering of common stock in the first half of fiscal
2000 was offset slightly by losses on disposals of fixed assets. We expect
interest income to decrease in the near-term.
INCOME TAX (PROVISION) BENEFIT
Income tax (provision) benefit includes income tax benefit and foreign
withholding tax expense. Income tax provision of approximately $8,000 for the
second quarter of fiscal 2000 consisted primarily of foreign withholding tax
expense for royalty revenue. Income tax benefit of approximately $287,000 for
the second quarter of fiscal 1999 was comprised of the benefits received under a
tax-sharing agreement with Oracle that provides for our consolidation into
Oracle's tax group for certain state income tax payment purposes. Upon the
effective date of our initial public offering, Oracle's ownership percentage was
reduced to less than 50% and, therefore, we are no longer included in any of
Oracle's consolidated state tax returns and will no longer receive a tax benefit
from Oracle.
12
<PAGE>
SIX MONTHS ENDED NOVEMBER 30, 1999 AND 1998.
REVENUES
Total revenues were approximately $11.4 million for the six months
ended November 30, 1999, an increase of $3.7 million or 47%, compared to
approximately $7.7 million for the six months ended November 30, 1998.
License and royalty revenues grew approximately $945,000 or 37% in the
first half of fiscal 2000 to $3.5 million. This increase was primarily related
to increased royalty revenues reflecting an increase in our customer base,
including certain customers entering the trial and deployment phases. License
and royalty revenues comprised 31% of total revenues in the first half of fiscal
2000, compared to 33% in the first half of fiscal 1999.
Service revenues grew approximately $2.7 million or 52% to $7.9 million
for the six months ended November 30, 1999, as a direct result of the continued
expansion of our professional services organization created in the beginning of
fiscal 1999. Also contributing to the growth in service revenues was the overall
increase in the level of billable custom-development projects. Service revenues
comprised 69% of total revenues in the first half of fiscal 2000, compared to
67% in the first half of fiscal 1999.
COST OF REVENUES
Total cost of revenues was approximately $11.8 million and $4.2 million
for the six months ended November 30, 1999 and 1998, representing 104% and 54%
of total revenues. We anticipate that total cost of revenues will increase in
absolute dollars in future periods as we provide continued services to support
customer implementations and as we experience higher third party license costs
as deployments increase.
Cost of license and royalty revenues consists primarily of license and
support fees paid to third parties for technology incorporated into our
products. Cost of license and royalty revenues decreased approximately $208,000
or 16% to $1.1 million for the first half of fiscal 2000, primarily due to the
full amortization of certain prepaid inbound licenses. For the first half of
fiscal 2000 and fiscal 1999, cost of license and royalty revenues was 32% and
52% of license and royalty revenues. We anticipate cost as a percentage of
related revenues will fluctuate in future periods, but follow an overall
decreasing trend. Amortization of certain third party costs will have the effect
of decreasing costs as a percentage of related revenues as these revenues
increase. However, introduction of new third party technology may offset the
effect of the amortized costs or increase cost as a percentage of related
revenues.
Cost of service revenues consists of employee compensation and related
overhead, as well as payments to external consultants. Cost of service revenues
increased approximately $7.8 million or 272% to $10.7 million in the first half
of fiscal 2000, compared to $2.9 million for the first half of fiscal 1999. This
increase in cost of service revenues was due primarily to the expansion of the
professional service organization, as well as an increase in the level of
billable custom development projects, which were necessary to meet the growth in
customer installation, training and deployment of our products. We expect cost
of service revenues to continue to increase in absolute dollars to the extent
existing and new customers install and deploy our products. For first half of
fiscal 2000 and fiscal 1999, cost of service revenues was 136% and 56% of
service revenues. The increase in cost as a percentage of related revenues was a
result of our continued investment in this portion of our business. We expect
cost of service revenues to increase in absolute dollars to the extent existing
and new customers install and deploy our products. We also expect the cost of
service revenues as a percentage of service revenues to fluctuate in future
periods. These costs may increase in the near-term due to continued expansion of
services as existing and new customers install and deploy our products and we
continue to provide and support limited trial installations of our products at
discounted prices to network operators in order to continue to increase our
market share.
13
<PAGE>
RESEARCH AND DEVELOPMENT EXPENSES
Research and development expenses consist primarily of salary and other
related costs for personnel and external consultants as well as costs related to
outsourced development projects to support product development. Research and
development expenses increased approximately $3.6 million or 45% to $11.6
million for the six months ended November 30, 1999. Increased staffing and
employee-related expenses and more outsourced development projects, in
particular a project with General Instrument, contributed to the increase in
expenses. This was offset by an increase in the level of custom development
projects, which when billable to customers, the related costs are classified as
cost of service revenues. The classification of costs between research and
development and cost of service revenues may fluctuate between categories
depending on the level of projects that are billable at any point in time.
Research and development expenses were 102% and 104% of total revenues for the
first half of fiscal 2000 and fiscal 1999. We believe that continued investment
in research and development is critical to attaining our strategic objectives.
Consequently, we expect research and development expenses to increase
significantly in absolute dollars in future periods. However, over the long-term
as revenues increase, we anticipate that research and development expenses as a
percentage of total revenues will decline.
SALES AND MARKETING EXPENSES
Sales and marketing expenses consist primarily of salaries and other
related costs for sales and marketing personnel, sales commissions, travel,
facilities for regional offices, public relations, marketing materials and
tradeshows. Sales and marketing expenses increased approximately $1.5 million or
28% to $6.9 million in the first half of fiscal 2000. Increased employee-related
expenses as well as marketing communications and professional recruitment
contributed to the majority of growth in expenses. These expenses were partially
offset by the decline in the use of external consultants. Sales and marketing
expenses were 61% and 70% of total revenues for the first half of fiscal 2000
and fiscal 1999. We believe sales and marketing expenses will increase in
absolute dollars in future periods as we expand our direct sales and marketing
efforts domestically and abroad. However, over the long term, as revenues
increase, we anticipate that these costs will generally continue to decrease as
a percentage of total revenues.
GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative expenses consist primarily of salaries and
other related costs for legal, corporate development, human resource and finance
employees, as well as legal and other professional fees. General and
administrative expenses increased approximately $1.6 million or 98% to $3.2
million for the first half of fiscal 2000. The increase was primarily due to
increased staffing, including the formation of our corporate development
organization, as well as increased spending for legal and accounting services.
In the first half of fiscal 2000 we also began to incur expenses attributable to
being a public company. To a lesser extent, the use of external consultants and
other outside professional services also contributed to the increase in expenses
for the first half of fiscal 2000. General and administrative expenses were 28%
and 21% of total revenues for the first half of fiscal 2000 and fiscal 1999. We
anticipate that general and administrative expenses will increase in absolute
dollars as we continue to add personnel to support our expanding operations and
assume the responsibilities of a public company. However, over the long term, as
revenues increase we believe that these costs will begin to decrease as a
percentage of total revenues.
AMORTIZATION OF PURCHASED INTANGIBLES
Purchased intangibles represent the purchase price of Navio in excess
of identified tangible and intangible assets and is amortized over three years.
In August 1997, we recorded approximately $18.3 million of purchased
intangibles, which is being amortized on a straight-line basis over an estimated
useful life of three years. We recorded approximately $3.0 million of
amortization expense for each of the six months ended November 30, 1999 and
1998.
14
<PAGE>
AMORTIZATION OF DEFERRED STOCK COMPENSATION
Deferred stock compensation represents the difference between the
estimated fair value of our common stock for accounting purposes and the option
exercise price of such options at the grant date. In fiscal 1999, we began
recording deferred stock compensation for stock options granted to employees and
others. These amounts are amortized on a straight-line basis over the 48-month
vesting period of such options. Amortization of deferred stock compensation was
approximately $1.0 million for the six months ended November 30, 1999, compared
to amortization of deferred stock compensation of $111,000 for the six months
ended November 30, 1998. The majority of the stock option grants being amortized
were granted in the latter half of fiscal 1999. As of November 30, 1999, we
recorded deferred stock compensation related to additional stock option grants
of approximately $1.3 million, net of terminations. We anticipate that deferred
stock compensation expense will remain relatively stable from year to year, with
decreases resulting from the effect of employee terminations. Beginning in
fiscal 2003, we expect deferred stock compensation expense to decrease ratably
from year to year through the first quarter of fiscal 2004.
AMORTIZATION OF WARRANTS
Warrant expense represents the amortization of warrants based on
their estimated fair value, as determined using the Black-Scholes model, at
the earlier of the grant date or the date it becomes probable that the
warrants will be earned. In accordance with the Emerging Issues Task Force
No. 96-18, the warrants will continue to be revalued in situations where they
are granted prior to establishment of a performance commitment. In April and
May 1999, we entered into agreements with several network operators that
require us to issue warrants to purchase up to an aggregate of 4,599,992
shares of common stock if the network operators satisfy commercial
milestones. As of November 30, 1999, we recorded warrants to purchase up to
749,998 shares of common stock as being earned by four network operators for
signing license agreements. These warrants are expensed over their
respective amortization periods. Amortization expense for the first six
months of fiscal 2000 was $1.1 million. No amortization expense was recorded
during the first six months of fiscal 1999. As of November 30, 1999,
approximately $3.7 million of prepaid warrants have been recorded on the
consolidated balance sheet, net of accumulated amortization of $1.1 million.
We expect amortization expense for warrants to increase ratably as additional
warrants are earned.
INTEREST AND OTHER INCOME, NET
Net interest and other income includes interest income (net of
expenses) on Liberate's cash, cash equivalents and short-term investments, as
well as bank charges and losses on disposals of fixed assets. Net interest and
other income increased from approximately $149,000 for the six months ended
November 30, 1998, to $2.3 million for the six months ended November 30, 1999.
Interest income on proceeds from our private placement offerings and initial
public offering of common stock in the first half of fiscal 2000 was offset
slightly by losses on disposals of fixed assets. We expect interest income to
decrease in the near-term.
INCOME TAX (PROVISION) BENEFIT
Income tax (provision) benefit includes income tax benefit and foreign
withholding tax expense. Income tax provision of approximately $49,000 for the
six months ended November 30, 1999, consisted primarily of foreign withholding
tax expense for royalty revenue. Income tax benefit of approximately $558,000
for the six months ended November 30, 1998 was comprised of the benefits
received under a tax-sharing agreement with Oracle that provides for our
consolidation into Oracle's tax group for certain state income tax payment
purposes. Upon the effective date of our initial public offering, Oracle's
ownership percentage was reduced to less than 50% and, therefore, we are no
longer included in any of Oracle's consolidated state tax returns and will no
longer receive a tax benefit from Oracle.
15
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LIQUIDITY AND CAPITAL RESOURCES
As of November 30, 1999, our principal source of liquidity was
approximately $125.8 million of cash, cash equivalents and short-term
investments. On August 2, 1999, Liberate completed an initial public offering in
which it sold 12,500,000 shares of common stock at $8 per share. Liberate sold
an additional 902,100 shares of common stock at $8 per share related to the
exercise of the underwriters' overallotment. The total aggregate proceeds from
these transactions were $107.2 million. Underwriters' discounts and other
related costs were $9.2 million for net proceeds of $98.0 million. Immediately
following the closing of the offering, Liberate also sold 1,627,604 shares of
common stock in a private placement to Lucent Technologies for an aggregate of
$12.1 million. The net proceeds were predominately held in cash equivalents and
short-term investments at November 30, 1999. In addition, following the closing
of the offering, we issued 843,880 shares of common stock to Middlefield
Ventures, an affiliate of Intel, in connection with the cancellation of a
convertible promissory note for $4.0 million payable to Middlefield. Related to
this transaction, the accrued interest on the convertible promissory note was
charged to paid-in capital.
Cash used in operations was approximately $34.0 million and $6.4
million for the six months ended November 30, 1999 and 1998, an increase of
$27.6 million from year to year. This increase was primarily due to a higher net
loss (related primarily to increased staffing), an increase in restricted cash,
accounts receivable and prepaid expenses and other current assets as well as a
decrease in deferred revenues for the six months ended November 30, 1999.
Net cash used in investing activities was approximately $69.6 million
and $455,000 for the six months ended November 30, 1999 and 1998, an increase of
$69.1 million from year to year. This increase was primarily due to the purchase
of short-term investments combined with purchases of property and equipment for
our new facilities.
Net cash from financing activities was approximately $110.9 million and
$85,000 for the six months ended November 30, 1999 and 1998. The initial public
offering and the private stock placement contributed $110.1 million of the
increase in cash generated by financing activities from year to year. In April
1999, Liberate and General Instrument entered into a manufacturer's agreement
whereby General Instrument will develop hardware using Liberate's software.
Under the manufacturer's agreement, Liberate will pay General Instrument $10.0
million for development over a three-year period. Amounts expensed under this
agreement were approximately $960,000 and $1.8 million for the three months and
six months ended November 30, 1999. See Note 5 of Notes to Condensed
Consolidated Financial Statements.
During the first quarter of fiscal 2000, the Company signed an
amendment to the Technology License and Distribution Agreement with Sun
Microsystems. This amendment called for Liberate to pay certain minimum
royalties in exchange for the right to certain Sun technology and to maintain
the status as a preferred vendor of Sun. Minimum guaranteed royalties of
approximately $3.8 million are to be paid to Sun through the period ended
December 31, 2004. Approximately $225,000 of expense related to this contract
was recorded for the six months ended November 30, 1999. See Note 5 of Notes to
Condensed Consolidated Financial Statements.
We currently anticipate that our current cash, cash equivalents and
short-term investments will be sufficient to meet our anticipated cash needs for
working capital and capital expenditures for at least the next twelve months.
Thereafter, cash generated from operations, if any, may not be sufficient to
satisfy our liquidity requirements. We may therefore need to sell additional
equity or raise funds by other means. Any additional financing, if needed, might
not be available on reasonable terms or at all. Failure to raise capital when
needed could seriously harm our business and operating results. If additional
funds were raised through the issuance of equity securities, the percentage of
ownership of our stockholders would be reduced. Furthermore, these equity
securities might have rights, preferences or privileges senior to our common
stock.
16
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YEAR 2000 READINESS DISCLOSURE
On January 1, 2000, computer systems and software products that were
not upgraded to comply with "Year 2000" requirements could have failed or
malfunctioned because they were not able to distinguish 21st century dates from
20th century dates. The scope of our Year 2000 readiness program included the
review and evaluation of our IT and non-IT systems and the evaluation of the
readiness of third parties and our client and server software products.
Under our Year 2000 readiness program, we inventoried and tested our
principal internal information technology systems for Year 2000 compliance.
Although we continue to test our internal systems, we have experienced no
material problems as a result of the Year 2000 changeover. However, because
we and our customers are substantially dependent upon the proper functioning
of our computer systems, a failure of our systems to be Year 2000 compliant
could materially disrupt our operations, which could seriously harm our
business.
Under our Year 2000 readiness program, we also tested our client and
server products to ensure that, when configured and used in accordance with the
related documentation and our customer's hardware platform, they would not
experience any problems as a result of the Year 2000 changeover. To date, we
have not received any reports from our customers that they have experienced any
material problems with our client and server software products as a result of
the Year 2000 changeover.
The Year 2000 problem may also affect third party software products
that are incorporated into our client and server tools, applications and other
software products that we modify and license to our customers. When we
incorporate third party software products into our products, we generally
discuss Year 2000 issues with these third parties and sometimes perform internal
testing on their products. We do not, however, as a general matter guarantee or
certify that the software licensed by these suppliers is Year 2000 compliant.
Any failure by third parties to provide Year 2000 compliant software products
that we incorporate into our products could result in financial loss, harm to
our reputation, and liability to others and could seriously harm our business.
To date, we have not encountered any material problems resulting from third
party software products incorporated into our client and server products related
to the Year 2000 changeover.
As part of our Year 2000 readiness program, we inquired as to the Year
2000 readiness of our customers from time to time. Although we do not currently
have extensive information concerning the Year 2000 compliance status of our
customers, we have not received any reports from our customers of any material
problems experienced by them on account of the Year 2000 changeover. Our current
or potential customers may incur significant expense to achieve Year 2000
compliance. If our customers are not Year 2000 compliant, they may experience
material costs to remedy problems, or they may face litigation costs. In either
case, Year 2000 issues could reduce or eliminate the budgets that current or
potential customers could have to license our products.
Because our Year 2000 compliance efforts were part of ongoing system
upgrades, we have funded our Year 2000 plan from operating cash flows and have
not separately accounted for these costs in the past. To date, these costs have
not been material. While we may incur additional costs related to Year 2000
compliance for administrative personnel to manage the continued testing, review
and remediation, and outside vendor and contractor assistance, if necessary, we
currently do not expect future Year 2000 compliance costs to be material. If we
were to experience material problems and costs with Year 2000 compliance, such
problems could seriously harm our business, including:
- Operational disruptions and inefficiencies for us, our
customers and vendors that provide us with internal systems
that will divert management's time and attention and financial
and human resources from ordinary business activities;
- Business disputes and claims for pricing adjustments by our
customers, some of which could result in litigation or
contract termination; and
- Harm to our reputation to the extent that our customer's
products experience errors or interruptions of service.
17
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RISK FACTORS
WE HAVE A LIMITED OPERATING HISTORY THAT MAKES AN EVALUATION OF OUR BUSINESS
DIFFICULT
We were incorporated in April 1996 and began shipping our initial
products to customers in the last quarter of fiscal 1997. Our limited operating
history makes evaluation of our business and prospects difficult. Companies in
an early stage of development frequently encounter heightened risks and
unexpected expenses and difficulties. For us, these risks include the:
- Limited number of network operators that have deployed
products and services incorporating our technology;
- Limited number of information appliance manufacturers that
have incorporated our technology into their products;
- Delays in deployment of high speed networks and
Internet-enhanced services and applications by our network
operator customers; and
- Our unproven long-term business model, which depends on
generating the majority of our revenues from royalty fees paid
by network operators and information appliance manufacturers.
These risks, expenses and difficulties apply particularly to us because our
market, the information appliance software market, is new and rapidly evolving.
WE HAVE A HISTORY OF LOSSES AND EXPECT TO INCUR LOSSES IN THE FUTURE
We incurred net losses of approximately $3.3 million in fiscal 1996,
$19.0 million in fiscal 1997, $94.4 million in fiscal 1998, $33.1 million in
fiscal 1999, and $25.0 million during the six months ended November 30, 1999.
Our net losses of $94.4 million in fiscal 1998 included a $58.1 million charge
related to acquired in-process research and development. As of November 30,
1999, we had an accumulated deficit of approximately $174.7 million. Since our
inception, we have not had a profitable quarter and may never achieve or sustain
profitability. Although our revenues increased from fiscal 1997 to fiscal 1998
and from fiscal 1998 to fiscal 1999, we may not be able to sustain our
historical revenue growth rates. We also expect to continue to incur increasing
cost of revenues, research and development, sales and marketing and general and
administrative expenses. If we are to achieve profitability given our planned
expenditure levels, we will need to generate and sustain substantially increased
license and royalty revenues; however, we are unlikely to be able to do so for
the foreseeable future. As a result, we expect to incur significant and
increasing losses and negative cash flows for the foreseeable future. In
addition, from the beginning of fiscal 1997 through November 30, 1999,
approximately 66% of our revenues have been derived from services provided by us
and not from license and royalty fees paid by network operators and information
appliance manufacturers in conjunction with the deployment of products and
services incorporating our software products. If we are unable to derive a
greater proportion of our revenues from these license and royalty fees, our
losses will likely continue indefinitely.
OUR QUARTERLY REVENUES AND OPERATING RESULTS ARE VOLATILE AND MAY CAUSE OUR
STOCK PRICE TO FLUCTUATE
Our quarterly operating results have varied in the past and are likely
to vary significantly from quarter to quarter. As a result, we believe that
period-to-period comparisons of our operating results are not a good indication
of our future performance. Moreover, we expect to derive substantially all of
our revenues for the near term from license fees and related consulting and
support services. Over the longer term, to the extent deployments increase, we
expect to derive an increasing portion of our revenues from royalties paid by
network operators and information appliance manufacturers. If deployments do not
increase or this transition otherwise does not occur, we are unlikely to be able
to generate or sustain substantially increased revenue and our operating results
will be seriously harmed.
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In the short term, we expect our quarterly revenues to be significantly
dependent on the sale of a small number of relatively large orders for our
products and services, which generally have a long sales cycle. As a result, our
quarterly operating results may fluctuate significantly if we are unable to
complete one or more substantial sales in any given quarter. In many cases, we
recognize revenues from services on a percentage of completion basis. Our
ability to recognize these revenues may be delayed if we are unable to meet
service milestones on a timely basis. Moreover, because our expenses are
relatively fixed in the near term, any shortfall from anticipated revenues could
result in losses for the quarter.
Although we have limited historical financial data, in the past we have
experienced seasonality in our quarter ending August 31. These seasonal trends
may continue to affect our quarter-to-quarter revenues.
THE MARKET FOR INFORMATION APPLIANCES IS NEW AND MAY NOT DEVELOP AS WE
ANTICIPATE
Because the information appliance market is newly emerging, the
potential size of this new market opportunity and the timing of its development
are uncertain. As a result, our profit potential is unproven. We are dependent
upon the commercialization and broad acceptance by consumers and businesses of a
wide variety of information appliances including, among others, television
set-top boxes, game consoles, smart phones and personal digital assistants.
Initial commercialization efforts in this industry have been primarily focused
on television set-top boxes. Broad acceptance of all information appliances,
particularly television set-top boxes, will depend on many factors. These
factors include:
- The willingness of large numbers of consumers to use devices
other than personal computers to access the Internet;
- The development of content and applications for information
appliances; and
- The emergence of industry standards that facilitate the
distribution of content over the Internet to these devices.
If the market for information appliances does not develop or develops more
slowly than we anticipate, our revenues will not grow as fast as anticipated, if
at all.
OUR SUCCESS DEPENDS ON NETWORK OPERATORS INTRODUCING, MARKETING AND PROMOTING
PRODUCTS AND SERVICES FOR INFORMATION APPLIANCES BASED ON OUR TECHNOLOGY
Our success depends on large network operators introducing, marketing
and promoting products and services based on our technology. There are, however,
only a limited number of large network operators worldwide. Moreover, only a
limited number of network operators have introduced or are in the process of
deploying products and services incorporating our technology and services for
information appliances. In addition, none of our network operator customers are
contractually obligated to introduce, market or promote products and services
incorporating our technology, nor are any of our network operator customers
contractually required to achieve any specific introduction schedule.
Accordingly, even if a network operator initiates a customer trial of products
incorporating our technology, that operator is under no obligation to continue
its relationship with us or to launch a full-scale deployment of these products.
Further, our agreements with network operators are not exclusive, so network
operators with whom we have agreements may enter into similar license agreements
with one or more of our competitors.
Moreover, because the large scale deployment of products and services
incorporating our technology by network operators is complex, time consuming and
expensive, each deployment of these products and services requires our expertise
to tailor our technology to the customer's particular product offering. This
customization process requires a lengthy and significant commitment of resources
by our customers and us. This commitment of resources may slow deployment, which
could, in turn, delay market acceptance of these products and services. Unless
network operators introduce, market and promote products and services
incorporating our technology in a successful and timely manner, our software
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platform will not achieve widespread acceptance, information appliance
manufacturers will not use our software in their products and our revenues will
not grow as fast as anticipated, if at all.
IF INFORMATION APPLIANCE MANUFACTURERS DO NOT MANUFACTURE PRODUCTS THAT
INCORPORATE OUR TECHNOLOGY, OR IF THESE PRODUCTS DO NOT ACHIEVE ACCEPTANCE, WE
MAY NOT BE ABLE TO SUSTAIN OR GROW OUR BUSINESS
We do not manufacture hardware components that incorporate our
technology. Rather, we license software technology to information appliance
manufacturers. Accordingly, our success will depend, in part, upon our ability
to convince a number of information appliance manufacturers to manufacture
products incorporating our technology and the successful introduction and
commercial acceptance of these products. Our efforts in this regard are
significantly dependent on network operators deploying services using our server
software.
While we have entered into a number of agreements with information
appliance manufacturers, none of these manufacturers are contractually obligated
to introduce or market information appliances incorporating our technology, nor
are any of them contractually required to achieve any specific production
schedule. Moreover, our agreements with information appliance manufacturers are
not exclusive, so information appliance manufacturers with whom we have
agreements may enter into similar license agreements with one or more of our
competitors. Our failure to convince information appliance manufacturers to
incorporate our software platform into their products, or the failure of these
products to achieve broad acceptance with consumers and businesses, will result
in revenues that do not grow as fast as expected, if at all.
COMPETITION FROM BIGGER, BETTER CAPITALIZED COMPETITORS COULD RESULT IN PRICE
REDUCTIONS, REDUCED GROSS MARGINS AND LOSS OF MARKET SHARE
Competition in the information appliance software market is intense.
Our principal competitors on the client software side include Microsoft, OpenTV
and Spyglass. On the server side, our primary competitor is Microsoft. We expect
additional competition from other established and emerging companies. We expect
competition to persist and intensify as the information appliance market
develops and competitors focus on additional product and service offerings.
Increased competition could result in price reductions, fewer customer orders,
reduced gross margins, longer sales cycles, reduced revenues and loss of market
share.
Many of our existing and potential competitors, particularly Microsoft,
have longer operating histories, a larger customer base, greater name
recognition and significantly greater financial, technical, sales and marketing
and other resources than we do. This may place us at a disadvantage in
responding to our competitors' pricing strategies, technological advances,
advertising campaigns, strategic partnerships and other initiatives. In
addition, many of our competitors have well-established relationships with our
current and potential customers. Moreover, some of our competitors, particularly
Microsoft, have significant financial resources, which have enabled them in the
past and may enable them in the future to make large strategic investments in
our current and potential customers. Such investments may enable competitors to
strengthen existing relationships or quickly establish new relationships with
our current or potential customers. For example, as a result of our investment
in AT&T, Microsoft obtained a nonexclusive licensing agreement under which AT&T
will purchase at least 7.5 million licenses of Microsoft software for television
set top boxes. Investments such as this may discourage our potential or current
customers who receive the investment from deploying our information appliance
software, regardless of their views of the relative merits of our products and
services.
ORACLE'S OWNERSHIP OF OUR STOCK AND OTHER RELATIONSHIPS WITH US COULD LIMIT THE
ABILITY OF OTHER STOCKHOLDERS TO INFLUENCE THE OUTCOME OF DIRECTOR ELECTIONS AND
OTHER TRANSACTIONS SUBMITTED FOR A VOTE OF OUR STOCKHOLDERS
Based on 83,583,854 shares outstanding on November 30, 1999, Oracle
beneficially owns approximately 47% of our outstanding capital stock. In
addition, in May 1999, we entered into a voting
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agreement with Oracle, Comcast, Cox Communications and MediaOne. Under this
agreement, among other things, Comcast, Cox and MediaOne have agreed to vote the
shares of our common stock held by them in order to elect a representative
designated by Oracle to our board of directors. Currently, two of our six
directors are directors and officers of Oracle. As a result, Oracle, acting both
through our board of directors and through its ownership of our capital stock,
may exert significant influence over us. This concentration of ownership could
also have the effect of delaying or preventing a third party from acquiring
control over us at a premium over the then current market price of our common
stock.
In addition, Oracle provides us with a distribution channel for our
products in Asia/Pacific, Europe and the United States and assists us in
providing our customers with support. We have also entered into several
commercial, technological and financial arrangements with Oracle on which our
business depends. If Oracle terminates these arrangements, if Oracle does not
fulfill its obligations under these arrangements, if Oracle ever acts in a way
that is adverse to our interests, or if we are no longer eligible to receive the
benefits of these arrangements, we may need to find alternative distribution
channel partners, seek alternative technologies for our products and services
and find alternative financial resources.
WE HAVE RELIED AND EXPECT TO CONTINUE TO RELY ON A LIMITED NUMBER OF CUSTOMERS
FOR A SIGNIFICANT PORTION OF OUR REVENUES
We currently derive, and we expect to continue to derive, a significant
portion of our revenues from a limited number of customers. For the six months
ended November 30, 1999, our five largest customers accounted for approximately
54% of our revenues, with Wind River Systems accounting for 18% of our total
revenues and Cable & Wireless accounting for 14% of our total revenues. For the
six months ended November 30, 1998, our five largest customers accounted for
approximately 61% of our total revenues, with Wind River Systems accounting for
26% of our total revenues and Nintendo accounting for 11% of our total revenues.
We expect that we will continue to be dependent upon a limited number of
customers for a significant portion of our revenues in future periods, although
the customers may vary from period to period. As a result, if we fail to
successfully sell our products and services to one or more customers in any
particular period, or a large customer purchases less of our products or
services, defers or cancels orders, or terminates its relationship with us, our
revenues could decline significantly.
OUR LENGTHY SALES CYCLE MAY CAUSE FLUCTUATIONS IN OUR OPERATING RESULTS, WHICH
COULD CAUSE OUR STOCK PRICE TO DECLINE
We believe that the purchase of our products and services involves a
significant commitment of capital and other resources by a customer. In many
cases, the decision for our customers to use our products and services requires
them to change their established business practices and conduct their business
in new ways. As a result, we may need to educate our potential customers on the
use and benefits of our products and services. In addition, our customers
generally must consider a wide range of other issues before committing to
purchase and incorporate our technology into their offerings. As a result of
these and other factors, including the approval at a number of levels of
management within a customer's organization, our sales cycle averages from six
to 12 months and may sometimes be significantly longer. Because of the length of
our sales cycle, we have a limited ability to forecast the timing and amount of
specific sales.
In addition, we base our quarterly revenue projections, in part, upon
our expectation that specific sales will occur in a particular quarter. In the
past, our sales have occurred in quarters other than those anticipated by us. If
our expectations, and thus our revenue projections, are not accurate for a
particular quarter, our actual operating results for that quarter could fall
below the expectations of financial analysts and investors.
DEMAND FOR OUR PRODUCTS AND SERVICES WILL DECLINE SIGNIFICANTLY IF OUR SOFTWARE
CANNOT SUPPORT AND MANAGE A SUBSTANTIAL NUMBER OF USERS
Despite frequent testing of our software's scalability in a laboratory
environment, the ability of our software platform to support and manage a
substantial number of users in an actual deployment is
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uncertain. If our software platform does not efficiently scale to support and
manage a substantial number of users while maintaining a high level of
performance, demand for our products and services and our ability to sell
additional products to our existing customers will be significantly reduced.
INTERNATIONAL REVENUES ACCOUNT FOR A SIGNIFICANT PORTION OF OUR REVENUES;
ACCORDINGLY, IF WE ARE UNABLE TO EXPAND OUR INTERNATIONAL OPERATIONS IN A TIMELY
MANNER, OUR GROWTH IN INTERNATIONAL REVENUES WILL BE LIMITED
International revenues accounted for approximately 48% of our total
revenues for the six months ended November 30, 1999, and approximately 55%
for the six months ended November 30, 1998. We anticipate that a significant
portion of our revenues for the foreseeable future will be derived from
sources outside the United States, especially as we increase our sales and
marketing activities with respect to international licensing of our
technology. Accordingly, our success will depend, in part, upon international
economic conditions and upon our ability to manage international sales and
marketing operations. To successfully expand international sales, we must
establish additional foreign operations, hire additional personnel and
increase our foreign direct and indirect sales forces. This expansion will
require significant management attention and resources, which could divert
attention from other aspects of our business. To the extent we are unable to
expand our international operations in a timely manner, our growth in
international sales, if any, will be limited.
Moreover, substantially all of our revenues and costs to date have been
denominated in U.S. dollars. However, expanded international operations may
result in increased foreign currency payables. Although we may from time to time
undertake foreign exchange hedging transactions to cover a portion of our
foreign currency transaction exposure, we do not currently attempt to cover
potential foreign currency exposure. Accordingly, any fluctuation in the value
of foreign currency could seriously harm our ability to increase international
revenues.
WE MAY HAVE TO CEASE OR DELAY PRODUCT SHIPMENTS IF WE ARE UNABLE TO OBTAIN KEY
TECHNOLOGY FROM THIRD PARTIES
We rely on technology licensed from third parties, including
applications that are integrated with internally developed software and used in
our products. Most notably, we license certain Java and Jini technologies from
Sun Microsystems, VxWorks real time operating system from Wind River Systems,
font technology from BitStream and multimedia architecture from RealNetworks.
These third party technology licenses may not continue to be available to us on
commercially reasonable terms, or at all, and we may not be able to obtain
licenses for other existing or future technologies that we desire to integrate
into our products. If we cannot maintain existing third party technology
licenses or enter into licenses for other existing or future technologies needed
for our products we would be required to cease or delay product shipments while
we seek to develop alternative technologies.
WE DO NOT CURRENTLY HAVE LIABILITY INSURANCE TO PROTECT AGAINST THIRD PARTY
INTELLECTUAL PROPERTY INFRINGEMENT CLAIMS THAT COULD BE EXPENSIVE TO DEFEND
We expect that, like other software product developers, we will
increasingly be subject to infringement claims as the number of products and
competitors developing information appliance software grows and the
functionality of products in different industry segments overlaps. From time to
time, we hire or retain employees or external consultants who have worked for
independent software vendors or other companies developing products similar to
those offered by us. These prior employers may claim that our products are based
on their products and that we have misappropriated their intellectual property.
We cannot guarantee that:
- An infringement claim will not be asserted against us in the
future;
- The assertion of such a claim will not result in litigation;
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- We would prevail in such litigation; or
- We would be able to obtain a license for the use of any
infringed intellectual property from a third party on
commercially reasonable terms, or at all.
We currently do not have liability insurance to protect against the
risk that licensed third party technology infringes the intellectual property of
others. Any claims relating to our intellectual property, regardless of their
merit, could seriously harm our ability to develop and market our products and
manage our day-to-day operations because they could:
- Be time consuming and costly to defend;
- Divert management's attention and resources;
- Cause product shipment delays;
- Require us to redesign our products; or
- Require us to enter into royalty or licensing agreements.
WE COULD SUFFER LOSSES AND NEGATIVE PUBLICITY IF OUR TECHNOLOGY CAUSES A FAILURE
OF OUR NETWORK OPERATOR CUSTOMERS' SYSTEMS
Our technology is integrated into the products and services of our
network operator customers. Accordingly, a defect, error or performance problem
with our technology could cause our customers' telecommunication, cable and
satellite television or Internet service systems to fail for a period of time.
Any such failure will cause severe customer service and public relations
problems for our customers. As a result, any failure of our network operator
customers' systems caused by our technology could result in:
- Delayed or lost revenue due to adverse customer reaction;
- Negative publicity regarding us and our products and services;
and
- Claims for substantial damages against us, regardless of our
responsibility for such failure.
Any claim could be expensive and require the expenditure of a significant amount
of resources regardless of whether we prevail. We currently do not have
liability insurance to protect against this risk.
OUR SUCCESS DEPENDS ON OUR ABILITY TO KEEP PACE WITH THE LATEST TECHNOLOGICAL
CHANGES BUT WE HAVE EXPERIENCED AND MAY IN THE FUTURE EXPERIENCE DELAYS IN
COMPLETING DEVELOPMENT AND INTRODUCTION OF NEW SOFTWARE PRODUCTS
The market for information appliance software is characterized by
evolving industry standards, rapid technological change and frequent new product
introductions and enhancements. Our technology enables network operators to
deliver content and applications to information appliances over the Internet.
Accordingly, our success will depend in large part upon our ability to adhere to
and adapt our products to evolving Internet protocols and standards. Therefore,
we will need to develop and introduce new products that meet changing customer
requirements and emerging industry standards on a timely basis. In the past, we
have experienced delays in completing the development and introduction of new
software products. We may encounter such delays in the development and
introduction of future products as well. In addition, we may:
- Fail to design our current or future products to meet customer
requirements;
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- Fail to develop and market products and services that respond
to technological changes or evolving industry standards in a
timely or cost effective manner; and
- Encounter products, capabilities or technologies developed by
others that render our products and services obsolete or
noncompetitive or that shorten the life cycles of our existing
products and services.
OUR LIMITED ABILITY TO PROTECT OUR INTELLECTUAL PROPERTY AND PROPRIETARY RIGHTS
MAY HARM OUR COMPETITIVENESS
Our ability to compete and continue to provide technological innovation
is substantially dependent upon internally developed technology. We rely
primarily on a combination of patents, trademark laws, copyright laws, trade
secrets, confidentiality procedures and contractual provisions to protect our
proprietary technology. In addition, we have been awarded two patents and have
17 patent applications pending in the U. S. Patent & Trademark Office. Patents
may not be issued from these or any future applications. Even if they are
issued, these patents may not survive a legal challenge to their validity or
provide significant protection for us.
The steps we have taken to protect our proprietary rights may not be
adequate to prevent misappropriation of our proprietary information. Further, we
may not be able to detect unauthorized use of, or take appropriate steps to
enforce, our intellectual property rights. Our competitors may also
independently develop similar technology. In addition, the laws of many
countries do not protect our proprietary rights to as great an extent as do the
laws of the United States. Any failure by us to meaningfully protect our
intellectual property could result in competitors offering products that
incorporate our most technologically advanced features, which could seriously
reduce demand for our products and services.
FAILURE TO MANAGE OUR GROWTH MAY SERIOUSLY HARM OUR ABILITY TO DELIVER PRODUCTS
IN A TIMELY MANNER, FULFILL EXISTING CUSTOMER COMMITMENTS AND ATTRACT AND RETAIN
NEW CUSTOMERS
Our rapid growth has placed, and is expected to continue to place, a
significant strain on our managerial, operational and financial resources,
especially as more network operators and information appliance manufacturers
incorporate our software into their products and services. This potential for
rapid growth is particularly significant in light of the large customer bases of
network operators and information appliance manufacturers and the frequent need
to tailor our products and services to our customers' unique needs. To the
extent we add several customers simultaneously or add customers whose product
needs require extensive customization, we may need to significantly expand our
operations. Moreover, we expect to significantly expand our domestic and
international operations by, among other things, expanding the number of
employees in professional services, research and development and sales and
marketing.
This additional growth will place a significant strain on our limited
personnel, financial and other resources. Our future success will depend, in
part, upon the ability of our senior management to manage growth effectively.
This will require us to implement additional management information systems, to
further develop our operating, administrative, financial and accounting systems
and controls, to hire additional personnel, to develop additional levels of
management within the corporation, to locate additional office space in the
United States and internationally and to maintain close coordination among our
development, accounting, finance, sales and marketing, consulting services and
customer service and support organizations. Failure to accomplish any of these
requirements would seriously harm our ability to deliver products in a timely
fashion, fulfill existing customer commitments and attract and retain new
customers.
THE LOSS OF ANY OF OUR KEY PERSONNEL WOULD HARM OUR COMPETITIVENESS
We believe that our success will depend on the continued employment of
our senior management team and key technical personnel, none of whom, except
Mitchell E. Kertzman, our President and Chief Executive Officer, has an
employment agreement with us. If one or more members of our senior
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management team or key technical personnel were unable or unwilling to continue
in their present positions, these individuals would be very difficult to replace
and our ability to manage day-to-day operations, develop and deliver new
technologies, attract and retain customers, attract and retain other employees
and generate revenues, would be seriously harmed.
OUR PLANNED EXPANSION OF OUR INDIRECT DISTRIBUTION CHANNELS WILL BE EXPENSIVE
AND MAY NOT SUCCEED
To date, we have sold our products and services principally through our
direct sales force. In the future, we intend to expand the number and reach of
our indirect channel partners, primarily overseas, through distribution
agreements similar to the one we have with Oracle. The development of these
indirect channels will require the investment of significant company resources,
which could seriously harm our business if our efforts do not generate
significant revenues. Moreover, we may not be able to attract indirect channel
partners that will be able to effectively market our products and services. The
failure to recruit indirect channel partners that are able to successfully
market our products and services could seriously hinder the growth of our
business.
WE MAY NEED TO MAKE ACQUISITIONS IN ORDER TO REMAIN COMPETITIVE IN OUR MARKET
AND ACQUISITIONS COULD BE DIFFICULT TO INTEGRATE, DISRUPT OUR BUSINESS AND
DILUTE STOCKHOLDER VALUE
In addition to the recently announced acquisition of SourceSuite LLC,
we may need to acquire other businesses in the future in order to remain
competitive or to acquire new technologies. As a result of this acquisition and
others that may occur in the future, we will need to integrate product lines,
technologies, widely dispersed operations and distinct corporate cultures. In
addition, the product lines or technologies of this and future acquisitions may
need to be altered or redesigned in order to be made compatible with our
software products or the software architecture of our customers. These
integration efforts may not succeed or may distract our management from
operating our existing business. Our failure to successfully manage future
acquisitions could seriously harm our operating results. In addition, our
stockholders would be diluted if we finance the acquisitions by incurring
convertible debt or issuing equity securities. We anticipate that the issuance
of 1,772,000 shares of Liberate's common stock upon closure of the transaction
will result in further dilution. These shares have been retroactively restated
to give effect to a two-for-one stock split declared on December 21, 1999, which
will be effective after January 14, 2000.
DEMAND FOR OUR PRODUCTS AND SERVICES WILL NOT INCREASE IF THE INTERNET DOES NOT
CONTINUE TO GROW AND IMPROVE
Acceptance of our software platform depends substantially upon the
widespread adoption of the Internet for commerce, communications and
entertainment. As is typical in the case of an emerging industry characterized
by rapidly changing technology, evolving industry standards and frequent new
product and service introductions, demand for and acceptance of recently
introduced Internet products and services are subject to a high level of
uncertainty. In addition, critical issues concerning the commercial use of the
Internet remain unresolved and may affect the growth of Internet use, especially
in the consumer markets we target. The adoption of the Internet for commerce,
communications and access to content and applications, particularly by those
that have historically relied upon alternative means of commerce, communications
and access to content and applications, generally requires understanding and
acceptance of a new way of conducting business and exchanging information.
Moreover, widespread application of the Internet outside of the United States
will require reductions in the cost of Internet access to prices affordable to
the average consumer.
To the extent that the Internet continues to experience an increase in
users, an increase in frequency of use or an increase in the amount of data
transmitted by users, we cannot guarantee that the Internet infrastructure will
be able to support the demands placed upon it. In addition, the Internet could
lose its viability as a commercial medium due to delays in development or
adoption of new standards or protocols required to handle increased levels of
Internet activity, or due to increased government regulation. Changes in, or
insufficient availability of, telecommunications or similar services to support
the
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Internet could also result in slower response times and could adversely impact
use of the Internet generally. If use of the Internet does not continue to grow
or grows more slowly than expected, or if the Internet infrastructure,
standards, protocols or complementary products, services or facilities do not
effectively support any growth that may occur, demand for our products and
services will decline significantly.
INCREASING GOVERNMENT REGULATION COULD CAUSE DEMAND FOR OUR PRODUCTS AND
SERVICES TO DECLINE SIGNIFICANTLY
We are subject not only to regulations applicable to businesses
generally, but also laws and regulations directly applicable to the Internet.
Although there are currently few such laws and regulations, state, federal and
foreign governments may adopt a number of these laws and regulations governing
any of the following issues:
- User privacy;
- Copyrights;
- Consumer protection;
- Taxation of e-commerce;
- The online distribution of specific material or content; and
- The characteristics and quality of online products and
services.
We do not engage in e-commerce, nor do we distribute content over the
Internet. However, one or more states or the federal government could enact
regulations aimed at companies, like us, which provide software that facilitates
e-commerce and the distribution of content over the Internet. The likelihood of
such regulation being enacted will increase as the Internet becomes more
pervasive and extends to more people's daily lives. Any such legislation or
regulation could dampen the growth of the Internet and decrease its acceptance
as a communications and commercial medium. If such a reduction in growth occurs,
demand for our products and services will decline significantly.
WE EXPECT OUR OPERATIONS TO CONTINUE TO PRODUCE NEGATIVE CASH FLOW;
CONSEQUENTLY, IF WE CANNOT RAISE ADDITIONAL CAPITAL, WE MAY NOT BE ABLE TO FUND
OUR CONTINUED OPERATIONS
Since our inception, cash used in our operations has substantially
exceeded cash received from our operations, and we expect this trend to continue
for the foreseeable future. We expect that the net proceeds from our initial
public offering and the private placement will be sufficient to meet our working
capital and capital expenditure needs for at least the twelve months following
the offering. After that, we may need to raise additional funds, and we cannot
be certain that we will be able to obtain additional financing on favorable
terms, or at all. If we need additional capital and cannot raise it on
acceptable terms, we may not be able to, among other things:
- Develop or enhance our products and services;
- Acquire complementary technologies, products or businesses;
- Open new offices, in the United States or internationally;
- Hire, train and retain employees; or
- Respond to competitive pressures or unanticipated
requirements.
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PROVISIONS OF OUR CORPORATE DOCUMENTS AND DELAWARE LAW COULD DETER TAKEOVERS AND
PREVENT YOU FROM RECEIVING A PREMIUM FOR YOUR SHARES
Provisions of our certificate of incorporation and bylaws as well as
provisions of Delaware law could make it more difficult for a third party to
acquire us, even if doing so would be beneficial to our stockholders.
WE ARE AT RISK OF SECURITIES CLASS ACTION LITIGATION DUE TO OUR EXPECTED STOCK
PRICE VOLATILITY
In the past, securities class action litigation has often been brought
against a company following periods of volatility in the market price of its
securities. This risk is especially acute for us because technology companies
have experienced greater than average stock price volatility in recent years
and, as a result, have been subject to, on average, a greater number of
securities class action claims than companies in other industries. Due to the
potential volatility of our stock price, we may in the future be the target of
similar litigation. Securities litigation could result in substantial costs and
divert management's attention and resources.
WE MAY INCUR NET LOSSES OR INCREASED NET LOSSES IF WE ARE REQUIRED TO RECORD A
SIGNIFICANT ACCOUNTING EXPENSE RELATED TO THE ISSUANCE OF WARRANTS
Under the terms of letter agreements with particular network operators
entered into in April and May 1999, we agreed to issue warrants to purchase up
to an aggregate of 4,599,992 shares of our common stock if these network
operators satisfy commercial milestones. In the event the milestones are met, we
could be required to record a significant non-cash accounting expense over the
estimated economic life of the arrangements with the network operators, which
would be equal to the value of the warrants at the time the milestones are
satisfied. If we are required to record non-cash accounting expenses related to
these warrants, we could incur net losses or increased net losses for a given
period and this could seriously harm our operating results and stock price. As
of November 30, 1999, we recorded warrants to purchase up to 749,998 shares of
our common stock as being earned by four network operators for signing license
agreements. In connection with the issuance of these warrants, approximately
$18,000 was recorded as a charge to operations during fiscal 1999, and
approximately $1.1 million was recorded as a charge to operations during the
first six months of fiscal 2000. In December 1999, additional warrants to
purchase 866,664 shares of common stock at $6.90 per share were issued to two
network operators in connection with prepaid royalty fees. The fair market value
of these warrants is approximately $100.0 million. A portion of these fully
vested warrants, valued at approximately $27.5 million, were exercised in
January 2000.
Item 3. Quantitative and Qualitative Disclosure about Market Risk
INTEREST RATE RISK
As of November 30, 1999, our investments consisted of $10.6 million of
short-term money market securities and $110.8 million of debt securities. These
securities, like all fixed income instruments, are subject to interest rate risk
and will fall in value if market interest rates increase. If market interest
rates were to increase immediately and uniformly by 10% prior to maturity, from
levels as of November 30, 1999, the decline of the fair value of the portfolio
would not be material.
FOREIGN CURRENCY
We transact business in various foreign currencies and, accordingly,
we are subject to exposure from adverse movements in foreign currency
exchange rates. To date, the effect of changes in foreign currency exchange
rates on revenues and operating expenses have not been material.
Substantially all of our revenues are earned in U.S. dollars. Operating
expenses incurred by our foreign subsidiaries are denominated primarily in
European currencies. We currently do not use financial instruments to hedge
these operating expenses. We intend to assess the need to utilize financial
instruments to hedge currency exposures on an ongoing basis.
27
<PAGE>
Part II. Other Information
Item 1. Legal proceedings
In December 1998, one of our former employees filed an action in the
California Superior Court for the County of San Mateo against us for, among
other things, unpaid commissions of approximately $1.5 million, constructive
employment termination, intentional misrepresentation and negligent
misrepresentation. In October 1999, the plaintiff amended his complaint
against us, adding claims for damages for failure to pay wages under the
California Labor Code and common law retaliation, and sought to impose a
constructive trust on the allegedly withheld commissions and any enhancement
in value of that money. We have conducted extensive discovery on these
claims, which we believe to be without merit. In December 1999, we filed a
motion for summary judgment/summary adjudication to dismiss all of the claims
brought by the plaintiff. In January 2000, the Court dismissed eight of the
ten claims brought against us leaving only the claims of intentional and
negligent misrepresentation for trial. We continue to believe that these
claims are without merit and that we have strong defenses to them. We intend
to continue to vigorously defend this action as to the remaining claims.
Item 2. Changes in Securities and Use of Proceeds
(c) Changes in Securities.
During the six months ended November 30, 1999, and prior to the closing
of our initial public offering, we granted options to purchase 2,552,372 shares
of common stock to employees, external consultants and other service providers
of Liberate under our 1996 Stock Plan. During the six months ended November 30,
1999, we granted 812,332 options to purchase shares of common stock to
employees, external consultants or other service providers of Liberate under our
1999 Equity Incentive Plan.
During the six months ended November 30, 1999, employees, external
consultants and other service providers of Liberate exercised options for
520,528 shares of common stock under all plans (including preferred shares that
converted to common upon the initial public offering).
On December 21, 1999, we announced a two-for-one stock split in the
form of a special stock dividend, effective after January 14, 2000. The stock
split will increase the number of shares of our common stock outstanding to
approximately 83,600,000 shares. All share, per share, common stock, stock
option and warrant amounts herein have been restated to reflect the effects
of this split.
The sale of the above securities was deemed to be exempt from
registration under the Securities Act of 1933 ("the Act") in reliance upon
Section 4(2) of the Act or Rule 701 promulgated under Section 3(b) of the Act.
(d) Use of Proceeds.
On August 2, 1999, we completed the initial public offering, in which
we sold 12,500,000 shares of common stock at $8 per share. Additionally, we sold
902,100 shares of common stock at $8 per share in connection with the exercise
of the underwriters' overallotment. The total aggregate proceeds from these
transactions were $107.2 million. Underwriters' discounts and other related
costs were $9.2 million resulting in net proceeds of $98.0 million. The net
proceeds were predominately held in cash equivalents and short-term investments
at November 30, 1999. Immediately following the closing of the offering, we also
sold 1,627,604 shares of common stock in a private placement to Lucent
Technologies for an aggregate of $12.1 million, net of commissions. The net
proceeds will be used and have been applied to working capital and were
predominantly held in cash equivalents, short-term money market securities and
debt securities at November 30, 1999.
Item 3. Defaults in Securities
None
28
<PAGE>
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
EXHIBIT
NO. EXHIBIT
10.7 Amendment to Employment Agreement between Liberate and Mitchell E.
Kertzman, dated January 5, 2000.
10.39 Employment letter between Liberate and Coleman Sisson, dated
November 5, 1999.
27.1 Financial Data Schedule.
(b) Reports on Form 8-K
None
29
<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
undersigned, thereunto duly authorized.
Liberate Technologies
Date: January 14, 2000 by: /s/ Nancy J. Hilker
----------------------
Nancy J. Hilker,
Vice President and
Chief Financial Officer
(duly authorized officer and
principal financial officer)
30
<PAGE>
January 5, 2000
Mitchell E. Kertzman
c/o Liberate Technologies
2 Circle Star Way
San Carlos, CA 94070
Amendment to Employment Agreement
Dear Mitchell:
This letter will formally confirm our agreement to amend the terms of
your employment agreement set forth in Liberate Technologies' (formerly Network
Computer, Inc. (the "Company")) letter to you dated October 12, 1998 (the
"Agreement"). In consideration for your agreement not to require the Company to
make the loan specified in the third paragraph of the first page of the
Agreement to you prior to December 31, 1999, we agree that the offer of the loan
set forth in that paragraph shall remain open to you through April 30, 2000.
In all other respects, the terms of the Agreement remain unchanged and
in full force and effect. We also confirm to you that the foregoing amendment
has been duly approved by the Compensation Committee of the Company's Board of
Directors and is made to be effective as of December 31, 1999.
Sincerely,
/s/ Nancy J. Hilker
Nancy Hilker,
Chief Financial Officer
Acknowledged and agreed:
- -----------------------------------------
Mitchell E. Kertzman
<PAGE>
[LOGO]
November 5, 1999
Mr. Coleman Sisson
27231 SE 27th St.
Issaquah, WA 98029
Dear Coleman,
We are pleased to offer you employment as Chief Operating Officer for Liberate
Technologies ("Liberate" or "the Company"). Your annual salary will be $225,000
less applicable withholding. You will be eligible for a target annual bonus of
$125,000, based upon goals and objectives as determined by the Company's
President and Chief Executive Officer. Your first year's target annual bonus, as
long as you remain employed, is guaranteed to be $125,000. This bonus is
scheduled to be paid 30 days after the first anniversary of your hire date. Your
starting date will be pursuant to discussions with Mitchell Kertzman.
As an employee of Liberate Technologies, you will be eligible to participate in
a number of Company-sponsored benefits, including health and medical benefits.
Subject to the Board of Directors' approval, the Company will grant you an
option to purchase up to 225,000 shares of the Company's common stock with an
exercise price per share equal to the fair market value per share on the date
that you commence employment with the Company. The options will vest as follows:
25% on the first anniversary of the date of hire, and monthly thereafter, in
equal increments upon the completion of each of the next 36 months of service.
The option is granted subject to the terms of the Company's Stock Option Plan
and its related agreements. However, should the Company experience a Change in
Control, which results in the termination of your employment without Cause
within twelve months of your hire date, you will become vested for 25% of your
original option grant, as if you had provided 12 months of service. For purposes
of this letter, a termination of employment without Cause will include continued
employment (or an offer for continued employment) at a level below that for
which you were originally hired.
Change in Control is defined as: (i) a proposed sale, transfer or disposition of
all or substantially all of the Company's assets or (ii) the consummation of a
merger or consolidation of the Company with or into another entity or any other
corporate reorganization, if persons who own less than 50% of the Company
immediately prior to such merger, consolidation or other reorganization own
immediately after such merger, consolidation or other reorganization 50% or more
of the voting power of the outstanding securities of each of (A) the continuing
or surviving entity and (B) any direct or indirect parent corporation of such
continuing or surviving entity. In addition, a transaction shall not constitute
a Change in Control if its sole purpose is to change the state of the Company's
incorporation or to create a holding company that will be owned in substantially
the same proportions by the persons who held the Company's securities
immediately before such transaction.
Cause is defined as: (i) the commission of any act of fraud, embezzlement, or
dishonesty, (ii) any unauthorized use or disclosure of confidential information
or trade secrets of the Company (or any parent or subsidiary), or (iii) any
other intentional misconduct adversely affecting the business or affairs of the
Company (or any parent or subsidiary) in a material manner. The foregoing
definition shall not be deemed to be inclusive of all the acts or omissions
which the Company (or any parent or subsidiary) may consider as cause for your
dismissal or discharge or the discharge of any other person in the service of
the Company (or any parent or subsidiary).
<PAGE>
PAGE 2
MR. COLEMAN SISSON
Liberate Technologies will assist you with your relocation to California. The
relocation package includes transportation for you and your family, shipment of
your household goods and personal belongings, temporary housing, car rental, and
certain incidental expenses related to your move. Our relocation management
company will work with you to make your arrangements. The cost of your
relocation has been estimated not to exceed $25,000. Specific details of your
relocation package will be provided to you subsequent to your acceptance of this
offer of employment.
You will also receive a starting bonus of $25,000. Should you voluntarily
terminate your employment with the Company prior to being employed for one year,
all relocation costs that Liberate Technologies incurred and your starting bonus
must be repaid to the Company.
Upon your execution of mutually agreeable documentation, the Company will loan
you up to $300,000, secured in a manner agreeable to the Company, for the sole
purpose of your purchasing a home. This offer of a loan remains open to you
through December 31, 2000. If the loan is made to you, it will bear interest at
the current market rate and will be payable in full plus interest at the end of
three years from the funding date of the loan, provided you are still employed
by the Company. If you terminate your employment with the Company prior to the
end of three years from the funding date of the loan, the loan will need to be
assumed by you.
Your employment with the Company is not for a specific term and can be
terminated by you or by the Company at any time for any reason. We request that
all of our employees, to the extent possible, give us advance notice if they
intend to resign. But if your employment is terminated by the Company for any
reason other than gross misconduct, you agree to accept six months' salary as
severance, in exchange for your execution of a release of all claims against the
Company. Your employment with the Company is also contingent upon you executing
the Proprietary Information Agreement, Employment Agreement and upon you
providing the Company with the legally required proof of your identity. The
Company also requires proof of eligibility to work in the United States.
In the event of any dispute or claim relating to or arising out of our
employment relationship, the termination of that relationship, or this agreement
(including, but not limited to, any claims of wrongful termination, breach of
contract or age, sex, race, disability or other discrimination or harassment),
you and the Company agree that all such disputes shall be fully and finally
resolved by binding arbitration conducted by the American Arbitration
Association in Santa Clara County, California, with the arbitrator exercising
all powers and remedies of a judge. By signing this agreement you and the
Company waive your rights to have disputes tried by a judge or a jury. However,
we agree that this arbitration provision shall not apply to any disputes or
claims relating to or arising out of breach or alleged breach of your
Proprietary Information Agreement and Employment Agreement with the Company.
<PAGE>
PAGE 3
MR. COLEMAN SISSON
To confirm your acceptance of this employment agreement, please sign and date
this letter in the space provided below and return it to me. A duplicate
original is enclosed for your records. This letter, along with other agreements
referred to above, set forth the terms of your employment with the Company. This
agreement supersedes any prior representations or agreements between you and the
Company, whether written or oral and it may not be modified or amended except by
a document signed by an authorized officer of the Company and you. This offer,
if not accepted, will expire on November 12, 1999.
Sincerely,
/s/ Mitchell Kertzman /[Illegible]
Liberate Technologies
By: Mitchell E. Kertzman
President and Chief Executive Officer
I agree to and accept employment with Liberate Technologies on the terms set
forth in this agreement.
/s/ Coleman Sisson 11/5/99
- -------------------------------------------------------------------------------
Coleman Sisson Date
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