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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K/A
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AMENDMENT NO. 1 TO ANNUAL REPORT PURSUANT TO SECTION 13
OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1998
Commission File Number 0-28436
OPEN MARKET, INC.
(Exact name of registrant as specified in its charter)
Delaware 04-3214536
(State or other jurisdiction of (I.R.S. Employer Identification
incorporation or organization) Number)
One Wayside Road
Burlington, Massachusetts 01803
(Address of principal executive (Zip Code)
offices)
(781) 359-3000
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
None
(Title of class)
Securities registered pursuant to Section 12(g) of the Act:
Title of each class
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Common Stock, $.001 par value
Preferred Stock Purchase Rights
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 [_]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [_]
As of February 26, 1999, the aggregate market value of the Registrant's
voting securities held by non-affiliates of the Registrant was approximately
$365,445,119.
As of February 26, 1999, 35,515,694 shares of the Registrant's Common Stock,
$.001 par value per share, were outstanding.
Portions of the Proxy Statement for the Annual Meeting of Stockholders
expected to be held in May 1999 are incorporated by reference in Part III.
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INTRODUCTORY NOTE
Due to a printer error, the Annual Report on Form 10-K filed on
March 31, 1999 contained a draft document not related to the Annual Report on
Form 10-K, which was not intended to be part of that filing. The Registrant is
hereby refiling its Annual Report on Form 10-K/A to delete that document.
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Table of Contents
PART I
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1. Business............................................................... 3
2. Properties............................................................. 12
3. Legal Proceedings...................................................... 12
4. Submission of Matters to a Vote of Security Holders.................... 12
PART II
5. Market for the Registrant's Common Equity and Related Stockholder
Matters................................................................ 13
6. Selected Financial Data................................................ 14
7. Management's Discussion and Analysis of Financial Condition And Results
of Operations.......................................................... 15
7A. Quantitative and Qualitative Disclosure About Market Risk............. 29
8. Consolidated Financial Statements and Supplementary Data............... 30
9. Changes In and Disagreements with Accounting and Financial Disclosure.. 30
PART III
10. Directors and Executive Officers of the Registrant.................... 54
11. Executive Compensation................................................ 55
12. Security Ownership of Certain Beneficial Owners and Management........ 55
13. Certain Relationships and Related Transactions........................ 55
PART IV
14. Exhibits, Financial Statement Schedules and Reports on Form 8-K...... 56
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PART I
Item 1. BUSINESS
Open Market, Inc. ("Open Market" or the "Company") develops, markets,
licenses and supports a family of application software products that allow its
customers to engage in business-to-business and business-to-consumer Internet
commerce, information commerce and commercial publishing. Open Market's
software includes a wide spectrum of functionality required to effectively
conduct business on the Internet, allowing companies to attract customers to
their Web sites, interest them in acting upon an offer, complete a transaction
and service them once a transaction has been completed.
Industry Background
The Internet and the World Wide Web have significantly altered the business
environment for companies of all sizes within every industry. For the first
time, businesses can reach buyers and buyers can reach businesses with
immediacy and efficiency and with few constraints. The changes introduced by
this new commercial medium will encourage most companies to take advantage of
it or be threatened by competitors more adept at exploiting it.
Over the last six years, business use of the Internet has progressed in
stages. The focus in 1994 and 1995 was on communication--providing Web access
to users and using the Net to enhance the flow of information. Recognizing
that prospective buyers were becoming "wired", companies turned next to
establishing a business presence on the Web. The focus during this stage began
with Web site content creation and now encompasses unique capabilities of the
medium including personalization, electronic communities and interactive
marketing. Having established an electronic presence and reached potential
buyers, businesses are moving to the next stage--commerce.
The Company believes that this trend towards Internet commerce will continue
to accelerate in 1999 and 2000 and that it will be applicable to the sellers
of both "hard goods" products and services as well as the sellers of "soft
goods" products, such as software and reference information. With regard to
the longer-term opportunity, industry analysts such as Forrester Research
currently project U.S. business on the Internet will grow from $43 billion in
1998 to $1.3 trillion in 2003. Open Market believes it is well positioned to
take advantage of this fast-growing segment.
The Open Market Solution
Open Market's solution is comprised of application software products
complemented by maintenance, support, professional services offerings and
training, which enable customers to engage in business-to-business and
business-to-consumer Internet commerce, information commerce and commercial
publishing. Open Market's solution combines the advantages of distributed Web
servers deployed throughout a company and across the Internet with the ability
to manage business transactions and Internet applications from secure,
centrally managed sites.
Open Market's products are based upon its distinctive SecureLink(TM)
architecture that addresses the unique requirements of doing business over the
Web. SecureLink provides a selling company with the freedom to establish its
electronic presence using virtually any system platform, any Web server
software and any authoring software or data repository. Similarly, SecureLink
imposes few constraints on buyers, allowing them to make purchases from
virtually any Web-enabled client. SecureLink also functions over the
established Web communications infrastructure including firewalls and proxy
servers.
Strategy
The Company's objective is to be a leading supplier of comprehensive,
packaged application software for Internet commerce, information commerce and
commercial publishing. To achieve this objective, the Company is pursuing the
following strategies:
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Broadly establish the premise that Internet commerce requires much more than
payment processing
Open Market believes that the Internet significantly alters the business
environment for companies of all sizes within every industry. In order for
Internet commerce strategies to be successful, Open Market believes that
comprehensive business applications with significantly more functionality than
just payment processing are required. Today, the successful leaders of
Internet commerce offer comprehensive, online order management, which usually
includes the capability to capture orders (item, price, tax and shipping
costs), process orders (authenticating buyers, determining form of payment,
processing payment and addressing fulfillment) and service orders online
(order and shipment status, transaction statements and customer service).
Provide comprehensive solutions utilizing packaged application software and
best-in-class services
The Company expects that the market for Internet commerce solutions will
move in favor of comprehensive, packaged applications. Such solutions usually
offer a faster time to market and therefore, inherently provide a faster time
to profitability. As in any maturing market, the natural evolution is from
customized to off-the-shelf solutions. A complete suite of services will be a
critical component of the ultimate success for Internet commerce customers.
The Company's product and services offerings are marketplace-driven and
reflect the best practices of customers that have been at the forefront of
Internet commerce.
Provide robust, end-to-end solutions in key markets
Open Market has recognized that in certain markets such as manufacturing and
distribution and information commerce, its competitive position is greatly
enhanced by offering a robust, end-to-end solution. In 1997, the Company
acquired two businesses that complement its business-to-business and
information commerce solutions. These acquisitions resulted in the
introduction of the Company's LiveCommerce(TM) Internet catalog product and
deeper integration between the Folio product suite and Transact(TM). In May of
1998, Open Market acquired ICentral, the developer of ShopSite(TM), industry-
leading software which enables businesses to establish a commercial web
presence quickly and affordably. The acquisition of ICentral enabled Open
Market to provide a complete solution to small and medium-sized businesses
through its commerce service provider channel. The Company continues to
evaluate opportunities for relationships with companies who offer
complementary products, as well as potential technology acquisitions, in order
to round out its solutions in these and other key markets.
Leverage the Company's expertise
Since the Company began operations in April 1994, it has focused its
financial and technical resources primarily on solutions for Internet
commerce. This focus has enabled the Company to develop a substantial
knowledge-base resulting from real world experience with a large base of
customers conducting Internet commerce. This extensive experience in the
marketplace is an asset that the Company intends to exploit in a number of
ways. First, the Company believes that there is an opportunity to transfer
this knowledge-base through its consulting organization and to capitalize on
what it perceives as a growing demand for business consulting services.
Second, the Company plans to continue to enhance its product offerings by
incorporating the "best practices" and lessons learned in the marketplace into
future product releases.
Leverage the Company's established direct and indirect distribution channels
Over the last four years, the Company made significant investments to
establish global direct and indirect distribution channels. The Company
increased its direct field-based sales force to 65 people worldwide and
believes that its seasoned team of sales professionals has the depth of
experience required for solution selling. In addition, the Company has
developed cooperative partnerships worldwide with Internet technology vendors
and systems integrators. Many of these companies, including Commerce Service
Providers ("CSPs"), help to extend the Company's sales and support
infrastructure, its post-sales implementation capabilities and market
awareness for its products.
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Provide global business solutions
Open Market believes that the Internet opens up a global market to
businesses of all sizes located anywhere in the world. Consequently, the
Company has invested significantly in an infrastructure designed to offer
comprehensive services outside of the United States. For example, since
February 1997, it has operated a fully staffed Technical Support and
Professional Services center in the Netherlands. In addition, the Company
began localization of its software products in 1997 and continued to make
localization a high priority in 1998. The Company has established partnerships
with several of the leading distributors around the world, including
Mitsubishi Electronic Information Network Corporation, Komatsu Soft and
Fujitsu Corporation in Japan, LG Software in Korea and Pernec Technologies in
Malaysia.
Leverage the Company's intellectual property
The Company believes that its intellectual property provides Open Market
with a significant strategic advantage. The issuance of three patents to the
Company in the first quarter of 1998 by the United States Patent and Trademark
Office is of significant importance to Open Market. The patents improve the
Company's ability to defend its market position and enhance the Company's
ability to sell products based on such patents which include: Transact,
LiveCommerce, ShopSite and the Folio(R) suite of products. Open Market intends
to make the technology covered by these patents broadly available and to
encourage the continued rapid evolution of commerce over the Web.
Products and Services
Software Products
Open Market has developed a comprehensive, integrated family of software
products, which include Transact, LiveCommerce, ShopSite and the Folio product
suite.
Transact
Transact performs comprehensive order management for Internet commerce,
including capturing of orders, with information such as item, price, tax and
shipping costs, processing orders by authenticating buyers, determining form
of payment, processing payment and addressing fulfillment and servicing orders
online by providing order and shipment status, transaction statements and
customer service.
Transact was first deployed in October 1994 and was commercially released in
May 1996. The fourth version of Transact became available in the first half of
1998. This version represents a significant re-architecture of the product and
incorporates the combined best practices from the Company's established
customer base. Its capabilities include:
. Analysis and Profiling--Transact's integrated database enables analysis
of sales, buyer behaviors and buyer profiles. It allows assessment of the
effectiveness of advertisements, special offers and other promotions. It
stores information needed to identify and target specific groups of
customers.
. Demand Generation--Transact's digital offers and digital coupons allow
merchants to use a variety of digital media, including the Web, e-mail,
"push" technology and CD-ROM, to distribute special offers and discounts
that attract target customers to their Web sites.
. Order Management--Transact provides for the secure, online capture of
orders and validation of payment and address. Transact can perform fraud
detection and check inventory before accepting orders and also supports
partial shipments and back orders.
. Fulfillment--Transact supports the offering of physical goods, digital
goods and subscriptions. Transact provides notification when an order is
placed via an interface to enterprise systems, via a fax, an e-mail, or a
secure Web page. As an order is processed, the customer is notified and
the online status of its order is updated. For digital goods, such as
software and information, Transact provides customers with a secure,
self-service download facility.
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. Payment--Transact supports multiple types of payment. In addition to
purchase orders, credit cards, procurement cards, micro-transactions and
Secure Electronic Transactions ("SET"), the system can also support debit
cards, smart cards, frequent buyer points and other payment types.
Transact performs real-time authorization requests and automatic
settlement. It supports automatic subscription renewals and partial
billing and credits with payment reauthorization.
. Self-Service--Transact provides customers with personalized "Smart
Pages"--secure access to complete shipping, payment and billing
information. Transact can retrieve tracking information from a third-
party shipping company. It also allows customers to resolve payment
problems and replace forgotten passwords themselves.
. Customer Service--Transact offers customer service representatives a
comprehensive set of tools for analyzing and resolving customer issues
quickly and easily. For example, representatives can locate orders by
customer, date, item and even payment type.
. Reporting--Transact's integrated database helps companies stay abreast of
developments in their online businesses. The system provides an array of
standard reports as well as support for some of the most popular
reporting and analysis software.
Transact is sold to two types of customers: (1) corporate customers who use
the product for their own Web-based business activities and (2) CSPs who use
the product to provide Internet commerce transaction capabilities to their
customers. Corporate customers include Ingram, Acer America, Milacron,
Standard & Poors, Tribune Company, USA Today and Business Week. Transact runs
on high-end UNIX systems and the Company expects to port the software to the
NT/Intel platform sometime in the second half of 1999.
CSPs include many of the world's largest telecommunications companies, such
as AT&T (which has been using Transact for more than two years as the core of
its SecureBuy service), Cable & Wireless, France Telecom, Swiss PTT and Nippon
Telegraph & Telephone. Barclay's Bank and First Union are among the banks and
other financial services firms that serve as CSPs using Transact. As of
December 31, 1998, more than fifty CSPs have purchased Open Market software.
LiveCommerce
In September 1997, Open Market introduced LiveCommerce, an application that
allows manufacturers, distributors and retailers to create and manage large
catalogs on the Web. Customers include C&K Components and Milacron. In
combination with Transact, LiveCommerce represents a comprehensive Internet
commerce solution for both large retailers and industrial manufacturers in
industries such as scientific equipment, computers, office supplies,
replacement parts and electronic components. The Company shipped Version 1.0
of LiveCommerce in October 1997 and Version 2.0 in 1998.
ShopSite
Open Market's ShopSite product is a browser-based, easy-to-use, store-
building product targeted to the needs of small businesses. ShopSite
simplifies the process of setting up an online catalog with easy-to-use
features, such as store design wizard, context-sensitive help, and a fill-in-
the-blank interface. In as few as fifteen minutes, a non-programmer can set up
a fully functioning online store--without installing anything on a local
machine. In addition, ShopSite users can seamlessly tie to Open Market's
Transact through a commerce service provider. Over 80 service providers offer
the Shopsite products, including Best Internet, Anaserve, Netcom, Hiway
Technologies and Infinet. The ShopSite product was acquired in the Company's
acquisition of ICentral in May of 1998. In October of 1998, the Company
introduced ShopSite TX, which combines a quick, easy and inexpensive
storefront with the Internet commerce infrastructure of Transact.
Folio Products
Open Market's Folio products allow publishers to make information available
electronically on either CD-ROM or the Internet. The products were developed
by Folio Corporation, which Open Market acquired in March
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1997. The products are widely used by commercial publishers selling business-
critical information to industries such as tax, legal, accounting, banking and
insurance.
Open Market's Folio products include:
. Folio(R) Builder--helps automate the process of gathering information
from multiple sources and formats into a single, secure repository, the
Folio infobase, for easy distribution and maintenance.
. Folio SiteDirector(TM)--reduces the effort required to manage and
distribute information over an intranet, extranet and the Internet. It is
an application that converts Folio infobases to HTML and delivers
information, on demand, to Web browsers.
. Folio VIEWS(R)--helps users easily find their way through information
collections that are hundreds of megabytes in size. Features such as
sophisticated, near-instantaneous searching, custom query templates,
highlighters, sticky notes and bookmarks make even the largest reference
collections seem friendly and familiar.
. Folio(R) Publisher--provides a software solution for commercial
publishers that want to sell their informational content electronically.
It lets publishers (1) package robust information retrieval software with
their information and (2) provide a redistribution license and software
solution for creating commercial infobase titles. The product's
sophisticated security helps publishers protect intellectual property and
support diverse sales agreements.
. Folio(R) Integrator--contains a software developer's kit for building
commercial InfoApps, which are customized applications that integrate
diverse data types.
. LivePublish(TM) and SecurePublish(TM)--addresses the publishing, rights
management and information commerce needs of the information publishing
industry. Introduced in November of 1998, LivePublish(TM) and
SecurePublish(TM) are the next generation of products in Open Market's
Folio information publishing product suite. LivePublish is a
comprehensive, enterprise-strength product for the production and secure
delivery of information via the Web including the public Internet,
intranets, and extranets. SecurePublish is an intranet subscription
server and logging system that enables publishers and corporate intranet
customers using LivePublish to negotiate contracts based on content
usage, not just concurrency usage or a site license. This new solution
addresses the publishing, rights management, and information commerce
needs of the information publishing industry.
The combination of the Folio product suite with Transact provides a robust,
end-to-end solution for the information commerce market.
Commercial publishing customers include Reed Elsevier, Thomson West, BNA and
Wolters-Kluwer. The Folio products are also used to manage information by
customers outside of the publishing industry, including Novell, KPMG,
PeopleSoft and Travelers Insurance.
Services
Open Market believes that offering a comprehensive suite of professional
services is a critical component of the ultimate success of its customers. In
support of this belief, the Company has invested in service program
development and worldwide delivery capabilities. Open Market offers a full
suite of services to its customers, including Maintenance and Technical
Support, Professional Services and Education Services.
The Company supports its products from service centers in Burlington,
Massachusetts; Provo, Utah; Amsterdam, Netherlands; Sydney, Australia and
Tokyo, Japan.
Maintenance and Technical Support
Open Market customers have a choice in the level of support they purchase
for their Open Market products. Basic support includes technical support with
problem reporting via phone, email, fax or the Web. It also includes product
updates and upgrades, discounts on training and a subscription to a quarterly
newsletter. Premium support includes basic support plus 7-day by 24-hour
technical support.
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Professional Services
The Company has witnessed growing demand for its Professional Services as
companies recognize the need to capture the knowledge and experience that Open
Market has gained from its extensive experience in the marketplace. Open
Market's Professional Services augment solutions to meet project goals and
technical needs, including:
. Business consulting
. Internet commerce business planning
. Solution design and implementation
. Information management project consultation
. Management and execution
. Resident consulting programs for extended resource needs
Education Services
Open Market understands that training is essential for customers who are
responsible for the management and operation of Open Market's products. Open
Market's Educational Services provide its customers the training they need for
all current Open Market products. Classes are held regularly at training
facilities in the Open Market regional service centers. In addition, the
Company offers customized training solutions onsite at the customer's own
facility.
Technology
Open Market has a differentiated set of products and services that are built
upon an innovative product architecture, a fully integrated approach to
security and patented technology.
SecureLink Architecture
Open Market's products are based upon its distinctive SecureLink
architecture, which addresses the unique requirements of doing business over
the Web. SecureLink provides a selling company the freedom to establish its
electronic presence using virtually any system platform, any Web server
software and any authoring software or data repository. Similarly, SecureLink
imposes few constraints on buyers, allowing them to make purchases from
virtually any Web-enabled client. SecureLink functions over the established
Web communications infrastructure, including firewalls and proxy servers.
The standards-based, distributed characteristic of the SecureLink
architecture will become even more important with the emergence of electronic
communities or destination sites. These entities will thrive by aggregating
information from multiple distributed sources and unifying it within a common
commercial infrastructure.
Security in Open Market's Commerce Architecture
Security is a primary concern for both buyers and sellers on the Internet.
Although both parties want to ensure that their communications are
appropriately secure, they will each have different requirements and different
levels of risk tolerance for securing their communication. Some typical
security concerns include privacy of the communication, authentication of the
other party and integrity of the communication. Buyers and sellers may also be
concerned about the storage of sensitive information, such as payment
credentials, as well as the protection of this information against
unauthorized users.
Open Market's approach to security is based on four key principles:
. Understanding the business risks and expectations for security in
Internet commerce applications
. Designing with the "whole system" in mind--a system cannot be secure if
parts of it are left open
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. Incorporating the best technology components for the applications
. Operating the system carefully--without proper operation, the best
security system can be compromised.
Open Market believes that advanced security technology is fundamental to the
success of Internet commerce and consequently has made transaction and content
security a key aspect of its product strategy. Since its inception, the
Company has invested heavily in developing security expertise in order to
provide robust, highly secure product and service offerings. These offerings
are based upon the Company's flexible, multi-level security architecture,
which allows customers to select the level of security appropriate for their
applications. The Company intends to continue its focus on developing and
enhancing its security technology.
Product Development
The Company believes that its future success will depend in large part on
its ability to keep pace with technological developments in the marketplace
and to address the increasingly sophisticated needs of its customers.
Accordingly, the Company intends to expand and enhance its existing product
offerings and to introduce new application products for the business-to-
business and business-to-consumer Internet commerce, information commerce and
commercial publishing markets. The Company's customers and partners provide
significant product feedback that is channeled into product development and
innovation. While the Company expects that certain of its new products will be
developed internally, the Company may, based on timing and cost
considerations, expand its product offerings through acquisitions. In
addition, the Company has relied and will continue to rely on external
relationships and development resources for development of certain of its
products and product components.
Since inception, the Company has made substantial investments in product
development and related activities. As of December 31, 1998, the Company had
118 employees and independent contractors devoted to product development. The
Company's research and development expenses were approximately $23 million,
$27 million and $16 million in 1998, 1997 and 1996, respectively. To date, the
Company has not capitalized any software development costs. The Company
expects to continue to devote substantial resources to its product development
activities.
Intellectual Property and Other Proprietary Rights
Patents
The Company relies on trademark, copyright, patent and trade secret laws,
employee and third-party non-disclosure agreements and other methods to
protect its proprietary rights.
In 1998, the United States Patent and Trademark Office issued three patents
to Open Market covering its technology that is not only core to the Company's
products, but that the Company believes should have a significant impact on
the industry at large.
The key technologies covered by the three patents are as follows:
The Payment Patent, Patent Number 5,724,424, covers secure, real-time
payment using credit and debit cards over the Internet. It is one of the
earliest and broadest Internet payment patents yet granted, with a filing
date of December 16, 1993.
The Network Sales Patent, Patent Number 5,715,314, covers the use of
"electronic shopping carts" which merchants provide to their customers as a
way to accumulate items to purchase before checking out. This patent also
describes a method of passing of payment and purchase information through a
URL. This technology allows digital offers to be distributed on the Web,
via e-mail, CD-ROMs and over broadcast media.
The Session Identifier Patent, Patent Number 5,708,780, covers an
essential facet of Web-based marketing--the ability to analyze how users
browse through content on a Web site. Session identifiers allow businesses
to market more effectively to buyers based upon viewing patterns. Session
identifiers can also be
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used to limit access to specific content, such as subscription, account
information, or an organization's internal information.
In addition to the above three patents issued in 1998, Open Market is the
exclusive licensee, under a Patent and Copyright License Agreement between the
Massachusetts Institute of Technology and Open Market, Inc. dated as of
October 17, 1994, of rights to U.S. Patent Number 4,845,658 "Information
Method and Apparatus Using Simplex and Duplex Communications" issued on July
4, 1989 (the "Broadcast Patent"). The Broadcast Patent describes a method for
broadcasting digital data from a centralized data source to multiple remote
sites (using systems such as satellite, cable, Internet) with user control
over the data selected and stored from the broadcast data. Open Market also
received a fourth patent in 1998, Patent Number 5,812,776, which covered the
use of telephone numbers as URL's involving redirection by a directory server.
Open Market continually assesses its technology for potential patent filings
and has additional patent applications pending in the United States relating
to the Company's product architecture and technology. While the Company
believes that the pending patent applications relate to patentable inventions,
there can be no assurance that any pending or future patent applications will
be granted or that any issued patent relied upon by the Company in the future
will not be challenged, invalidated or circumvented, or that the rights
granted thereunder or under licensing agreements will provide competitive
advantages to the Company. The Company believes that, due to the rapid pace of
technological innovation for Internet products, its ability to establish and
maintain a position of technology leadership in the industry is dependent more
on the skill of its development personnel than upon the legal protections
afforded its existing technology.
The Company's success is dependent in part upon its proprietary software
technology. There can be no assurance that its agreement with employees,
consultants and others who participate in the development of its software will
not be breached or that the Company's trade secrets will not otherwise be
known to or independently developed by competitors. Furthermore, there can be
no assurance that the Company's efforts to protect its proprietary technology
will not fail to prevent the development and design by others of products or
technology similar to or competitive with those developed by the Company.
The Company is not aware that it is infringing on any patent or violating
any other proprietary rights of any third party relating to the Company or the
Company's products. However, the software market is characterized by frequent
and substantial intellectual property litigation. Intellectual property
litigation is complex and expensive and the outcome of such litigation is
difficult to predict.
The Company's success will depend in part on its continued ability to obtain
and use licensed technology that is important to the functionality of its
products. An inability to continue to procure or use such technology would
likely have a material adverse effect on the Company's business, operating
results, or financial condition.
Channels and Partnerships
The Company's objective is to achieve broad market penetration by employing
multiple distribution channels, including direct sales, OEMs, system
integrators, independent software vendors and VARs.
The Company has offices throughout the United States and in Canada, the
United Kingdom, France, Germany, the Netherlands, Italy, Japan and Australia.
It has established distribution relationships in several other countries,
including Singapore, Malaysia, Korea, India, Brazil, South Africa and Israel.
Augmenting the Company's direct field based sales force, which totaled 65
employees at the end of 1998, are more than 50 business partners selling
solutions based on the Folio product suite. In addition, Open Market's CSPs
collectively have the potential to deliver the benefits of Open Market's
software to small and medium-sized businesses across the world.
Customers and Markets
Open Market's software products are used by a variety of companies across a
broad spectrum of markets, including telecommunications, financial services,
industrial manufacturing and distribution, retail and
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commercial publishing. These businesses take advantage of Open Market's
solutions either directly by deploying the software within their own
enterprises, or indirectly by procuring services from commerce service
providers (CSPs) running Open Market software. These CSPs offer commerce
services to small and mid-sized companies that wish to outsource the cost and
complexity associated with implementing and maintaining this software within
their own organizations.
CSPs include many of the world's largest telecommunications companies, such
as AT&T (which has been using Transact for more than two years as the core of
its SecureBuy service), France Telecom, Swiss PTT and Nippon Telegraph &
Telephone. Barclay's Bank and First Union are among the banks and other
financial services firms that serve as CSPs using Transact. As of December 31,
1998, more than fifty CSPs have purchased Open Market software.
Business-to-business manufacturers and distributors use Open Market's
software to conduct Internet commerce with their partners. Open Market has a
comprehensive solution for business-to-business suppliers who not only want to
build and manage a compelling online catalog, but who also want to sell
products directly over the Internet. Some of Open Market's customers in this
area include: C&K Components, Ingram Micro, Tektronix, Acer America and
Milacron.
Commercial publishers, including Reed Elsevier, Thomson West, BNA and
Wolters-Kluwer, use Open Market's products to create and distribute high-value
collections of professional reference information via CD-ROM and the Internet.
Corporate users of professional information use the Folio product suite to
customize, personalize, manage and distribute information vital to their
ongoing business. Examples include Novell, KPMG, PeopleSoft and Travelers
Insurance.
The combined approach of Folio software to organize information
electronically and Transact to capture the commercial value of that
information comprises Open Market's end-to-end information commerce solution.
For example, commercial publishers can easily combine information from
disparate sources into a single, secure repository - the Folio infobase - and
then publish it on the World Wide Web. Folio technology makes it possible to
manage, index, search and distribute multi-gigabyte collections of free-format
information. Open Market's information commerce solution enables corporate
consumers of professional publishing information to search huge stores of
information, find exactly what they are looking for and purchase it quickly
and easily.
With the growth of the Internet and the shift in Internet user demographics,
many retailers have accelerated their move to the Internet. The business-to-
consumer segment is focused on large retail and manufacturing companies that
sell physical goods directly to the consumer. Large consumer companies such as
Sony and USA Today are using Open Market's Transact system to handle their
high-end Internet commerce needs.
Folio products have been widely adopted across a broad spectrum of
industries including commercial publishers who use Folio products to publish
more than 3,200 titles containing legal, tax, accounting and banking reference
material.
Competition
The market for Internet commerce software and services is relatively new,
intensely competitive, quickly evolving and subject to rapid technological
change. The Company expects competition to continue to increase in the future.
The Company's Internet commerce products compete with two categories of
competitors. The first category is in-house custom solutions built by a
company's information technology group. The second category is products and
components offered by companies such as BroadVision, IBM, Intershop,
InterWorld, Microsoft, Oracle and others. Some of the Company's current and
potential competitors have longer operating histories, greater name
recognition, larger installed customer bases and significantly greater
financial, technical and marketing resources than those of the Company. Such
competition could materially adversely affect the Company's business,
operating results, or financial condition.
11
<PAGE>
In addition, several companies compete with the total information publishing
solution offered by the Folio suite of products. There are companies such as
Verity and Fulcrum that offer text-search retrieval engines that are seen as
competitive products but that do not address rights management or
personalization. Other potential competitors have not yet made a transition to
the Internet and have not addressed the commerce aspects of an Internet
solution. The emergence of the Internet and the creation and adoption of new
standards such as XML are creating a new group of competitors. Some of these
competitors are large companies such as Microsoft and Lotus who have greater
name recognition and more resources at their disposal.
Competitive factors in the Internet-based software and services market
include innovative technology, breadth of product features, product quality,
marketing and distribution resources, customer service and support and price.
While the Company believes that its experience to date demonstrates its
ability to compete, there can be no assurance that the Company will be able to
compete successfully against current or future competitors.
Employees
As of December 31, 1998, the Company had 398 employees and independent
contractors. Of the total employees and independent contractors, 118 were in
engineering, 112 in sales and marketing, 45 in customer service, 60 in
professional services and 63 in general and administration. The Company's
future success depends in significant part upon the continued service of its
key technical and senior management personnel and its continuing ability to
attract and retain highly qualified technical and management personnel.
Competition for highly qualified personnel is intense and there can be no
assurance that the Company will be able to retain its key managerial and
technical employees or that it will be able to attract and retain additional
highly qualified personnel in the future. None of the Company's employees is
represented by a labor union. The Company has not experienced any work
stoppages and considers its relations with its employees to be good.
Item 2. PROPERTIES
Open Market's principal offices are located in Burlington, Massachusetts and
consist of approximately 120,000 square feet of office space. The Burlington
facility lease expires in February 2010. The Company subleases 25,898 square
feet of this space to a commercial tenant. The Company also leases
approximately 81,000 square feet of office space in Cambridge, Massachusetts.
This entire space was sublet in 1998 to commercial tenants for the balance of
the lease term. The Company believes its existing facilities are adequate to
meet its future needs.
In addition, the Company owns and occupies a building which consists of
approximately 32,000 square feet in Provo, Utah. This office space is used
primarily as an engineering, marketing, sales and customer support facility
for the Company's Folio and ShopSite product groups.
The Company also has sales offices throughout the United States and in
Canada, the United Kingdom, France, Germany, the Netherlands, Italy, Japan and
Australia. The Company offers support services to its customers from five
facilities located in Burlington, Massachusetts; Provo, Utah; Amsterdam in the
Netherlands; Sydney, Australia and Tokyo, Japan.
Item 3. LEGAL PROCEEDINGS
The Company is not engaged in any material legal proceedings.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of the Company's security holders during
the fourth quarter of the year ended December 31, 1998.
12
<PAGE>
PART II
Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock is quoted on the Nasdaq National Market under the
symbol OMKT. The following table sets forth for the periods indicated the high
and low closing sales prices per share of the Company's Common Stock as
reported on the Nasdaq National Market.
<TABLE>
<CAPTION>
Quarter Ended High Low
------------- ------- -------
<S> <C> <C>
December 31, 1998......................................... $20.750 $ 5.000
September 30, 1998........................................ $20.687 $ 8.563
June 30, 1998............................................. $28.375 $14.125
March 31, 1998............................................ $21.000 $ 9.500
December 31, 1997......................................... $16.750 $ 9.313
September 30, 1997........................................ $15.813 $ 9.625
June 30, 1997............................................. $13.250 $ 6.625
March 31, 1997............................................ $15.875 $ 9.000
</TABLE>
As of February 26, 1999, there were 418 holders of record of the Company's
Common Stock.
The Company has never paid any cash dividends on its Common Stock. The
Company currently intends to retain any earnings for future growth and
therefore does not anticipate paying any cash dividends on its Common Stock in
the foreseeable future.
13
<PAGE>
Item 6. SELECTED FINANCIAL DATA
The selected financial data presented below for the years ended December 31,
1998, 1997 and 1996 are derived from the Company's audited consolidated
financial statements. The following selected financial information should be
read in conjunction with "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and the consolidated financial statements
and the notes thereto, included elsewhere in this report.
<TABLE>
<CAPTION>
For the Years Ended
December 31,
----------------------------
1998 1997 1996
-------- -------- --------
(In Thousands, Except
Share and Per Share Data)
<S> <C> <C> <C>
Operating Information
Revenues:
Revenues...................................... $ 62,145 $ 61,260 $ 22,501
Cost of revenues.............................. 17,299 11,643 5,493
-------- -------- --------
Gross profit.................................. 44,846 49,617 17,008
-------- -------- --------
Selling and marketing......................... 32,013 36,554 23,810
Research and development...................... 23,275 26,732 16,393
General and administrative.................... 11,954 11,335 5,925
In-process research and development........... 5,700 34,250 --
Restructuring charge.......................... 2,042 -- --
-------- -------- --------
Total operating expenses...................... 74,984 108,871 46,128
-------- -------- --------
Loss from operations.......................... (30,138) (59,254) (29,120)
-------- -------- --------
Interest income, net.......................... 276 2,050 2,963
Other (expense) income........................ (285) (218) 7
-------- -------- --------
Loss before provision for income taxes........ (30,147) (57,422) (26,150)
-------- -------- --------
Provision for income taxes.................... 325 584 360
-------- -------- --------
Net loss...................................... $(30,472) $(58,006) $(26,510)
-------- -------- --------
Weighted average shares outstanding--basic and
diluted**.................................... 33,483 30,994 20,923
Net loss per share--basic and diluted**....... $ (0.91) $ (1.87) $ (1.31)
======== ======== ========
</TABLE>
<TABLE>
<CAPTION>
December 31,
-----------------------
1998 1997 1996
------- ------- -------
<S> <C> <C> <C>
Balance Sheet Information
Cash and marketable securities......................... $34,879 $30,638 $72,033
Working capital........................................ $27,845 $18,840 $66,820
Total assets........................................... $94,958 $80,874 $85,802
Stockholders' equity................................... $54,993 $43,459 $72,367
Number of shares outstanding........................... 35,291 30,971 28,565
Number of employee and contractors..................... 398 527 351
======= ======= =======
</TABLE>
- --------
** See Note 2 of Notes to Consolidated Financial Statements
14
<PAGE>
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Overview
Open Market develops, markets, licenses and supports enterprise-class,
packaged application software products and professional services that allow
its customers to engage in business-to-business and business-to-consumer
Internet commerce, information commerce and commercial publishing. Open
Market's Internet commerce software includes a wide spectrum of functionality
required to effectively conduct business on the Internet, allowing companies
to attract customers to their Web site, engage customers in acting upon a
commercial offer, complete a secure transaction and service customers once a
transaction has been completed.
This section of the Annual Report may include historical information and
certain forward-looking statements. Please review below the information
contained under the heading "Certain Factors That May Affect Future Operating
Results" that addresses certain risks and uncertainties that could cause the
Company's future operating results to differ from those indicated by any
forward looking statements made by the Company or others. The Company
recommends that the business and historical discussions put forth in this
section be read together with the discussion of such risks and uncertainties.
In addition, the following discussion should be read in conjunction with the
consolidated financial statements and the notes thereto, and the information
included elsewhere herein. All dollar amounts presented in the following
discussion are presented in thousands, except share and per share amounts and
employee data.
Results of Operations
Revenues
Revenues for the three-year period were as follows:
<TABLE>
<CAPTION>
Comparative
Years Ended December 31, Percentage Changes
-------------------------- -----------------------
1997 to 1996 to
1998 1997 1996 1998 1997
-------- -------- -------- --------- ---------
<S> <C> <C> <C> <C> <C>
Product revenues...... $ 42,245 $ 48,168 $ 17,200 (12%) 180%
Service Revenues...... 19,900 13,092 5,301 52% 147%
-------- -------- -------- --------- ---------
Total revenues...... $ 62,145 $ 61,260 $ 22,501 1% 172%
======== ======== ======== ========= =========
</TABLE>
Total revenues by geography for the three-year period were as follows:
<TABLE>
<CAPTION>
Years Ended December 31,
--------------------------
1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
North America..................................... $ 42,003 $ 43,282 $ 18,643
Europe/Africa..................................... 14,841 10,811 1,877
Asia/Pacific Rim.................................. 4,690 5,957 1,921
Other............................................. 611 1,210 60
-------- -------- --------
Total revenues.................................. $ 62,145 $ 61,260 $ 22,501
======== ======== ========
</TABLE>
Geographical percentage of total revenues for the three-year period were as
follows:
<TABLE>
<CAPTION>
Years Ended December 31,
------------------------------
1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
North America................................. 68% 70% 83%
Europe/Africa................................. 23% 18% 7%
Asia/Pacific Rim.............................. 8% 10% 8%
Other......................................... 1% 2% 2%
-------- -------- --------
Total revenues.............................. 100% 100% 100%
======== ======== ========
</TABLE>
15
<PAGE>
Summary
The Company generates revenues from its software product license fees,
professional service fees, and product maintenance and technical support fees.
Prior to December 1997, the Company recognized revenue in accordance with
Statement of Position (SOP) 91-1. Subsequent to December 1997, the Company has
recognized revenue in accordance with SOP 97-2, Software Revenue Recognition,
which amended SOP 91-1.
The Company's customer base is diversified, with no single customer
representing greater than 10% of total revenues in 1997 or 1998. In 1996, one
customer accounted for greater than 10% of the Company's total revenues. The
Company's customers include many Fortune 2000 corporations and affiliated
companies, including several of the world's largest telecommunications
companies and publishing firms.
Total revenue growth in fiscal years 1997 and 1998 was derived from the
continued demand for the Company's Internet commerce products, an increase in
demand for the Company's professional service offerings, and growth in
maintenance and support revenues due to continuing expansion in the Company's
customer base. Total revenues for 1998 increased marginally, approximately 1%
over the prior year, primarily due to lower-than-planned revenues in (1) North
America due to slower-than-expected development in the domestic Internet
commerce market, and (2) the Asia/Pacific Rim region primarily as a result of
the Asian economic crisis. Additionally, in 1998, the Company discontinued
sale of three product lines, Axcess, WebServer, and Secure WebServer, that it
had previously offered in fiscal years 1996 and 1997. Management believes that
this impacted annual revenue growth by 20% in 1998 versus 1997.
Product Revenues
The Company's 1998 product revenues decreased 12% over the prior year.
Product revenues include: (1) software products, which include the licensing
of Transact, the Company's flagship product for Internet commerce,
LiveCommerce, the Folio product suite, and ShopSite products, and (2) royalty
revenues, which include publisher royalties and merchant license fees. In
1998, the decrease in product revenue was principally due to two factors: (1)
a decrease in software product revenues from the Company's Folio products
group and (2) in 1997, the Company recorded approximately $4,700 in product
revenues for the sale of its Axcess product line to Raptor, Inc., a one-time
event as well as approximately $4,700 in other discontinued products. The
decrease in Folio software revenues was due to a decrease in demand for the
Company's CD-Rom based publishing software, which is sold to corporate
customers primarily through the Company's business partners. Management
believes that the decrease in demand for CD-Rom based publishing software over
the year was due to the industry's gradual migration to Internet based
publishing software.
Product revenues accounted for 68%, 79% and 76% of total revenues in fiscal
years 1998, 1997 and 1996, respectively. Management expects that product
revenues will continue to comprise the greater percentage of total revenues
for the foreseeable future.
In 1997, the Company's product revenues grew 180% over 1996 revenues. The
Company increased the unit sales of its flagship product, Transact, while also
acquiring Folio and driving the Folio product sales to higher levels.
Additionally, product revenue growth in 1997 was partly attributed to the one-
time licensing of the Company's Axcess technology to Raptor, Inc., and
increases in publisher royalties and merchant license revenues from the prior
year.
Service Revenues
In fiscal 1998, the Company's total service revenues grew 52% over the prior
year due to increased demand for its professional service offerings and its
maintenance and support services. Professional services include education,
implementation and consulting services. Professional service revenues
increased primarily due to an increase in consulting projects related to the
development of payment gateways, fraud modules, and custom engineering, as
well as other special projects related to the Company's Internet commerce
solutions. In 1998, the Company continued to build its infrastructure as well
as improve the marketing and delivery of these services.
16
<PAGE>
Accordingly, in fiscal 1998, professional service revenues increased 70% over
fiscal years 1997 and increased 90% from 1996 to 1997 and accounted for 20%,
12% and 17% of total revenues in fiscal years 1998, 1997 and 1996,
respectively.
In fiscal 1997, the Company's service revenues grew by 147% over the prior
year due to a developing professional service practice as well as an increased
customer base that generated significant maintenance and support revenue. The
demand for consulting services in fiscal 1997 fueled the significant growth in
professional service revenues. These consulting services included the
development of various gateways and modules related to the Company's Internet
commerce solutions.
Maintenance and support revenues are derived from the execution and delivery
of the Company's software product maintenance and technical support program. A
product maintenance and support agreement secures the customer's right to
receive product updates, upgrades and enhancements from the Company, on a
when-and-if-available basis, for all products specifically covered under the
agreement. The customer also receives technical support in the form of
telephone or on-site assistance from the Company, as appropriately required,
to continually ensure the smooth operation of the covered products in the
customer's environment. Customers are typically required to renew their
contracts on an annual basis as the standard maintenance and support agreement
is 12 months in duration. Thus, maintenance and support revenues are typically
a function of new product sales and the annual renewal of existing contracts
in the program. Maintenance and support is calculated at 20% to 30% of the
list price of the product purchased depending on the type of program chosen
and less any applicable discounts. In fiscal years 1996, 1997 and 1998, the
Company experienced positive trending of its maintenance and support revenues
in conjunction with its expanding customer base and strong renewal rates. In
fiscal 1998, maintenance and support revenues increased 29% over fiscal years
1997 and increased 301% from 1996 to 1997 and accounted for 12%, 9% and 6% of
total revenues in fiscal years 1998, 1997 and 1996, respectively. Management
believes that despite these positive historical trends, a significant or
prolonged downturn in product revenues and/or increased cancellations of the
maintenance and support program by existing customers could have a negative
impact on future maintenance and support revenue trends.
Cost of Revenues
Cost of revenues for the three-year period were as follows:
<TABLE>
<CAPTION>
Years Ended December 31,
----------------------------
1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
Cost of product revenues......................... $ 2,767 $ 2,477 $ 768
Percentage cost of product revenues............ 6.5% 5% 4%
Product gross margin........................... 93.5% 95% 96%
</TABLE>
Cost of product revenues includes the costs to distribute products, costs of
media on which products are delivered, royalties for third-party technology
that is embedded into certain products of the Company, and royalties for the
resale of third-party software products. In fiscal years 1997 and 1998, the
increased cost of product revenues was primarily due to increased costs for
the Company's third-party royalty commitments. Management believes that these
costs as a percentage of product revenues will remain in the range of 6% to
10% for the foreseeable future as the Company incorporates more third-party
technology into its products and continues to resell third-party software
products with its Internet commerce solutions.
Cost of service revenues for the three-year period were as follows:
<TABLE>
<CAPTION>
Years Ended December 31,
---------------------------
1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
Cost of service revenues......................... $ 14,532 $ 9,166 $ 4,725
Percentage cost of service revenues............ 73% 70% 89%
Service gross margin........................... 27% 30% 11%
</TABLE>
17
<PAGE>
Cost of service revenues consists primarily of personnel related costs and
costs incurred in providing development, consulting, support, and other
technical services to customers. In fiscal 1998, growth in employee-related
and outside consulting expenses increased from the prior year as a result of
growth in the Company's consulting business. The Company continued to increase
the number of its consultants by hiring and using external sources throughout
the year in order to meet the needs of its customers. Additionally, service
gross margin as a percentage of service revenues decreased approximately 3%
from the prior year, primarily due to continued investments in resources
required to grow the consulting business and lower consultant utilization
rates resulting from extended training processes for new employees.
In fiscal 1997, the cost of service revenues increased as the Company built
an infrastructure to support its customers during fiscal 1996 by increasing
headcount and opening its support center in Europe. In fiscal 1997, service
gross margin as a percentage of service revenues increased approximately 19%
from fiscal 1996 as a result of improved consultant utilization rates.
Additionally, the Company increased the number of consultants throughout the
year in order to meet the needs of its customers.
Operating Expenses
Operating expenses for the three-year period were as follows:
<TABLE>
<CAPTION>
Years Ended December 31,
------------------------
1998 1997 1996
------- -------- -------
<S> <C> <C> <C>
Selling and marketing.............................. $32,013 $ 36,554 $23,810
Research and development........................... 23,275 26,732 16,393
General and administrative......................... 11,954 11,335 5,925
Acquired in-process research and development....... 5,700 34,250 --
Restructuring charges.............................. 2,042 -- --
------- -------- -------
Total operating expenses........................... $74,984 $108,871 $46,128
======= ======== =======
</TABLE>
Selling and Marketing
Selling and marketing expenses consist primarily of the cost of sales and
marketing personnel and outside consultants, as well as the costs associated
with marketing programs, industry tradeshows, sales seminars, advertising, and
product literature. In fiscal 1998, selling and marketing expenses decreased
approximately 12% from the prior year. The decrease was attributed primarily
to a decrease in salary and travel expenses as a result of reductions in sales
and marketing headcount throughout the year and lower commission expenses as a
result of lower product revenues. The Company's domestic sales strategy
consists primarily of a direct sales force for Internet commerce products and
a combination of a direct sales force and channel partners for its suite of
Folio publishing products. The Company's international sales strategy consists
of both a direct sales force and channel partners to market and distribute all
of its products.
The substantial increase in these expenses in 1997 from 1996 was primarily
attributable to the increase in the number of sales and marketing personnel
from the acquisition of Folio. Other costs included in selling and marketing
are the preparation and distribution of new product sales literature and an
increase in facilities from foreign sales offices that opened during 1997. In
fiscal 1997, selling and marketing expenses also increased due to commission
expenses on significantly larger revenues.
Research and Development
Research and development expenses consist primarily of the cost of research
and development personnel and independent contractors, certain purchased
technology, as well as equipment and facilities costs related to such
activities. In fiscal 1998, these expenses decreased approximately 13% over
the prior year primarily as a result of a reduction in employee related
expenses. The Company completed a number of technical projects
18
<PAGE>
during the year that resulted in significant planned reductions in engineering
headcount and expenses related to outside technical consultants whose services
were no longer required upon completion of these various projects. In
addition, the Company realized headcount reductions and other efficiencies
from consolidation of the research and development activities from the
Waypoint, Folio and ICentral acquisitions. Accordingly, management does not
believe that the fiscal 1998 reductions will hinder the Company's position as
a technology leader within the Internet commerce industry. The Company has
invested approximately $70,000 into research and development over the last
three fiscal years and management believes that the current level of
investment will remain consistent in the coming periods. Qualifying
capitalizable software development costs were immaterial in all periods and
accordingly, the Company has charged all such expenses to research and
development in the period incurred.
The substantial increase in these expenses in 1997 from 1996 was primarily
attributable to the increase in the number of research and development
personnel from the acquisitions of Folio and Waypoint. The Company continued
the hiring of additional software engineers and consultants to develop and
enhance the Company's products during 1997, in addition to those added through
the acquisition. Internationalization costs for the Company's various products
also contributed to the increased research and development costs.
General and Administrative
General and administrative expenses consist primarily of the cost of
finance, management and administrative personnel, and legal and other
professional fees. These expenses increased slightly in fiscal 1998 from the
prior year due to strong overall management of expenses and increased
efficiencies resulting from headcount reductions. The marginal increase was
due to an increase in the amortization of goodwill.
The substantial increase in these expenses in 1997 from 1996 was primarily
attributable to the increase in the number of general and administrative
personnel from the acquisition of Folio. Other items that contributed to
increased costs were amortization of goodwill (as a result of the acquisition
of Folio) and increased legal fees, as well as the expansion of the Company's
operations.
Acquired In-Process Research and Development
Acquired in-process research and development expenses consisted of $5,700
relating to the ICentral acquisition in fiscal 1998, and $9,250 and $25,000
relating to the acquisitions of Waypoint and Folio, respectively, in fiscal
1997. These costs were expensed as of the acquisition dates and are included
in the accompanying consolidated statements of operations for the respective
periods. The amount allocated to acquired in-process research and development
relates to projects that have not yet reached technological feasibility and
that, until completion of development, have no alternative future use.
As of the acquisition date of ICentral in April 1998, ICentral had initiated
a research and development effort related to the third major revision of its
flagship ShopSite product suite, an Internet commerce product suite that
allows small to medium-sized web merchants to transact business on the
Internet. The elements of the product suite are as follows: (1) ShopSite
Express, a tool that allows web designers to add a shopping system to any
existing web site, (2) ShopSite Manager, which offers the shopping
functionality of ShopSite Express combined with an automated commerce site
management system, and (3) ShopSite Pro, which combines the features of
ShopSite Manager with an additional set of advanced commerce tools including
real-time payment processing. The in-process technology included significant
new modifications of the features and functionality of the current suite of
products, such as the addition of Cybercash as a payment option, quantity
discount interface capability to allow customers to purchase at quantity
discounts, tax modifications to allow the merchant to decide whether to
calculate tax before or after shipping is calculated, improved shipping
configuration of United Parcel Service shipping zones, and a mailing list
generator. It is expected that these modifications will further enhance the
product's ease of use in the marketplace. As of the acquisition date, the in-
process project was approximately 60% complete and it was estimated that the
in-process technology would have a 7-year life and that the first product(s)
would be introduced during the first quarter of fiscal 1999.
19
<PAGE>
The value of the acquired in-process technology was computed using a
discounted cash flow analysis on the anticipated income stream of the
estimated future product sales of the developed technology. This was
determined by estimating the costs of developing the purchased in-process
development project into commercially viable products, estimating the
resulting net cash flows from the project adjusting the cash flow for
percentage of completion and the core technology component of the acquired
technology and discounting adjusted the net cash flows to their present value.
The estimates used to value the future revenue benefits of the in-process
research and development were based on elements of relevant market sizes and
growth/risk factors, expected trends in technology, and the nature and
expected timing of new product introductions by the Company and its
competitors.
In the valuation analysis, aggregate revenues for ICentral products were
estimated to be approximately $3,300 for fiscal 1998 and increasing to
approximately $62,500 in 2007. Revenues for the in-process technology were
estimated to be approximately $2,300 for fiscal 1998 and increasing to
approximately $28,700 in fiscal 2002, representing a compound annual growth
rate of approximately 65%. The estimated revenues for the in-process
technologies were expected to peak within four years of the acquisition date.
The estimated overall life of the acquired developed technologies of ICentral
is five years.
Operating expenses used in the valuation of ICentral included selling,
general and administrative, and research and development expenses. Operating
expenses were estimated based on historical expense levels of similar
companies operating in similar industries. Selling, general and administrative
expenses expressed as a percentage of revenue for the in-process technologies
were estimated to be 30% throughout the estimation period. Research and
development expenses, also expressed as a percentage of estimated revenue,
were estimated to be approximately 32% and 13% in 1998 and 1999, respectively,
and stabilizing at 20% for the remainder of the estimation period. Cost of
sales was estimated based on an analysis of historical information for similar
companies operating in similar industries. Cost of sales for both the
developed and in-process technologies was estimated to be 19% throughout the
estimation period.
The discount rate selected for both the developed and in-process
technologies was 22% and was estimated by calculating a Weighted Average Cost
of Capital ("WACC") based on publicly traded guideline companies. The WACC
represents the blended, after-tax costs of debt and equity. The cost of equity
was estimated using the Capital Asset Pricing Model ("CAPM") and by reviewing
venture capital rates of return.
The fair values of the assets acquired from ICentral were allocated between
the following:
<TABLE>
<CAPTION>
Asset Fair Market Value
----- -----------------
<S> <C>
In-process Research and Development........................ $ 5,700
Developed Technology....................................... $ 2,110
Goodwill-type Assets....................................... $ 4,190
Acquired Assets............................................ $ 86
-------
Total.................................................... $12,086
=======
</TABLE>
The valuation analysis was performed in accordance with the provisions of
Accounting Principles Board ("APB") Opinions Nos. 16 and 17, wherein all
identifiable assets and intangible assets acquired were identified and
analyzed to determine their fair market values. In addition, to identify the
in-process research and development and determining if there were any
alternative future uses for these projects, these projects were evaluated in
the context of Interpretation 4 of Financial Accounting Standards Board
Statement No. 2 (" FAS 2") and FAS 86: Accounting For Software Costs. Such
evaluation consisted of a specific review of the efforts and uniqueness of the
developments of these projects, and a determination of whether technological
feasibility had been achieved. Accordingly, the Company believed that the
foregoing assumptions used in the ICentral acquired in-process research and
development analysis were reasonable at the time of acquisition. However, no
assurance can be given that the underlying assumptions used to estimate
expected sales revenues, development costs, or profitability, or the events
associated with such projects will transpire, or have transpired, as
estimated.
20
<PAGE>
The Company believes that the ShopSite product suite requires continual
upgrading and refinement to remain competitive in the targeted markets. Thus,
the failure to complete the in-process projects as scheduled may cause
ShopSite revenue to fall off precipitously from forecasted levels. The Company
estimates that if the scheduled ShopSite product releases were not achieved,
the existing ShopSite product suite would remain commercially viable for only
the next 12 to 18 months.
In fiscal 1997, the in-process research and development for the Waypoint and
Folio acquisitions was expensed as a charge against operations in the first
quarter of 1997. The amount allocated to acquired in-process research and
development from the Waypoint and Folio acquisitions relates to projects that
had not yet reached technological feasibility and that, until completion of
development, have no alternative future use. These projects will require
substantial development and testing prior to reaching technological
feasibility. However, there can be no assurance that these projects will reach
technological feasibility or develop into products that may be sold profitably
by the Company. The technology acquired has required, and will continue to
require, substantial additional development by the Company.
Restructuring charges
In the fourth quarter of 1998, the Company implemented a restructuring plan
to better align its operating costs with its anticipated future revenue
stream. The major component of the restructuring relates to the elimination of
approximately 67 employees across the following functions: Engineering (27),
Marketing (17), General and Administrative (22) and Services (1). In addition,
10 employees moved from Engineering to Consulting. Other components related to
the exiting of certain contractual arrangements for porting and product
integration that resulted from a change in product strategy. Other charges
included the write-off of unutilized software, originally intended for use by
the sales force but not implemented due to the reduction in Marketing
personnel. At December 31, 1998 approximately $1,088 of accrued restructuring
charges remained, which is comprised of approximately $756 of severance-
related costs and $332 of contractual costs. The total cash impact of the
restructuring amounted to approximately $1,748. The total cash paid as of
December 31, 1998 was approximately $660 and the remaining amount will be paid
in 1999.
Following are the significant components of the restructuring charge:
<TABLE>
<S> <C>
Employee severance, benefits and related costs....................... $1,260
Write-off of assets.................................................. 294
Termination costs of certain contractual arrangements................ 488
------
$2,042
======
</TABLE>
Non-operating Income
Non-operating income for the three-year period were as follows:
<TABLE>
<CAPTION>
Years Ended December 31,
---------------------------
1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
Interest income.................................. $ 1,373 $ 2,827 $ 3,042
Interest expense................................. (1,097) (777) (79)
Other (expense)/income........................... (285) (218) 7
-------- ------- -------
Total non-operating income..................... $ (9) $ 1,832 $ 2,970
======== ======= =======
</TABLE>
Interest income represents interest earned on cash, cash equivalents, and
marketable securities. The decreases in interest income in fiscal years 1997
and 1998, as compared to the prior year, were attributed primarily to lower
average investments in cash, cash equivalents, and marketable securities as a
result of funding of operations and capital expenditures. Interest expense
relates to the interest charged on the line-of-credit, the Company's note
payable issued in conjunction with the Folio acquisition, a non-recourse
factoring agreement,
21
<PAGE>
the mortgage for the Company's Provo, Utah facility, as well as an obligation
under a license agreement. The increase in interest expense relates to the
additional financing arrangements the Company entered into throughout fiscal
1997 and 1998. Other income/expense primarily represents foreign currency
translation gains and losses. In fiscal 1998, the Company also recorded a loss
of approximately $197 on an equity investment.
Provision for Income Taxes
Provision for income taxes for the three-year period were as follows:
<TABLE>
<CAPTION>
Years Ended December 31,
--------------------------
1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
Provision for income taxes....................... $ 325 $ 584 $ 360
</TABLE>
The Company recorded a provision for foreign income taxes in fiscal years
1996, 1997, and 1998. This provision relates to the amount of estimated taxes
due in foreign jurisdictions for the Company's foreign operations and certain
withholding tax. The Company has had losses for U.S. tax purposes for all
periods to date and, accordingly, there has been no provision for U.S. income
taxes. Management believes that the provision for income taxes will fluctuate
in the future and is dependent upon the geographical location of future sales
and the associated withholding taxes in certain countries. The provision for
income taxes will also fluctuate when the Company becomes eligible for
corporate income taxation in the United States.
Liquidity and Capital Resources
At December 31, 1998, the Company had approximately $34,879 in cash, cash
equivalents, and marketable securities, an increase of $4,241 from December
31, 1997.
The Company's operating activities utilized cash and cash equivalents of
approximately $27,538, $28,815 and $27,053 during fiscal 1998, 1997 and 1996,
respectively. Accounts receivable increased approximately 22% in fiscal 1998
from the prior year primarily as a result of the quarterly cyclical nature of
the sales process as well as the granting of extended payment terms to certain
new and long-standing creditworthy customers.
The Company's investing activities used cash and cash equivalents of
approximately $10,974, $7,646 and $28,663 for fiscal years 1998, 1997 and
1996, respectively. In fiscal 1998, the principal uses of cash for investing
activities were $5,535 paid for purchases related to certain property, plant,
and equipment and $5,496 paid in cash for purchases of certain marketable
securities.
The Company's financing activities provided cash and cash equivalents of
approximately $38,700, $6,168 and $101,814 for fiscal years 1998, 1997 and
1996, respectively. During fiscal 1998, the Company received proceeds of
$5,000 from Intel and $20,000 from CMG and CVI for the private sale of equity
securities. In addition, the Company received proceeds of $3,451 from the
exercise of stock options under the Company's 1994 Stock Incentive Plan and
stock purchases under the Company's 1996 Employee Stock Purchase Plan. In
fiscal 1998, the Company repaid $5,000 of the note payable issued to Reed
Elsevier in 1997 in connection with the Folio acquisition with a cash payment
of $1,818. The balance of $3,182 was settled by the issuance of the Company's
common stock.
In July 1998, the Company entered into a $2,800 mortgage of its Provo, Utah,
building which bears interest at the fixed rate of 8.5%. The mortgage
principal payments are based upon a 20-year term with a balloon payment of
$2,468 due on June 19, 2003.
The Company has an unsecured credit facility arrangement with a bank, which
provides up to $15,000 in financing in the form of a demand line of credit.
Borrowings under this line are limited to 80% of eligible domestic accounts
receivable and 90% of eligible foreign accounts receivable, as defined, and
bear interest at the prime lending rate (7.75% at December 31, 1998). The
Company is required to comply with certain restrictive covenants under this
agreement and the line is collateralized by the Company's accounts receivable.
The
22
<PAGE>
Company was in compliance with all such covenants at December 31, 1998. During
1998, the Company increased its borrowings under this facility to $11,000 and
$4,000 remained available as of December 31, 1998.
The Company has a non-recourse factoring agreement under which it can factor
up to $8,000 of qualified accounts receivable, as defined. The Company sold
approximately $3,000 of accounts receivable during the second quarter of 1998.
There was $1,750 of accounts receivable outstanding under the factoring
agreement at December 31, 1998. The Company sold no accounts receivable during
the third and fourth quarters of 1998.
At December 31, 1998, the Company had net operating loss carryforwards for
income tax purposes of approximately $96,000. These losses are available to
reduce federal and state taxable income, if any, in future years. These losses
are subject to review and possible adjustment by the Internal Revenue Service
and may be limited in the event of certain cumulative changes in ownership
interests of significant shareholders over a three-year period that are in
excess of 50%. While the Company believes that it has experienced a change in
ownership in excess of 50%, it does not believe that this change in ownership
will significantly impact the Company's ability to utilize its net operating
loss carryforwards.
The Company believes that its existing capital resources are adequate to
meet its cash requirements for at least the next 12 months. There can be no
assurance, however, that changes in the Company's plans or other events
affecting the Company's operations will not result in accelerated or
unexpected expenditures.
Restatement of June 30, 1998 and September 30, 1998 Financial Statements
In March 1999, the Company restated its June 30, 1998 and September 30, 1998
financial statements to reflect a change for the purchase price allocation
related to the 1998 acquisition of ICentral and the related amortization of
intangibles. This adjustment decreased the amount previously allocated to in-
process technology by $5,100, which has been capitalized as developed
technology and goodwill and will be amortized on a straight-line basis over
five years. The restatement was the result of concerns presented by the
Securities and Exchange Commission (SEC) regarding the valuation methodology
used for the determination of charges for acquired in-process research and
development costs. The Company believes that its periodic reports filed June
30, 1998 and September 30, 1998, which included such charges related to the
acquisition costs for ICentral, were made in accordance with generally
accepted accounting principles and established industry practices at the time.
In addition, the valuation of the acquired in-process research and development
was supported by an independent valuation by Arthur Andersen LLP.
The Company has not been contacted by the SEC regarding its valuation
methodology. However, in response to the SEC's new guidelines, the Company has
decided to proactively move to the new valuation methodology for its 1998
acquisition of ICentral. Therefore, the Company expensed $5,700 to in-process
research and development in the second quarter of 1998, capitalized $6,300 of
developed technology and goodwill, and amortized the developed technology and
goodwill over the 5-year estimated useful life.
Year 2000 Compliance
Background
The Company recognizes that it must ensure that its products and operations
will not be adversely impacted by Year 2000 software failures, which can arise
in date-sensitive software applications that utilize a field of two digits to
define the applicable year. In such applications, a date using "00" as the
year may be recognized as the year 1900 rather than the year 2000.
State of Readiness
With respect to the Company's internal systems, 80% of the Company's mission
critical information technology systems are considered to be Year 2000
compliant, as defined by the criteria established by the British Standards
Institute. With respect to the Company's software products, the Company has
developed and
23
<PAGE>
implemented a detailed Year 2000 test procedure for the phase review and
software release process to ensure that its software products are Year 2000
compliant. The execution of this test procedure began in October 1998 and
management expects that such testing will continue throughout 1999 and well
into 2000. Additionally, approximately 90% of the Company's embedded product
vendors are already considered to be Year 2000 compliant, based wholly on
external and internal testing of such embedded products. As a result,
management expects that the Company and its key vendors will be positioned to
successfully meet all Year 2000 compliance issues for the Company's products.
Related Costs
Management has assessed the related costs for Year 2000 compliance to be in
the range of $500 to $700. To date, the Company has incurred costs of
approximately $300 for its Year 2000 projects. Such costs may include those
for research and development, capital equipment, outside software tools,
outside contractors, and other internal resources that may be assigned to the
project. Management acknowledges that these costs may be subject to
reassessment as testing of the Company's products and mission critical systems
is completed and compliance is fully achieved.
Perceived Risks
At the present time, management does not expect Year 2000 issues to have a
material adverse impact on the Company's business or future results of
operations. However, there can be no assurance that there will not be
interruptions of operations or other limitations of system or product
functionality, or that the Company will not incur significant costs to avoid
such interruptions or limitations. For example, such interruptions or
limitations may include disruptions in customer service and technical support
facilities, interruptions to customer access to on-line products and services,
information or other communications, delays in manufacturing and shipping of
products, and other interruptions or delays in the day-to-day operations of
the Company. In addition, even if the Company's products are Year 2000
compliant, other systems or software used by the Company's domestic and
international customers may not be Year 2000 compliant. The failure of any
such non-compliant third-party software or systems contained in such operating
environments may negatively affect the performance of the Company's products,
which may lead to increased costs associated with correcting technical
problems, lost sales, or other negative consequences resulting from customer
dissatisfaction, including litigation. Such failure may have a material
adverse effect on the Company's business, financial condition and operating
results.
Contingency Plans
In order to avoid such material adverse effects, the Company will continue
to seek business relationships only with those entities that are actively and
successfully addressing Year 2000 issues. If the inability of certain existing
vendors or customers to successfully address Year 2000 issues begins to
present adverse business effects for the Company, management may elect to
suspend such business relationships until such time that such vendors or
customers become fully compliant.
Euro Currency
On January 1, 1999 certain member countries of the European Union (EU)
established fixed conversion rates between their existing currencies and the
EU's common currency, the euro. The former currencies of the participating
countries are scheduled to remain legal tender as denominations of the euro
until January 1, 2002 when the euro will be adopted as the sole legal
currency.
The Company is currently assessing the impact that the conversion to the
euro will have on its European operations. The Company is evaluating the
potential impact in several areas of its business including the ability of its
information systems to handle euro-denominated transactions and the impact on
exchange costs and currency exchange rate risks. The Company is also
evaluating the impact that cross-border price transparencies, which may affect
the ability to price products differently in various countries, will have on
its margin. Although
24
<PAGE>
the Company is still in the assessment phase, the conversion to the euro is
not expected to have a material impact on the Company's operations or
financial position.
Certain Factors That May Affect Future Results
Introduction
This Annual Report contains certain forward-looking statements. For this
purpose, any statements contained herein that are not statements of historical
fact may be deemed to be forward-looking statements. Without limiting the
generality of the foregoing, the words "believes", "anticipates", "plans",
"expects", and similar expressions are intended to identify forward-looking
statements. There are a number of important factors that could cause the
Company's actual results to differ materially from those indicated by forward-
looking statements made in this Annual Report and presented elsewhere by
management from time to time. Some of the important risks and uncertainties
that may cause the Company's operating results to differ materially or
adversely are discussed below.
Rapid Technological Change
The computer software industry is characterized by rapid technological
change. As a result, there is uncertainty about the widespread acceptance of
new products that can cause significant delays in the sales cycle. The Company
must continue to upgrade its own technologies and commercialize products and
services incorporating such technologies that may also lengthen the sales
cycle. The introduction of product or service enhancements or new products or
services embodying new technologies, industry standards, or customer
requirements could supplant or make obsolete the Company's existing products
and services.
Developing Internet Market
The market for the Company's Internet products and services has only
recently begun to develop, is rapidly evolving and is characterized by an
increasing number of market entrants that have introduced and developed
products and services for Internet commerce. The Company's future operating
results depend upon the development and growth of the market for Internet-
based packaged software applications, including electronic commerce
applications. The acceptance of electronic commerce in general and, in
particular, the Internet as a sales marketing and order receipt and processing
medium are highly uncertain and subject to a number of risks. Critical issues
concerning the commercial use of the Internet (including security,
reliability, cost, ease of use, quality and service and the effect of
government regulation) remain unresolved and may impact the growth of the
Internet. If the market fails to develop or develops more slowly than
expected, the Company's operating results could be materially adversely
affected.
Recent Acquisition
In April 1998, the Company completed the strategic acquisition of ICentral.
The Company faces challenges relating to integration of operations such as
coordinating geographically separate organizations, integrating personnel with
disparate business backgrounds and combining different corporate cultures.
There can be no assurance that the acquired business or its products will be
successful, that the Company will successfully integrate the acquired business
into the Company, or that the Company will achieve the desired synergies from
the transaction.
Product Release Schedules
Delays in the planned release of the Company's new products may adversely
affect forecasted revenues, and create operational inefficiencies resulting
from staffing levels designed to support the forecasted revenues. The
Company's failure to introduce new products, services, or product enhancements
on a timely basis may delay or hinder market acceptance and allow competitors
to gain greater market share than the Company.
25
<PAGE>
Government Regulation and Legal Uncertainties
The Company is not currently subject to direct regulation by any government
agency, other than regulations applicable to businesses generally, and there
are currently few laws or regulations directly applicable to access to, or
commerce on, the Internet. However, due to the increasing popularity and use
of the Internet, it is possible that a number of laws and regulations may be
adopted with respect to the Internet, covering issues such as user privacy,
taxation, the content of products, and the nature of services. The adoption of
any such laws or regulations may decrease the growth of the Internet or
inhibit companies' ability to conduct electronic commerce, which could in turn
adversely affect the Company's business, operating results or financial
condition. Moreover, the applicability of the Internet of existing laws
governing issues such as property ownership, libel and personal privacy is
uncertain. Further, due to the encryption technology contained in the
Company's products, such products are subject to U.S. export controls. There
can be no assurance that such export controls, either in their current form or
as may be subsequently enacted, will not delay the introduction of new
products or limit the Company's ability to distribute products outside of the
United States. While the Company intends to take precautions against unlawful
exportation, the global nature of the Internet makes it difficult to
effectively control the distribution of the Company's products. In addition,
federal or state legislation or regulation may further limit levels of
encryption or authentication technology. Further, various countries regulate
the import of certain encryption technology and have adopted laws relating to
personal privacy issues that could limit the Company's ability to distribute
products in those countries. Any such export or import restrictions, new
legislation or regulation or government enforcement of existing regulations
could have a material adverse impact on the Company's business, operating
results and financial condition.
Complex Products; Lengthy Sales Cycles
The Company's products are complex and often involve significant investment
decisions by prospective customers. Accordingly, the license of the Company's
software products can be expected to require the Company to engage in a
lengthy sales cycle and to provide a significant level of education to
prospective customers regarding the use and benefits of the Company's
products. As a result, the Company's sales cycles may be subject to a number
of significant delays over which it has little or no control. Delays in such
transactions due to lengthy sales cycles or delays in customer production or
deployment of a system could have a material adverse effect on the Company's
business, operating results and financial condition and could be expected to
cause the Company's operating results to vary significantly from quarter to
quarter.
Security
A significant barrier to market acceptance of online commerce and
communication is the concern regarding the secure exchange of valuable and
confidential information over public networks. The Company relies on
encryption and authentication technology to provide the security and
authentication necessary to effect the secure exchange of valuable and
confidential information. There can be no assurance that advances in computer
capabilities, new discoveries in the field of cryptography or other events or
developments (such as breakins and similar disruptive problems caused by
Internet users) will not result in a compromise or breach of algorithms used
by the Company in its products to protect customer transaction data. If any
such compromise or breach was to occur, it could have a material adverse
effect on the Company's business, financial condition, and operating results.
Competition
The market for Internet commerce software is new, rapidly evolving and
intensely competitive. The Internet is characterized by an increasing number
of market entrants that have introduced or developed products and services for
commerce on the Internet. Many of the Company's competitors have greater
financial, technical, and marketing resources and greater name recognition
than does the Company. The Company's operating results will be affected by the
number of competitors and their pricing strategies and market acceptance of
their products.
26
<PAGE>
Dependence on Personnel
The Company's future success depends in significant part upon the continued
service of its key technical and senior management personnel, and its
continuing ability to attract and retain highly qualified technical and
managerial personnel. The Company's ability to establish and maintain a
position of technology leadership in the industry depends in large part upon
the skills of its development personnel.
Pricing
Future prices that the Company is able to charge for its products may
decline from historical levels due to competitive reasons and other factors.
In the future, the Company may have to reduce the prices of its products
substantially or introduce lower-priced lines of products to gain greater
market share.
Limited Operating History
The Company has a limited operating history. The Company's ability to
successfully market its existing products and to develop and market new
products must be considered in light of the risks, expenses and difficulties
frequently encountered by companies in their early stage of development,
particularly companies in new and rapidly evolving markets.
Fluctuations in Quarterly Operating Results
The Company's expense levels are fixed in advance and based in part on its
expectations as to future revenues. Quarterly sales and operating results will
generally depend on the volume and timing of orders received within the
quarter. The Company may be unable to adjust spending in a timely manner to
compensate for unexpected revenue shortfalls. The Company expects in the
future to experience significant fluctuations in quarterly operating results
that may be caused by many factors, including, among other things, the number,
timing, and significance of product enhancements and new product announcements
by the Company or its competitors; the length of the Company's sales cycle;
market acceptance of, and demand for, the Company's products; the pace of
development of electronic commerce conducted on the Internet; customer order
deferrals in anticipation of enhancements or new products offered by the
Company or its competitors; non-renewal of service agreements; software
defects and other product quality problems; the Company's ability to attract
and retain key personnel; the extent of international sales; changes in the
level of operating expenses, and general economic conditions. As a result, the
Company's operating results in future quarters may be below the expectations
of market analysts and investors.
Foreign Exchange
To the extent that foreign currency exchange rates fluctuate in the future,
the Company may be exposed to continued financial risk. Although the Company
attempts to limit this risk by denominating most sales in United States
dollars and limiting the amount of assets in its foreign operations, there can
be no assurance that the Company will be successful in limiting its exposure.
Volatility of Stock Price
Open Market's Common Stock is quoted on the Nasdaq National Market. The
market price of Open Market's Common Stock, like that for the shares of many
other high technology companies, has been and may continue to be volatile.
Recently, the stock market in general and the shares of software companies in
particular have experienced significant price fluctuations. These broad market
fluctuations combined with general economic and political conditions in the
United States and abroad, and factors such as quarterly fluctuations in
results of operations, the announcement of technological innovations, the
introduction of new products by the Company or its competitors, and general
conditions in the computer hardware and software industries, may have a
significant impact on the market price of Open Market's Common Stock.
27
<PAGE>
Dependence on Intellectual Property Rights
The Company's success is dependent to a significant degree on its
proprietary software technology. The Company provides its products to end
users generally under non-exclusive, non-transferable licenses for the term of
the agreement, which is usually in perpetuity. The Company's policy is to
enter into confidentiality and assignment agreements with its employees,
consultants, and vendors and generally to control access to, and distribution
of, its software, documentation, and other proprietary information.
Notwithstanding these precautions, it may be possible for a third party to
copy or otherwise obtain and use the Company's software or other proprietary
information without authorization or to develop similar software
independently. Although the Company holds three U.S. patents, issued in March
1998, and covering certain aspects or uses of electronic commerce software,
there can be no assurance as to the degree of intellectual property protection
such patents will provide. Policing unauthorized use of the Company's products
is difficult, particularly because the global nature of the Internet makes it
difficult to control the ultimate destination or security of software or other
data transmitted. The laws of other countries may afford the Company little or
no effective protection of its intellectual property. There can be no
assurance that the steps taken by the Company will prevent misappropriation of
its technology or that agreements entered into for that purpose would be
enforceable.
Risk of Infringement
The Company may, in the future, receive notices of claims of infringement of
other parties' patent, trademark, copyright, and other proprietary rights.
There can be no assurance that claims for infringement or invalidity (or
claims for indemnification from our customers resulting from infringement
claims) will not be asserted or prosecuted against the Company. In particular,
claims could be asserted against the Company for violation of patent,
trademark, copyright, or other laws as a result of the use by the Company, its
customers, or other third parties of the Company's products to transmit,
disseminate, or display information over or on the Internet. Any such claims,
with or without merit, could be time consuming to defend, result in costly
litigation, divert management's attention and resources, cause product
shipment delays, or require the Company to enter into royalty or licensing
agreements. There can be no assurance that such licenses would be available on
reasonable terms, if at all, and the assertion or prosecution of any such
claims could have a material adverse effect on the Company's business,
financial condition, and operating results.
Risk of Product Defects
Sophisticated software products, such as those of the Company, may contain
undetected errors or failures that become apparent when the products are
introduced or when the volume of services provided increases. There can be no
assurance that, despite testing by the Company and potential customers, errors
will not be found in the Company's products, resulting in loss of revenues,
delay in market acceptance, diversion of development resources, damage to the
Company's reputation, or increased service and warranty costs, which would
have a material adverse effect on the Company's business, financial condition,
and operating results.
Litigation
Litigation may be necessary in the future to enforce the Company's
intellectual property rights, to protect the Company's patents, copyright or
trade secrets, to determine the validity and scope of the proprietary rights
of others, or to defend against claims of infringement or invalidity. Such
litigation, whether successful or unsuccessful, could result in substantial
costs and diversions of resources, which may have a material adverse effect on
the Company's business, financial condition, and operating results. Litigation
regarding intellectual property rights, copyrights, and patents is
increasingly common in the software industry. Intellectual property litigation
is complex and expensive, and the outcome of such litigation is difficult to
predict. In addition, the Company faces risks on other general corporate legal
matters.
28
<PAGE>
Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
Foreign Exchange Hedging. The accounts of the Company's foreign subsidiaries
are translated in accordance with SFAS No. 52, Foreign Currency Translation.
In translating the accounts of the foreign subsidiaries into U.S. dollars,
assets and liabilities are translated at the rate of exchange in effect at
year-end, while stockholders' equity is translated at historical rates.
Revenue and expense accounts are translated using the weighted average
exchange rate in effect during the year. Foreign currency translation and
transaction gains or losses for the Company's subsidiaries are included in the
accompanying consolidated statements of operations since the functional
currency for the Company's subsidiaries is the U.S. dollar. The Company had
sales of approximately $944 denominated in foreign currencies during 1998. The
Company recognized a loss of approximately $23 related to such foreign
currency transactions and translations in 1998, which is included in other
income (loss) in the accompanying consolidated statements of income.
Investment Portfolio. The Company does not invest in derivative financial
instruments that meet the high credit quality standards, as specified in the
Company's investment policy guidelines; the policy also limits the amount of
credit exposure of any one issue, issuer, and type of investment. See "Note
2--Summary of Significant Accounting Policies" in the Notes to Consolidated
Financial Statements.
29
<PAGE>
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
See Index to Consolidated Financial Statements set forth on page 31 hereof.
Financial Information by Quarter (unaudited)
The following table sets forth certain unaudited quarterly financial data
for 1997 and 1998. In the opinion of management, the unaudited quarterly
information has been prepared on the same basis as the audited Consolidated
Financial Statements and includes all adjustments, consisting only of normal
recurring adjustments, necessary for the fair presentation of the information
for the periods presented. The quarterly operating results are not necessarily
indicative of results of operations for any future period.
<TABLE>
<CAPTION>
Three Months Ended (all amounts in thousands)
-------------------------------------------------------------------------------
Mar. 31, June 30, Sept. 30, Dec. 31, Mar. 31, June 30, Sept. 30, Dec. 31,
1997 1997 1997 1997 1998 1998 1998 1998
-------- -------- --------- -------- -------- -------- --------- --------
Restated Restated Restated
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Revenues:
Product revenues........ $ 9,056 $12,433 $11,859 $14,820 $11,273 $ 12,157 $ 8,693 $10,122
Service revenues........ 2,302 3,101 3,872 3,817 3,929 4,369 5,670 5,932
-------- ------- ------- ------- ------- -------- ------- -------
Total revenues........ 11,358 15,534 15,731 18,637 15,202 16,526 14,363 16,054
-------- ------- ------- ------- ------- -------- ------- -------
Cost of Revenues:
Product revenues........ 866 639 468 504 600 742 702 723
Service revenues........ 2,122 2,400 2,294 2,350 2,906 3,503 3,850 4,273
-------- ------- ------- ------- ------- -------- ------- -------
Total cost of
revenues............. 2,988 3,039 2,762 2,854 3,506 4,245 4,552 4,996
-------- ------- ------- ------- ------- -------- ------- -------
Gross profit.......... 8,370 12,495 12,969 15,783 11,696 12,281 9,811 11,058
-------- ------- ------- ------- ------- -------- ------- -------
Operating Expenses:
Selling and marketing... 7,982 9,590 9,417 9,565 7,876 8,007 8,097 8,033
Research and
development............ 5,375 7,461 7,107 6,789 6,776 6,568 5,350 4,581
General and
administrative......... 2,371 3,284 3,021 2,659 2,929 3,021 3,212 2,792
In-process research and
development............ 34,250 -- -- -- -- 5,700 -- --
Restructure charge...... -- -- -- -- -- -- -- 2,042
-------- ------- ------- ------- ------- -------- ------- -------
Total operating
expenses............. 49,978 20,335 19,545 19,013 17,581 23,296 16,659 17,448
-------- ------- ------- ------- ------- -------- ------- -------
Loss from operations.. (41,608) (7,840) (6,576) (3,230) (5,885) (11,015) (6,848) (6,390)
-------- ------- ------- ------- ------- -------- ------- -------
Interest income......... 890 710 719 509 318 291 376 388
Interest expense........ (50) (220) (287) (220) (240) (296) (312) (249)
Other (expense) income.. (36) (49) (95) (39) (10) (62) 19 (232)
-------- ------- ------- ------- ------- -------- ------- -------
Loss before income
taxes................ (40,804) (7,399) (6,239) (2,980) (5,817) (11,082) (6,765) (6,483)
-------- ------- ------- ------- ------- -------- ------- -------
Provision for income
taxes.................. 340 111 133 -- 32 33 121 139
-------- ------- ------- ------- ------- -------- ------- -------
Net loss.............. $(41,144) $(7,510) $(6,372) $(2,980) $(5,849) $(11,115) $(6,886) $(6,622)
======== ======= ======= ======= ======= ======== ======= =======
</TABLE>
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
30
<PAGE>
OPEN MARKET, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<S> <C>
Report of Independent Public Accountants.................................. 32
Consolidated Balance Sheets as of December 31, 1998 and 1997.............. 33
Consolidated Statements of Operations for the years ended December 31,
1998, 1997 and 1996...................................................... 34
Consolidated Statements of Stockholders' Equity (Deficit) for the years
ended December 31, 1998, 1997 and 1996................................... 35
Consolidated Statements of Cash Flows for the years ended December 31,
1998, 1997 and 1996...................................................... 36
Notes to Consolidated Financial Statements................................ 37
</TABLE>
31
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors and Stockholders of Open Market, Inc.:
We have audited the accompanying consolidated balance sheets of Open Market,
Inc. (a Delaware corporation) and subsidiaries as of December 31, 1998 and
1997, and the related consolidated statements of operations, stockholders'
equity (deficit) and cash flows for each of the three years in the period
ended December 31, 1998. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express
an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position
of Open Market, Inc. and subsidiaries as of December 31, 1998 and 1997, and
the results of their operations and their cash flows for each of the three
years in the period ended December 31, 1998, in conformity with generally
accepted accounting principles.
/s/ Arthur Andersen LLP
Boston, Massachusetts
February 2, 1999
32
<PAGE>
OPEN MARKET, INC.
CONSOLIDATED BALANCE SHEETS
(In Thousands, Except Share and Per Share Data)
<TABLE>
<CAPTION>
December 31,
--------------------
1998 1997
--------- ---------
<S> <C> <C>
ASSETS
Current Assets:
Cash and cash equivalents.............................. $ 19,921 $ 19,666
Marketable securities.................................. 14,958 10,972
Accounts receivable, net of allowance for doubtful
accounts of $2,523 and $1,470 in 1998 and 1997,
respectively.......................................... 28,250 23,102
Prepaid expenses and other current assets.............. 1,892 1,423
Loan to Founder........................................ -- 993
--------- ---------
Total current assets................................. 65,021 56,156
--------- ---------
Property and equipment, at cost:
Computers and office equipment......................... 14,743 12,129
Leasehold improvements................................. 5,421 1,072
Land and building...................................... 4,200 4,200
Furniture and fixtures................................. 2,157 812
Construction in progress............................... -- 3,300
--------- ---------
Total property and equipment......................... 26,521 21,513
Less--Accumulated depreciation and amortization.......... 11,093 6,356
--------- ---------
Net property and equipment........................... 15,428 15,157
--------- ---------
Long-term marketable securities.......................... 1,510 --
Intangible Assets........................................ 11,627 7,787
Other Assets............................................. 1,372 1,774
--------- ---------
Total assets......................................... $ 94,958 $ 80,874
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Current maturities of long-term obligations............ $ 88 $ 50
Line of credit......................................... 11,000 5,168
Note payable........................................... 5,000 10,000
Accounts payable....................................... 2,848 3,268
Accrued expenses....................................... 13,692 14,440
Deferred revenues...................................... 4,548 4,390
--------- ---------
Total current liabilities............................ 37,176 37,316
--------- ---------
Long-term obligations, net of current maturities......... 2,789 99
Commitments (Note 5 and 8)
Stockholders' Equity:
Preferred Stock, $.10 par value--
Authorized--2,000,000 shares
Issued and outstanding--None.......................... -- --
Common stock, $.001 par value--
Authorized--100,000,000 shares
Issued and outstanding--35,291,000 and 30,971,000
shares in 1998 and 1997, respectively................. 35 31
Additional paid-in capital............................. 186,074 137,427
Other equity........................................... -- 6,920
Deferred compensation.................................. -- (275)
Accumulated deficit.................................... (131,116) (100,644)
--------- ---------
Total stockholders' equity........................... 54,993 43,459
--------- ---------
Total liabilities and stockholders' equity........... $ 94,958 $ 80,874
========= =========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
33
<PAGE>
OPEN MARKET, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In Thousands, Except Share and Per Share Data)
<TABLE>
<CAPTION>
For the Years Ended
December 31,
----------------------------------
1998 1997 1996
---------- ---------- ----------
<S> <C> <C> <C>
Revenues:
Product revenues........................ $ 42,245 $ 48,168 $ 17,200
Service revenues........................ 19,900 13,092 5,301
---------- ---------- ----------
Total revenues........................ 62,145 61,260 22,501
---------- ---------- ----------
Cost of Revenues:
Product revenues........................ 2,767 2,477 768
Service revenues........................ 14,532 9,166 4,725
---------- ---------- ----------
Total cost of revenues................ 17,299 11,643 5,493
---------- ---------- ----------
Gross profit.......................... 44,846 49,617 17,008
---------- ---------- ----------
Operating Expenses:
Selling and marketing................... 32,013 36,554 23,810
Research and development................ 23,275 26,732 16,393
General and administrative.............. 11,954 11,335 5,925
In-process research and development..... 5,700 34,250 --
Restructuring charge.................... 2,042 -- --
---------- ---------- ----------
Total operating expenses.............. 74,984 108,871 46,128
---------- ---------- ----------
Loss from operations.................. (30,138) (59,254) (29,120)
Interest Income........................... 1,373 2,827 3,042
Interest Expense.......................... (1,097) (777) (79)
Other (expense)/income.................... (285) (218) 7
---------- ---------- ----------
Loss before provision for income
taxes................................ (30,147) (57,422) (26,150)
Provision for income taxes................ 325 584 360
---------- ---------- ----------
Net loss.............................. $ (30,472) $ (58,006) $ (26,510)
========== ========== ==========
Net loss per share--basic and diluted..... $ (0.91) $ (1.87) $ (1.31)
========== ========== ==========
Weighted average common equivalent shares
outstanding--basic and diluted........... 33,483,000 30,994,000 20,923,000
========== ========== ==========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
34
<PAGE>
OPEN MARKET, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
(In Thousands, Except Share and Per Share Data)
<TABLE>
<CAPTION>
Stockholders' Equity (Deficit)
----------------------------------------------------------------------------------------------------------
Redeemable
Convertible
Preferred Stock Common Stock Other Equity
-------------------- ---------------- -------------------- Total
$.001 Additional Common Deferred Stockholders'
Number Carrying Number Par Paid-in Shares Carrying Compen- Accumulated Equity
of Shares Value of Shares Value Capital Equivalents Value sation Deficit (Deficit)
---------- -------- ---------- ----- ---------- ----------- -------- -------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Balance, December
31, 1995........ 3,581,000 $ 11,205 9,390,000 $ 9 $ 32 -- $ -- $ -- $ (15,228) $(15,187)
Issuance of
Series C
redeemable
convertible
preferred
stock, net of
issuance costs
of $900........ 2,695,000 26,950 -- -- -- -- -- -- (900) (900)
Conversion of
redeemable
convertible
preferred stock
into common
stock.......... (6,276,000) (38,155) 13,437,000 13 38,142 -- -- -- -- 38,155
Issuance of
common stock in
initial public
offering, net
of
underwriters'
commission and
issuance costs
of $6,673...... -- -- 4,600,000 5 76,122 -- -- -- -- 76,127
Exercise of
common stock
options........ -- -- 1,138,000 1 470 -- -- -- -- 471
Issuance of
common stock
purchase
warrant (Note
6(j)).......... -- -- -- -- 211 -- -- -- -- 211
Net loss........ -- -- -- -- -- -- -- -- (26,510) (26,510)
---------- -------- ---------- ---- -------- -------- ------- ----- --------- --------
Balance, December
31, 1996........ -- -- 28,565,000 28 114,977 -- -- -- (42,638) 72,367
Exercise of
common stock
options........ -- -- 710,000 1 355 -- -- -- -- 356
Employee stock
purchase plan.. -- -- 59,000 -- 658 -- -- -- -- 658
Issuance of
common stock in
Waypoint
acquisition.... -- -- 739,000 1 9,548 -- -- -- -- 9,549
Issuance of
common stock in
Folio
acquisition,
net of purchase
price
adjustment..... -- -- 898,000 1 11,509 628,000 6,920 -- -- 18,430
Deferred
compensation
related to
stock options.. -- -- -- -- 380 -- -- (380) -- --
Amortization of
deferred
compensation
related to
stock options.. -- -- -- -- -- -- -- 105 -- 105
Net loss........ -- -- -- -- -- -- -- -- (58,006) (58,006)
---------- -------- ---------- ---- -------- -------- ------- ----- --------- --------
Balance, December
31, 1997........ -- -- 30,971,000 31 137,427 628,000 6,920 (275) (100,644) 43,459
Exercise of
common stock
options........ -- -- 977,000 1 3,447 -- -- -- -- 3,448
Employee stock
purchase plan.. -- -- 132,000 -- 1,147 -- -- -- -- 1,147
Issuance of
common stock
for payment of
note payable... -- -- 221,000 -- 3,182 -- -- -- -- 3,182
Conversion of
other equity to
common stock... -- -- 628,000 1 6,919 (628,000) (6,920) -- -- --
Issuance of
stock in
ICentral
acquisition.... -- -- 480,000 -- 10,000 -- -- -- -- 10,000
Issuance of
common stock in
private
placement, net
of issuance
costs of
$75,177........ -- -- 1,882,000 2 24,260 -- -- -- -- 24,262
Reversal of
deferred
compensation
related to
termination of
stock options.. -- -- -- -- (330) -- -- 275 -- (55)
Compensation
expense related
to stock
options........ -- -- -- -- 22 -- -- -- -- 22
Net loss........ -- -- -- -- -- -- -- -- (30,472) (30,472)
---------- -------- ---------- ---- -------- -------- ------- ----- --------- --------
Balance, December
31, 1998........ -- $ -- 35,291,000 $ 35 $186,074 -- $ -- $ -- $(131,116) $ 54,993
========== ======== ========== ==== ======== ======== ======= ===== ========= ========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
35
<PAGE>
OPEN MARKET, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Thousands)
<TABLE>
<CAPTION>
For the Years Ended
December 31,
----------------------------
1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
Cash Flows from Operating Activities:
Net loss........................................ $(30,472) $(58,006) $(26,510)
Adjustments to reconcile net loss to net cash
used in operating activities--
Depreciation and amortization................... 5,332 3,797 1,723
Amortization of intangible assets............... 2,460 1,351 --
Write-off of in-process research and
development.................................... 5,700 34,250 --
Compensation expense............................ (33) 105 --
Issuance of common stock purchase warrant....... -- -- 211
Write-down of assets related to restructuring... 294 -- --
Changes in assets and liabilities--
Accounts receivable............................. (8,344) (14,565) (3,900)
Prepaid expenses and other current assets....... (423) 472 (949)
Accounts payable................................ (596) 1,907 2,980
Accrued expenses................................ (1,613) 2,382 3,039
Deferred revenues............................... 157 (508) (3,647)
-------- -------- --------
Net cash used in operating activities............ (27,538) (28,815) (27,053)
-------- -------- --------
Cash Flows from Investing Activities:
Purchases of property and equipment............. (5,535) (3,846) (4,525)
Increase in construction-in-progress............ -- (3,300) --
Repayment (issuance) of loan to Founder......... 993 507 (1,500)
Sales (purchases) of marketable securities...... (5,496) 11,296 (22,268)
Cash acquired from Waypoint acquisition......... -- 372 --
Cash paid in Folio acquisition.................. -- (11,400) --
Cash paid in ICentral acquisition............... (1,420) -- --
Increase (decrease) in other assets............. 484 (1,275) (370)
-------- -------- --------
Net cash used in investing activities............ (10,974) (7,646) (28,663)
-------- -------- --------
Cash Flows from Financing Activities:
Net borrowings under the line of credit......... 5,831 5,168 --
Payments on long-term obligations............... (55) (14) (834)
Proceeds on mortgage obligations................ 2,777 -- --
Proceeds from the issuance of redeemable
convertible preferred stock, net of issuance
costs.......................................... -- -- 26,050
Payment on note payable......................... (1,818) -- --
Proceeds from the factoring of accounts
receivable..................................... 3,128 -- --
Proceeds from the exercise of common stock
options........................................ 3,448 356 471
Proceeds from the employee stock purchase plan.. 1,147 658 --
Proceeds from issuance of common stock in pri-
vate placement................................. 24,262 -- 76,127
-------- -------- --------
Net cash provided by financing activities........ 38,700 6,168 101,814
-------- -------- --------
Foreign Exchange Effect on Cash and Cash Equiva-
lents........................................... 67 194 (45)
Net (Decrease)Increase in Cash and Cash Equiva-
lents........................................... 188 (30,293) 46,098
Cash and Cash Equivalents, beginning of year..... 19,666 49,765 3,712
-------- -------- --------
Cash and Cash Equivalents, end of year........... $ 19,921 $ 19,666 $ 49,765
======== ======== ========
Supplemental Disclosure of Cash Flow Information:
Interest paid during year........................ $ 1,272 $ 53 $ 79
======== ======== ========
Taxes paid during year........................... $ 48 $ 270 $ --
======== ======== ========
Supplemental Schedule of Noncash Financing Activ-
ities:
Conversion of preferred stock into common stock.. $ -- $ -- $ 38,155
======== ======== ========
Supplemental Disclosure Of Non-Cash Investing
Activities (see Note 4):
Payment of note payable through issuance of
common stock.................................... $ 3,182 $ -- $ --
======== ======== ========
In connection with the acquisition of ICentral,
the following non-cash transaction occurred:
Fair value of assets acquired................... $ 12,086 $ -- $ --
Liabilities assumed............................. (666) -- --
Issuance of common stock........................ (10,000) -- --
-------- -------- --------
Cash paid for acquisition and acquisition
costs.......................................... $ 1,420 $ -- $ --
======== ======== ========
In connection with the acquisition of Waypoint,
the following non-cash transaction occurred:
Fair value of assets acquired................... $ -- $ 9,922 $ --
Liabilities assumed............................. -- (156) --
Issuance of common stock........................ -- (9,548) --
Cash acquired................................... -- (590) --
-------- -------- --------
Cash acquired in acquisition, net of acquisition
costs.......................................... $ -- $ (372) $ --
======== ======== ========
In connection with the acquisition of Folio, the
following non-cash transaction occurred:
Fair value of assets acquired................... $ -- $ 45,512 $ --
Liabilities assumed............................. -- (5,682) --
Issuance of common stock for repayment of note
payable........................................ -- (18,430) --
Repayment of note payable....................... -- (10,000) --
-------- -------- --------
Cash paid for acquisition and acquisition
costs.......................................... $ -- $ 11,400 $ --
======== ======== ========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
36
<PAGE>
OPEN MARKET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In Thousands, except Share and Per Share Data)
(1) Operations
Open Market, Inc. ("Open Market" or "the Company") develops, markets,
licenses and supports a family of application software products that allow its
customers to engage in business-to-business and business-to-consumer Internet
commerce, information commerce and commercial publishing. Open Market's
software includes a wide spectrum of functionality required to effectively
conduct business on the Internet, allowing companies to attract customers to
their Web site, engage them in acting upon an offer, complete a transaction
and service the customers once a transaction has been completed.
The Company is subject to risks common to growing technology-based
companies, including rapid technological change, a developing Internet market,
recent acquisitions, product release schedules, government regulation and
legal uncertainties, complex products-lengthy sales cycles, security,
competition, dependence on personnel, pricing, limited operating history,
fluctuations in quarterly operating results, foreign exchange, volatility of
stock price, dependence on intellectual property rights infringement and
product defects.
(2) Summary of Significant Accounting Policies
The accompanying consolidated financial statements reflect the application
of the following significant accounting policies described in this note and
elsewhere in the accompanying notes to consolidated financial statements.
(a) Principles of Consolidation
The accompanying consolidated financial statements include the accounts of
the Company and its wholly owned subsidiaries. All material intercompany
accounts and transactions have been eliminated in consolidation.
(b) Revenue Recognition
The Company applies Statement of Position No. 97-2, Software Revenue
Recognition, which superseded Statement of Position 91-1. The Company
generates revenue from licensing the rights to use its software products to
end users and sublicense fees from resellers. The Company also generates
service revenues from the sale of postcontract customer support and
professional service offerings.
Revenues from software license agreements are recognized upon delivery of
the software if there is evidence of an agreement, there are no significant
post-delivery obligations, and the payment is fixed, determinable and
probable. If an acceptance period is required, revenues are recognized upon
customer acceptance. The Company enters into reseller arrangements for certain
products that typically provide for sublicense fees payable to the Company
based on a percentage of the Company's list price. Royalty and sublicense
revenues from the Company's reseller arrangements are recognized when earned,
either on a per-unit basis as reported to the Company by its licensees, or,
with regards to guaranteed minimums, upon shipment of the master copy of all
software to which the guaranteed minimum sublicense fees relate, if there are
no significant post-delivery obligations. Revenues for post-contract customer
support are recognized ratably over the term of the support period, which is
typically one year. Service revenue, which includes education, implementation
and consulting services, is recognized in the period services are provided, if
customer acceptance is not required, there is evidence of an agreement, the
revenues are fixed and determinable and collectibility is probable.
Cost of product revenues consists of costs to distribute the product,
including the cost of the media on which it is delivered and royalty payments
to third-party vendors. Cost of service revenues consists primarily of
consulting and support personnel salaries and related costs.
37
<PAGE>
OPEN MARKET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(In Thousands, except Share and Per Share Data)
Deferred revenues represent cash received from customers for products and
services in advance of revenue recognition.
(c) Cash, Cash Equivalents and Marketable Securities
The Company accounts for investments under Statement of Financial Accounting
Standards (SFAS) No. 115, Accounting for Certain Investments in Debt and
Equity Securities. Under SFAS No. 115, investments for which the Company has
the positive intent and ability to hold to maturity, consisting of cash
equivalents and marketable securities, are reported at amortized cost, which
approximates fair market value. Cash equivalents are highly liquid investments
with original maturities of less than three months. Marketable securities are
investment-grade securities with original maturities of greater than three
months but less than one year. The average maturity of the Company's
marketable securities is approximately ten months at December 31, 1998. Long-
term marketable securities are investment-grade securities with original
maturities of greater than one year. To date, the Company has not recorded any
realized gains or losses.
<TABLE>
<CAPTION>
December 31,
---------------
1998 1997
------- -------
<S> <C> <C>
Cash and cash equivalents--
Cash...................................................... $12,582 $ 4,406
Commercial paper and corporate bonds...................... 4,045 12,714
Money market accounts..................................... 2,632 1,946
U.S. government, state, municipal......................... 662 600
and agency securities.................................... -- --
------- -------
Total cash and cash equivalents......................... $19,921 $19,666
======= =======
Marketable securities--
Corporate and other debt securities....................... $ 8,570 $ 5,022
State and municipal bonds................................. 6,388 3,950
U.S. government and agency securities..................... -- 2,000
------- -------
Total marketable securities............................. $14,958 $10,972
======= =======
Long-term marketable securities--
Corporate and other debt securities....................... $ 1,510 --
------- -------
Total long-term marketable securities................... $ 1,510 $ --
======= =======
</TABLE>
(d) Depreciation and Amortization
The Company provides for depreciation and amortization using the straight-
line method to allocate the cost of property and equipment over their
estimated useful lives as follows:
<TABLE>
<CAPTION>
Estimated
Asset Classification Useful Life
-------------------- -----------
<S> <C>
Computers and office equipment................................ 3-5 years
Leasehold improvements........................................ Lease term
Building...................................................... 25 years
Furniture and fixtures........................................ 7 years
</TABLE>
38
<PAGE>
OPEN MARKET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(In Thousands, except Share and Per Share Data)
(e) Research and Development Expenses
The Company has evaluated the establishment of technological feasibility of
its products in accordance with SFAS No. 86, Accounting for the Costs of
Computer Software To Be Sold, Leased or Otherwise Marketed. The Company sells
products in a market that is subject to rapid technological change, new
product development and changing customer needs; accordingly, the Company has
concluded that technological feasibility is not established until the
development stage of the product is nearly complete. The Company defines
technological feasibility as the completion of a working model. The time
period during which costs could be capitalized, from the point of reaching
technological feasibility until the time of general product release, is very
short, and consequently, the amounts that could be capitalized are not
material to the Company's financial position or results of operations.
Therefore, the Company has charged all such costs to research and development
in the period incurred.
(f) Translation of Foreign Currencies
The accounts of the Company's foreign subsidiaries are translated in
accordance with SFAS No. 52, Foreign Currency Translation. In translating the
accounts of the foreign subsidiaries into U.S. dollars, assets and liabilities
are translated at the rate of exchange in effect at year-end, while
stockholders' equity is translated at historical rates. Revenue and expense
accounts are translated using the weighted average rate in effect during the
year. Foreign currency translation and transaction gains or losses for the
foreign subsidiary are included in the accompanying consolidated statements of
operations since the functional currency of these subsidiaries is the U.S.
dollar. The Company had sales of approximately $944 denominated in foreign
currencies during 1998. The Company recognized a loss of approximately $23
related to such foreign currency transactions and translations in 1998, which
is included in other income (loss) in the accompanying consolidated statements
of income.
(g) Net Loss Per Share
The Company applies SFAS No. 128, Earnings Per Share. SFAS No. 128
establishes standards for computing and presenting earnings per share and
applies to entities with publicly held common stock or potential common stock.
The Company has applied the provisions of SFAS No. 128 and Staff Accounting
Bulletin (SAB) No. 98 retroactively to all periods presented. Diluted net loss
per share for the years ended 1998, 1997 and 1996 is the same as basic net
loss per share as the inclusion of the potential common stock equivalents
would be antidilutive. Calculations of basic and diluted net loss per common
share are as follows:
<TABLE>
<CAPTION>
1998 1997 1996
---------- ---------- ----------
<S> <C> <C> <C>
Net loss............................... $ (30,472) $ (58,006) $ (26,510)
Accretion of preferred stock discount.. -- -- (900)
---------- ---------- ----------
Net loss applicable to common
stockholders.......................... $ (30,472) $ (58,006) $ (27,410)
========== ========== ==========
Net loss per common share--basic and
diluted............................... $ (0.91) $ (1.87) $ (1.31)
========== ========== ==========
Weighted average common shares
outstanding--basic and diluted........ 33,483,000 30,994,000 20,923,000
========== ========== ==========
Antidilutive securities excluded from--
common stock equivalents.............. 5,726,000 6,237,000 4,967,000
========== ========== ==========
</TABLE>
(h) Concentrations of Credit Risk
SFAS No. 105, Disclosure of Information about Financial Instruments with
Off-Balance-Sheet Risk and Financial Instruments with Concentrations of Credit
Risk, requires disclosure of any significant off-balance-sheet
39
<PAGE>
OPEN MARKET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(In Thousands, except Share and Per Share Data)
risk and credit risk concentrations. The Company has no significant off-
balance-sheet risk or credit risk concentrations. The Company maintains its
cash and cash equivalents with several financial institutions and invests in
investment-grade securities. The Company maintains reserves for the potential
write-off of accounts receivable. The Company recorded revenues of greater
than 10% of total revenues for one customer in 1996 of 18%. The Company did
not have any customers with revenues greater than 10% of total revenues in the
years ended December 31, 1998 and 1997, respectively.
(i) Postretirement Benefits
The Company has no obligations for postretirement benefits.
(j) Financial Instruments
The estimated fair values of the Company's financial instruments, which
include cash equivalents, marketable securities, accounts receivable, accounts
payable, line of credit and long-term debt and obligations, approximate their
carrying value.
(k) Use of Estimates
The preparation of the accompanying consolidated financial statements
required the use of certain estimates by management in determining the
Company's assets, liabilities, revenues and expenses. Actual results could
differ from those estimates.
(l) Comprehensive Income
In June 1997, the Financial Accounting Standards Board (FASB) issued SFAS
No. 130 Reporting Comprehensive Income. SFAS No. 130 requires disclosure of
all components of comprehensive income on an annual and interim basis.
Comprehensive income is defined as the change in equity of a business
enterprise during a period from transactions and other events and
circumstances from nonowner sources. The Company's comprehensive loss is the
same as the reported net loss for all periods presented.
(m) Disclosures about Segments of an Enterprise
The Company has adopted SFAS No. 131, Disclosures about Segments of an
Enterprise and Related Information in the fiscal year ended December 31, 1998.
SFAS No. 131 establishes standards for reporting information regarding
operating segments in annual financial statements and requires selected
information for those segments to be presented in interim financial reports
issued to stockholders. SFAS No. 131 also establishes standards for related
disclosures about products and services and geographic areas. Operating
segments are identified as components of an enterprise about which separate
discrete financial information is available for evaluation by the chief
operating decision maker, or decision making group, in making decisions how to
allocate resources and assess performance. The Company's chief decision-maker,
as defined under SFAS No. 131, is a combination of the Chief Executive Officer
and the Chief Financial Officer. To date, the Company has viewed its
operations and manages its business as principally one operating segment. As a
result, the financial information disclosed herein, represents all of the
material financial information related to the Company's principal operating
segment.
40
<PAGE>
OPEN MARKET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(In Thousands, except Share and Per Share Data)
Revenues from sources in total and as a percentage of total revenues 1998,
1997 and 1996 were as follows:
<TABLE>
<CAPTION>
December 31,
------------------------------------
1998 1997 1996
----------- ----------- ----------
<S> <C> <C> <C> <C> <C> <C>
Europe/Africa............................. $14,841 23% $10,811 18% $1,877 7%
Asia/Pacific Rim.......................... 4,690 8 5,957 10 1,921 8
Other..................................... 611 1 1,210 2 60 2
------- --- ------- --- ------ ---
$20,142 32% $17,978 30% $3,858 17%
======= === ======= === ====== ===
</TABLE>
All of the Company's product sales for the years ended December 31, 1998,
1997 and 1996 were shipped from its facilities located in the United States.
(n) New Accounting Standards
In June 1998, the FASB issued SFAS No. 133, Accounting for Derivative
Instruments and Hedging Activities. SFAS No. 133 establishes accounting and
reporting standards for derivative instruments, including certain derivative
instruments embedded in their contracts, (collectively referred to as
derivatives) and for hedging activities. It requires that an entity recognize
all derivatives as either assets or liabilities in the statement of financial
position and measure those instruments at fair value. If certain conditions
are met, a derivative may be specifically designated as (a) a hedge of the
exposure to change in the fair value of a recognized asset or liability or an
unrecognized firm commitment, (b) a hedge of a foreign currency exposure of a
net investment in a foreign operation, an unrecognized firm commitment, an
available-for-sale security or a foreign-currency-denominated forecasted
transaction. SFAS No. 133 is effective for all fiscal quarters of fiscal years
beginning after June 15, 1999. This new standard is not anticipated to have a
significant impact on the Company's financial statements based on the current
structure and operations.
(3) Restructuring
In the fourth quarter of 1998, the Company implemented a restructuring plan
to better align its operating costs with its anticipated future revenue
stream. The major component of the restructuring charge relates to the
elimination of approximately 67 employees across the following functions:
Engineering (27), Marketing (17), General and Administrative (22) and Services
(1). In addition, 10 employees moved from Engineering to Consulting. Other
components related to the exiting of certain contractual arrangements for
porting and product integration that resulted from a change in product
strategy. Other charges included the write-off of unutilized software,
originally intended for use by the sales force but not implemented due to the
reduction in marketing personnel. At December 31, 1998 approximately $1,088 of
accrued restructuring charges remained, which is comprised of approximately
$756 of severance-related costs and $332 of contractual costs. The total cash
impact of the restructuring amounted to approximately $1,748. The total cash
paid as of December 31, 1998 was approximately $660 and the remaining amount
will be paid in 1999. Following are the significant components of the
restructuring charge:
<TABLE>
<S> <C>
Employee severance, benefits and related costs....................... $1,260
Write-off of assets.................................................. 294
Termination costs of certain contractual arrangements................ 488
------
$2,042
======
</TABLE>
41
<PAGE>
OPEN MARKET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(In Thousands, except Share and Per Share Data)
(4) Acquisitions
(a) ICentral Incorporated
On April 30, 1998, the Company acquired all of the outstanding shares of
capital stock of ICentral, Incorporated (ICentral) based in Provo, Utah.
ICentral specializes in Internet store-building products geared to small and
medium-sized businesses. As payment of the purchase price, the Company (i)
issued an aggregate of 480,140 shares of the common stock of the Company and
(ii) made a cash payment of $720 to the former stockholders of ICentral. The
value of the shares of the Company's common stock issued in connection with
the acquisition was approximately $10,000 based on a weighted average market
price, as defined. In addition, in connection with this acquisition, the
Company entered into employment agreements with certain key employees of
ICentral under which the Company agreed to pay bonuses in an aggregate amount
of $1,000, depending on certain future events, as defined. The employees
earned $667 under the employment agreements in the year ended December 31,
1998. For financial statement purposes, this acquisition was accounted for as
a purchase, and accordingly, the results of operations of ICentral subsequent
to April 30, 1998 are included in the Company's consolidated statements of
operations. Fifty percent of the shares of common stock issued to the former
shareholders of ICentral have been registered for resale pursuant to a
registration statement on Form S-3, declared effective by the Securities and
Exchange Commission on November 3, 1998.
The aggregate purchase price of $12,086 consisted of the following:
<TABLE>
<CAPTION>
Description Amount
----------- -------
<S> <C>
Common stock......................................................... $10,000
Cash................................................................. 720
Assumed liabilities.................................................. 666
Acquisition costs.................................................... 700
-------
Total purchase price: $12,086
=======
</TABLE>
The purchase price was allocated based upon the fair value of the tangible
and intangible assets acquired. These allocations represent the fair values
determined by an appraisal. The appraisal incorporated proven valuation
procedures and techniques in determining the fair value of each intangible
asset. The purchase price has been allocated as follows:
<TABLE>
<CAPTION>
Description Amount
----------- -------
<S> <C>
Current assets...................................................... $ 86
Other acquired intangible assets.................................... 6,300
In-process research & development................................... 5,700
-------
Total assets acquired: $12,086
=======
</TABLE>
As of the acquisition date of ICentral in April 1998, ICentral had initiated
a research and development effort related to the third major revision of its
flagship ShopSite product suite, an Internet commerce product suite that
allows small to medium-sized web merchants to transact business on the
Internet. The elements of the product suite are as follows: (1) ShopSite
Express, a tool that allows web designers to add a shopping system to any
existing web site, (2) ShopSite Manager, which offers the shopping
functionality of ShopSite Express combined with an automated commerce site
management system, and (3) ShopSite Pro, which combines the features of
ShopSite Manager with an additional set of advanced commerce tools including
real-time payment processing. The in-process technology included significant
new modifications of the features and functionality of the current
42
<PAGE>
OPEN MARKET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(In Thousands, except Share and Per Share Data)
suite of products, such as the addition of Cybercash as a payment option,
quantity discount interface capability to allow customers to purchase at
quantity discounts, tax modifications to allow the merchant to decide whether
to calculate tax before or after shipping is calculated, improved shipping
configuration of United Parcel Service shipping zones, and a mailing list
generator. It is expected that these modifications will further enhance the
product's ease of use in the marketplace. As of the acquisition date, the in-
process project was approximately 60% complete and it was estimated that the
in-process technology would have a seven-year life and that the first
product(s) would be introduced during the first quarter of fiscal 1999.
The value of the acquired in-process technology was computed using a
discounted cash flow analysis on the anticipated income stream of the
estimated future product sales of the developed technology. This was
determined by estimating the costs of developing the purchased in-process
development project into commercially viable products, estimating the
resulting net cash flows from the project, adjusting the cash flow for the
percentage of completion and the core technology component of the acquired
technology and discounting the adjusted net cash flows to their present value.
The estimates used to value the future revenue benefits of the in-process
research and development were based on elements of relevant market sizes and
growth/risk factors, expected trends in technology, and the nature and
expected timing of new product introductions by the Company and its
competitors.
In the valuation analysis, aggregate revenues for ICentral products were
estimated to be approximately $3,300 for fiscal 1998 and increasing to $62,500
in 2007. Revenues for the in-process technology were estimated to be
approximately $2,300 for fiscal 1998 and increasing to $28,700 in fiscal 2002,
representing a compound annual growth rate of approximately 65%. The estimated
revenues for the in-process technologies were expected to peak within four
years of the acquisition date. The estimated overall life of the acquired
developed technologies of ICentral is five years.
Operating expenses used in the valuation of ICentral included selling,
general and administrative, and research and development expenses. Operating
expenses were estimated based on historical expense levels of similar
companies operating in similar industries. Selling, general and administrative
expenses expressed as a percentage of revenue for the in-process technologies
were estimated to be 30% throughout the estimation period. Research and
development expenses, also expressed as a percentage of estimated revenue,
were estimated to be approximately 32% and 13% in 1998 and 1999, respectively,
and stabilized at 20% for the remainder of the estimation period. Cost of
sales was estimated based on an analysis of historical information for similar
companies operating in similar industries. Cost of sales for both the
developed and in-process technologies was estimated to be 19% throughout the
estimation period.
The discount rate selected for both the developed and in-process
technologies was 22% and was estimated by calculating a Weighted Average Cost
of Capital ("WACC") based on publicly traded guideline companies. The WACC
represents the blended, after-tax costs of debt and equity. The cost of equity
was estimated using the Capital Asset Pricing Model ("CAPM") and by reviewing
venture capital rates of return.
43
<PAGE>
OPEN MARKET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(In Thousands, except Share and Per Share Data)
The valuation analysis was performed in accordance with the provisions of
Accounting Principles Board ("APB") Opinions Nos. 16 and 17, wherein all
identifiable assets and intangible assets acquired were identified and
analyzed to determine their fair market values. In addition, to identify the
in-process research and development and determining if there were any
alternative future uses for these projects, these projects were evaluated in
the context of Interpretation 4 of Financial Accounting Standards Board
Statement No. 2 ("SFAS 2") and SFAS No. 86: Accounting For Software Costs.
Such evaluation consisted of a specific review of the efforts and uniqueness
of the developments of these projects, and a determination of whether
technological feasibility had been achieved. Accordingly, the Company believed
that the foregoing assumptions used in the ICentral acquired in-process
research and development analysis were reasonable at the time of acquisition.
However, no assurance can be given that the underlying assumptions used to
estimate expected sales revenues, development costs, or profitability, or the
events associated with such projects will transpire, or have transpired, as
estimated. The Company believes that the ShopSite product suite requires
continual upgrading and refinement to remain competitive in the targeted
markets. Thus, the failure to complete the in-process projects as scheduled
may cause ShopSite revenue to fall off precipitously from forecasted levels.
The Company estimates that if the scheduled ShopSite product releases were not
achieved, the existing ShopSite product suite would remain commercially viable
for only the next 12 to 18 months. The Company recorded approximately $840 of
amortization expense relating to these intangible assets during 1998.
(b) Waypoint Software Corporation
On February 12, 1997, the Company acquired all of the outstanding shares of
capital stock of Waypoint Software Corporation (Waypoint), a software
development company specializing in the business-to-business industrial
catalog segment of the Internet. As payment of the purchase price, the Company
issued an aggregate of approximately 739,000 shares of its common stock to the
stockholders of Waypoint and issued options to acquire approximately 6,000
shares of the Company's common stock at $0.456 per share to Waypoint option
holders. The value of the shares of, and the options to acquire, the Company's
common stock issued in connection with the acquisition was approximately
$11,000 based on a weighted average market price, as defined, of the Company's
freely tradable shares. The shares issued were subject to certain selling
restrictions and, as a result, were not freely tradable. Therefore, for
purposes of calculating aggregate consideration paid, the value of the shares
issued was recorded at a discounted value. In addition, in connection with
this acquisition, the Company has entered into employment agreements with
certain of the principals of Waypoint under which the Company has agreed to
pay bonuses in an aggregate amount of $1,200 over two years depending on
certain future events, as defined. The employees earned $600 under their
employment agreements in the year ended
44
<PAGE>
OPEN MARKET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(In Thousands, except Share and Per Share Data)
December 31, 1997 with the final payment expected in February 1999. For
financial statement purposes, this acquisition was accounted for as a
purchase, and accordingly, the results of operations of Waypoint subsequent to
February 12, 1997 are included in the Company's consolidated statements of
operations. The shares of common stock of the Company issued to the former
stockholders of Waypoint have been registered for resale pursuant to a
registration statement on Form S-3 declared effective by the Securities and
Exchange Commission on June 11, 1997.
The aggregate purchase price of $9,922 consisted of the following:
<TABLE>
<CAPTION>
Description Amount
----------- ------
<S> <C>
Common stock.......................................................... $9,548
Assumed liabilities................................................... 156
Acquisition costs..................................................... 218
------
Total purchase price: $9,922
======
</TABLE>
The purchase price was allocated based upon the fair value of the tangible
and intangible assets acquired. These allocations represent the fair values
determined by an independent appraisal. The appraisal incorporated proven
valuation procedures and techniques in determining the fair value of each
intangible asset. The purchase price has been allocated as follows:
<TABLE>
<CAPTION>
Description Amount
----------- ------
<S> <C>
Current assets....................................................... $ 590
Property, plant and equipment........................................ 76
Other assets......................................................... 6
In-process research and development.................................. 9,250
------
Total assets acquired: $9,922
======
</TABLE>
The in-process research and development has been expensed as a charge
against operations as of the closing of the transaction, and is included in
the accompanying consolidated statement of operations. The amount allocated to
in-process research and development relates to projects that had not yet
reached technological feasibility and that, until completion of development,
have no alternative future use. These projects will require substantial
development and testing prior to the reaching of technological feasibility.
However, there was no assurance that these projects would reach technological
feasibility or develop into products that might be sold profitably by the
Company. The technology acquired in the acquisition of Waypoint has required,
and may require, substantial additional development by the Company.
(c) Folio Corporation
Pursuant to a Stock Purchase Agreement dated as of February 20, 1997 (the
"Stock Purchase Agreement"), the Company acquired all of the outstanding
shares of capital stock of Folio Corporation (Folio), a leading supplier of
software for managing business-critical information. As payment of the
purchase price, the Company (i) issued 897,866 shares of common stock of the
Company, (ii) made a cash payment of $10,000, (iii) agreed to issue 897,866
shares of common stock of the Company in January 1998 and (iv) issued a
promissory note of the Company in the original principal amount of $10,000
payable in either cash or a combination of cash and common stock of the
Company. (See Note 5) The value of the shares of common stock of the Company
issued or reserved for issuance was approximately $25,000, based on a weighted
average market price, as defined, of the Company's freely tradable shares. The
shares of common stock issued in March, 1997 and in January 1998
45
<PAGE>
OPEN MARKET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(In Thousands, except Share and Per Share Data)
were not freely tradable due to selling restrictions. Therefore, although
448,933 and 538,342 shares were registered by the Company in August 1997 and
February 1998, respectively, upon the request of the former stockholder of
Folio as required under the terms of the Stock Purchase Agreement, for
purposes of calculating the aggregate consideration paid, the value of such
shares, was recorded at a discounted value at the time of issuance. The Stock
Purchase Agreement provided for a purchase price adjustment based on the
change in the net assets of Folio from the estimated value at December 31,
1996 through the date of closing. As a result of this adjustment, the former
stockholder of Folio forfeited 270,116 shares of common stock of the Company
to be issued in the transaction. Other equity in the accompanying December 31,
1997 consolidated balance sheet included the value of the shares to be issued
in January 1998, net of the forfeited shares. The Company repaid $5,000 of the
note payable issued to Reed Elsevier in 1997 in connection with the Folio
acquisition with a $1,818 cash payment. The balance of $3,182 was settled by
the issuance of common stock. The Company repaid the remaining $5 million in
cash in March 1999. For financial statement purposes, this acquisition was
accounted for as a purchase, and accordingly, the results of operations of
Folio subsequent to March 7, 1997 are included in the Company's consolidated
statements of operations. For tax purposes, this transaction will be treated
as a deemed asset purchase in accordance with the Internal Revenue Code
Section 338(h)(10).
The aggregate purchase price of $45,512 consisted of the following:
<TABLE>
<CAPTION>
Description Amount
----------- -------
<S> <C>
Common stock......................................................... $21,612
Cash paid............................................................ 11,818
Note payable......................................................... 5,000
Assumed liabilities.................................................. 5,682
Acquisition costs.................................................... 1,400
-------
Total purchase price: $45,512
=======
</TABLE>
The purchase price was allocated based upon the fair value of the tangible
and intangible assets acquired. These allocations represent the fair values
determined by an independent appraisal. The appraisal incorporated proven
valuation procedures and techniques in determining the fair value of each
intangible asset. The purchase price has been allocated as follows:
<TABLE>
<CAPTION>
Description Amount
----------- -------
<S> <C>
Current assets...................................................... $ 4,729
Property, plant and equipment....................................... 6,605
Other assets........................................................ 41
In-process research and development................................. 25,000
Other acquired intangible assets.................................... 9,137
-------
Total assets acquired: $45,512
=======
</TABLE>
The in-process research and development has been expensed as a charge
against operations as of the closing of the transaction, and is included in
the accompanying consolidated statement of operations. The amount allocated to
in-process research and development relates to projects that had not yet
reached technological feasibility and that, until completion of development,
have no alternative future use. These projects will require substantial
development and testing prior to reaching technological feasibility. However,
there can be no assurance that these projects will reach technological
feasibility or develop into products that may be sold profitably by the
Company. The technology acquired in the acquisition of Folio has required, and
will continue to require, substantial additional development by the Company.
The intangible assets are being amortized over
46
<PAGE>
OPEN MARKET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(In Thousands, except Share and Per Share Data)
five to seven years. The Company recorded approximately $1,620 and $1,351 of
amortization expense relating to these intangible assets during 1998 and1997,
respectively.
(d) Pro Forma Results of Operations
The following unaudited pro forma combined results of operations of the
Company assume that the Waypoint and Folio acquisitions were completed on
January 1, 1997.
<TABLE>
<S> <C>
Total revenues.................................................... $ 64,005
--------
Net loss.......................................................... (26,773)
========
Net loss per share--basic and diluted............................. $ (0.85)
========
</TABLE>
These pro forma amounts represent the historical operating results of
Waypoint and Folio prior to their respective dates of acquisition, combined
with those of the Company with appropriate adjustments which give effect to
interest income, interest expense, amortization expense, as well as the
exclusion of the charge for in-process research and development. These pro
forma results are not necessarily indicative of operating results, which would
have occurred if the Waypoint and Folio acquisitions had been operated by
current management during the periods presented.
The results prior to the ICentral acquisition were not material to the
Company. Accordingly, ICentral proforma results for 1998 and 1997 were not
presented.
(5) Long-Term Obligations
(a) Line-of-Credit Arrangement
The Company has an unsecured credit facility arrangement with a bank, which
provides up to $15,000 in financing in the form of a demand line of credit.
Borrowings under this line are limited to 80% of eligible domestic accounts
receivable and 90% of eligible foreign accounts receivable, as defined, and
bear interest at the prime lending rate (7.75% at December 31, 1998). The
Company is required to comply with certain restrictive covenants under this
agreement and the line is collateralized by the Company's accounts receivable.
The Company was in compliance with all such covenants at December 31, 1998.
During 1998, the Company increased its borrowings under this facility to
$11,000 and $4,000 remained available as of December 31, 1998.
(b) Note Payable
In connection with the acquisition of Folio, Corp. (See Note 4) the Company
issued a $10,000 promissory note payable to Reed Elsevier. The note is payable
in either cash or shares of common stock of the Company. The Company is
required to make payments in total of $10,000 and the note bears interest at
8%. During 1998, the Company made a $5,000 payment on the note comprised of
cash of $1,818 and 220,701 shares of common stock valued at $3,182. The
balance of the note payable was paid in cash in March 1999.
(c) Mortgage
In July 1998, the Company entered into a $2,800 mortgage of its Provo, Utah,
building which bears interest at the fixed rate of 8.5%. The mortgage
principal payments are based upon a 20-year term with a balloon payment of
$2,468 due on June 19, 2003.
47
<PAGE>
OPEN MARKET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(In Thousands, except Share and Per Share Data)
(d) Obligation Under License Agreement
During 1994, the Company entered into a license agreement with a university
to utilize certain patented computer software. The Company expensed the
present value of the future commitments under contract, $217, as a component
of research and development expense during 1994. The balance of the obligation
was $94 and $149 at December 31, 1998 and 1997, respectively. The obligation
will be repaid in annual installments of $52 through 2000.
Future maturities of long-term obligations as of December 31, 1998 are as
follows:
<TABLE>
<S> <C>
Year ending December 31,
1999................................................................. $ 88
2000................................................................. 110
2001................................................................. 68
2002................................................................. 74
2003................................................................. 81
Thereafter........................................................... 2,456
------
2,877
Less Current Portion................................................. 88
------
Total long-term obligations.......................................... 2,789
======
</TABLE>
(6) Income Taxes
The Company accounts for income taxes under SFAS No. 109, Accounting for
Income Taxes, the objective of which is to recognize the amount of current and
deferred income taxes payable or refundable at the date of the financial
statements as a result of all events that have been recognized in the
accompanying consolidated financial statements, as measured by enacted tax
laws.
The provision for income taxes for the years ended December 31, 1998, 1997
and 1996 consists of foreign income and withholding taxes.
At December 31, 1998, the Company has net operating loss carryforwards for
federal income tax purposes of approximately $96,000, which expire through
2005 - 2018. The Company also has certain tax credits available to offset
future federal and state income taxes, if any. Net operating loss
carryforwards and credits are subject to review and possible adjustments by
the Internal Revenue Service and may be limited in the event of certain
cumulative changes in excess of 50% in the ownership interests of significant
stockholders over a three-year period. The Company believes it has experienced
a change in ownership in excess of 50%. The Company does not believe that this
change in ownership will significantly impact the Company's ability to utilize
its net operating loss carryforwards.
The components of the Company's deferred tax asset are as follows:
<TABLE>
<CAPTION>
1998 1997
------- -------
<S> <C> <C>
Net operating loss carryforwards........................... $38,594 $26,000
Amortization of intangibles................................ 15,393 9,790
Tax credit carryforwards................................... 2,087 1,400
Temporary differences...................................... (762) 2,021
------- -------
Total deferred tax assets.................................. 55,312 39,211
Less--valuation allowance.................................. (55,312) (39,211)
------- -------
Net deferred tax assets.................................... $ -- $ --
======= =======
</TABLE>
48
<PAGE>
OPEN MARKET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(In Thousands, except Share and Per Share Data)
It is the Company's objective to become a profitable enterprise and to
realize the benefits of its deferred tax assets. However, in evaluating the
realizability of these deferred tax assets, management has considered the
Company's short operating history, the volatility of the market in which it
competes, the operating losses incurred to date, and believes that given the
significance of this evidence, a full valuation reserve against its deferred
tax assets is required as of December 31, 1998 and 1997. The increase in the
valuation allowance during these periods primarily relates to the Company's
operating results.
(7) Stockholders' Equity
(a) Preferred Stock
In April 1996, the Company's Board of Directors authorized the issuance of
up to 2,000,000 shares of $.10 par value preferred stock. At December 31,
1998, no shares are issued and outstanding.
(b) Common Stock
In April 1996, the stockholders authorized the issuance of up to 100,000,000
shares of common stock. At December 31, 1998, there are 20,051,000 shares
reserved for issuance under the Company's option and stock purchase plans.
(c) Private Placements
In June 1998, Intel Corporation made an investment in the Company,
purchasing 335,852 unregistered shares of the Company's common stock for an
aggregate purchase price of $5,000. In addition, the Company plans to port its
Transact software to Intel Pentium(R) Processor II-based servers running
Windows NT and Intel's next-generation IA-64 processor. The estimated costs of
$1--2 million associated with the port will be expensed as incurred with a
completion of the IA-64 version expected at the time of the release of Intel's
next-generation IA-64 processor. The Company expensed approximately $200 in
the year ended December 31, 1998. The two companies also plan to collaborate
on joint marketing activities.
In July 1998, CMG Information Services, Inc., an investor and developer of
Internet companies ("CMG") and Capital Ventures International, a fund managed
by Heights Capital Management ("CVI"), made a $20,000 equity investment in the
Company. Pursuant to the terms of the agreements, the Company issued an
aggregate of 1,545,893 shares of common stock of the Company to CMG and CVI at
a price of $12.94 per share. In addition, the Company issued to CMG and CVI
warrants to purchase 334,728 shares of common stock at a price of $16.43 per
share. The Company filed a registration statement on Form S-3, covering all
such shares of common stock, which was declared effective by the Securities
and Exchange Commission on August 13,1998.
(d) Initial Public Offering
In May 1996, the Company completed an initial public offering of 4,600,000
shares of its common stock at $18.00 per share. The Company received net
proceeds of approximately $76,127 after deducting the underwriters' commission
and issuance costs. Upon the closing of the initial public offering, all
shares of the Company's Series A, B and C redeemable convertible preferred
stock automatically converted into 13,437,000 shares of the Company's common
stock.
(e) Stockholders' Rights
In January 1998, the Company's Board of Directors adopted a Shareholder
Protection Rights Plan declaring a dividend of one right for each share of the
Company's common stock outstanding at the close of business on
49
<PAGE>
OPEN MARKET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(In Thousands, except Share and Per Share Data)
February 12, 1998. The rights entitle the Company's shareholders to purchase
one one-thousandth of a share of a series of junior participating preferred
stock of the Company at an exercise price of $65.00. The rights become
exercisable in the event that another party acquires or announces its
intention to acquire beneficial ownership of 18% or more of the Company's
common stock. Such percentage may, at the Board's discretion, be lowered,
although in no event may it be lower than 10%. In the event of such an
acquisition or similar event, each right, except those owned by the acquirer,
will enable the holder of the right to purchase that number of common shares
of the Company which equals the exercise price of the right divided by one-
half of the market price of the common stock. In addition, if the Company is
involved in a merger or other transaction with another party in which it is
not the surviving corporation, or it sells or transfers 50% or more of its
assets or earning power to another party, each right will entitle its holder
to purchase that number of shares of common stock of the other party which
equals the exercise price of the right divided by one-half of the market price
of such common stock. The rights expire ten years from the date of the grant.
(f) 1994 Stock Incentive Plan
During 1994, the Company's Board of Directors adopted the 1994 Stock
Incentive Plan (the Incentive Plan). Under the Incentive Plan, as amended, the
Company has reserved and may issue up to 19,201,000 shares of common stock or
options to purchase common stock. As of December 31, 1998, there are 4,857,000
shares available for issuance under the Incentive Plan.
Restricted Common Stock
In 1994, the Company sold 5,813,000 shares of restricted common stock to
employees at $.00033 per share. These shares were subject to repurchase
agreements and were scheduled to vest over a four-year period. The Company
could have repurchased any unvested shares of common stock held by these
individuals upon the termination of their employment at $.00033 per share.
During 1995, the Company repurchased 74,000 shares of unvested common stock.
All of the unvested shares became vested upon the completion of the Company's
initial public offering in May 1996.
Options
Under the terms of the Incentive Plan, the Board of Directors may grant
incentive stock options or nonqualified stock options to purchase shares of
the Company's common stock. The purchase price and vesting schedule applicable
to each option grant are determined by the Board of Directors. Options
generally vest over a four-year period and expire 10 years from the date of
grant.
The Company records deferred compensation when stock options are granted to
employees at an exercise price per share that is less than the fair market
value on the date of the grant. Deferred compensation is recorded in an amount
equal to the excess of the fair market value per share over the exercise price
multiplied by the number of shares purchasable under the option. During 1997,
the Company recorded $330 of deferred compensation for an option to purchase
30,000 shares of common stock. Compensation of $55 was recognized as an
expense in 1997. In 1998, in connection with the termination of the employee,
the Company reversed $55 of compensation expense recorded in 1997.
Additionally, in connection with the modification of a certain option
agreement, the Company recorded $22 and $50 in compensation expense in 1998
and 1997, respectively.
Repricing
In November 1998, the Compensation Committee of the Board of Directors
authorized a Stock Option Exchange Program (the Program). Under the terms of
the program all current employees excluding executive
50
<PAGE>
OPEN MARKET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(In Thousands, except Share and Per Share Data)
officers subject to regulation 16 had the option to request that the Company
cancel their existing options and replace them with a new option. Options for
a total of 2,258,153 shares were surrendered under the program by employees
and exchanged for new options at the new option exercise price and vesting
schedule. The new exercise price is equal to the fair market value of the
Company's common stock on November 13, 1998, or $7.875. The repriced shares
are subject to certain selling restrictions though 1999. These repriced
options are reflected as grants and cancellations in the stock activity below.
The following is a summary of the stock option activity:
<TABLE>
<CAPTION>
Weighted
Number of Average Price
Shares per Share
---------- -------------
<S> <C> <C>
Outstanding, December 31, 1995..................... 4,904,000 $ 0.37
Granted.......................................... 1,469,000 11.21
Exercised........................................ (1,138,000) 0.41
Terminated....................................... (268,000) 3.74
---------- ------
Outstanding, December 31, 1996..................... 4,967,000 $ 3.38
Granted.......................................... 2,708,000 11.17
Exercised........................................ (710,000) 0.50
Terminated....................................... (728,000) 9.44
---------- ------
Outstanding, December 31, 1997..................... 6,237,000 $ 6.38
Granted.......................................... 4,546,000 12.59
Exercised........................................ (977,000) 3.53
Terminated....................................... (4,080,000) 11.47
---------- ------
Outstanding, December 31, 1998..................... 5,726,000 $ 6.24
========== ======
Exercisable, December 31, 1996..................... 2,232,000 $ 0.82
========== ======
Exercisable, December 31, 1997..................... 2,107,000 $ 2.86
========== ======
Exercisable, December 31, 1998..................... 2,021,000 $ 2.91
========== ======
</TABLE>
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
------------------------------------------- --------------------------
Weighted Weighted Weighted
Average Average Average
Range of Exercise Number Remaining Exercise Price Number Exercise Price
Prices Outstanding Contractual Life per Share Outstanding per Share
- ----------------- ----------- ---------------- -------------- ----------- --------------
<S> <C> <C> <C> <C> <C> <C>
$00.17-00.18............ 361,000 6.14 $ 0.17 354,000 $ 0.17
$00.25-00.25............ 1,289,000 6.81 $ 0.25 1,091,000 $ 0.25
$01.50-07.50............ 372,000 8.29 $ 4.88 103,000 $ 3.41
$07.88-07.88............ 2,448,000 8.86 $ 7.88 4,000 $ 7.87
$09.38-11.25............ 811,000 8.15 $10.62 353,000 $10.55
$11.87-16.13............ 414,000 8.87 $12.35 110,000 $12.22
$17.25-17.25............ 24,000 9.92 $17.25 -- --
$17.50-17.50............ 2,000 7.58 $17.50 2,000 $17.50
$21.38-21.38............ 1,000 9.25 $21.38 -- --
$21.50-21.50............ 4,000 7.85 $21.50 4,000 $21.50
--------- ---- ------ --------- ------
5,726,000 8.09 $ 6.24 2,021,000 $ 2.91
========= =========
</TABLE>
51
<PAGE>
OPEN MARKET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(In Thousands, except Share and Per Share Data)
(g) The 1996 Director Option Plan
In April 1996, the Company's Board of Directors approved the 1996 Director
Option Plan (the Director Plan) whereby the Company has reserved and may issue
up to 100,000 shares of common stock. Under the terms of the Director Plan,
each newly elected director will be granted an option to purchase 20,000
shares of common stock. In addition, commencing with the 1998 annual meeting
of the stockholders and for every annual meeting of stockholders thereafter,
each director who is not a founder or employee of the Company will be granted
an option to purchase 6,000 shares of common stock. These options vest over a
four-year period and expire 10 years from the date of grant at the then fair
market value. The vesting of these options will accelerate upon a change of
control, as defined. At December 31, 1998, there were 68,267 options
outstanding under the Director Plan.
(h) The 1996 Employee Stock Purchase Plan
In April 1996, the Company's Board of Directors approved the 1996 Employee
Stock Purchase Plan (the Purchase Plan) whereby, the Company has reserved and
may issue up to an aggregate of 750,000 shares of its common stock for
issuance in accordance with the Purchase Plan. Under the terms of the Purchase
Plan, employees who meet certain eligibility requirements may purchase shares
of the Company's common stock at 85% of the closing price of the common stock
on the first or last day of each six-month offering period, whichever is
lower. In 1998 and 1997 the Company issued 132,000 and 59,000 shares,
respectively for gross proceeds of approximately $1,147, and $658,
respectively. At December 31, 1998 there are 559,000 shares available for
issuance under the plan.
(i) Pro Forma Disclosure of Stock-Based Compensation
In October 1995, the FASB issued SFAS No. 123, Accounting for Stock-Based
Compensation. SFAS No. 123 requires the measurement of the fair value of stock
options or warrants granted to employees to be included in the statement of
operations or, alternatively, disclosed in the notes to consolidated financial
statements. The Company has determined that it will continue to account for
stock-based compensation for employees under Accounting Principles Board
Opinion No. 25 and elect the disclosure-only alternative under SFAS No. 123.
The Company records the fair market value of stock options and warrants
granted to nonemployees in the consolidated statement of operations. The
Company has computed the pro forma disclosures required under SFAS No. 123 for
stock options granted in 1998, 1997 and 1996 using the Black-Scholes option
pricing model. The weighted average assumptions used for 1998, 1997 and 1996
are as follows:
<TABLE>
<CAPTION>
1998 1997 1996
----------- ----------- -----------
<S> <C> <C> <C>
Risk-free interest rate............... 4.70%--4.91% 5.75%--6.88% 5.54%--6.76%
Expected dividend yield............... -- -- --
Expected life......................... 6 years 7 years 7 years
Expected volatility................... 108% 70% 70%
</TABLE>
52
<PAGE>
OPEN MARKET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(In Thousands, except Share and Per Share Data)
The total value of the options granted to employees and stock issued under
the employee stock purchase plan during 1998, 1997 and 1996 was computed as
approximately $32,302, $16,943 and $9,716, respectively. Of these amounts
approximately $7,830, $8,908 and $4,725 would be charged to operations for the
years ended December 31, 1998, 1997 and 1996, respectively. The remaining
amount, approximately $19,430, would be amortized over the remaining vesting
periods. The pro forma effect of these option grants for the years ended
December 31, 1998, 1997 and 1996 is as follows:
<TABLE>
<CAPTION>
1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
Net loss, as reported......................... $(30,472) $(58,006) $(26,510)
======== ======== ========
Net loss, pro forma........................... $(38,302) $(66,914) $(31,235)
======== ======== ========
Net loss per share--basic and diluted
As reported................................. $ (0.91) $ (1.87) $ (1.31)
======== ======== ========
Pro forma................................... $ (1.14) $ (2.16) $ (1.54)
======== ======== ========
</TABLE>
The resulting pro forma compensation expense may not be representative of
the amount to be expected in future years as the pro forma expense may vary
based upon the number of options granted. The Black-Scholes option pricing
model was developed for use in estimating the fair value of traded options
that have no vesting restrictions and are fully transferable. In addition,
option pricing models require the input of highly subjective assumptions,
including expected stock price volatility. Because the Company's employee
stock options have characteristics significantly different from those of
traded options and because changes in the subjective input assumptions can
materially affect the fair value estimate, in management's opinion, the
existing models do not necessarily provide a reliable single measure of the
fair value of its employee stock options.
(j) Common Stock Purchase Warrant
During September 1996, the Company issued a stock purchase warrant to one of
its customers for the purchase of 100,000 shares of the Company's common stock
at an exercise price of $25.00 per share. At the time of issuance, the Company
recorded a charge of $211, representing the fair market value of the warrant,
as calculated using the Black-Scholes option pricing model. The warrant
expired on December 31, 1997.
(8) Commitments
(a) Facilities
The Company leases its facilities and certain equipment under operating
leases that expire through February 2010. The future minimum lease commitments
at December 31, 1998, net of sublease income, are as follows:
<TABLE>
<S> <C>
Year Ended December 31,
1999.............................................................. $ 2,460
2000.............................................................. 2,754
2001.............................................................. 3,003
2002.............................................................. 2,933
2003.............................................................. 2,770
Thereafter........................................................ 18,858
--------
$ 32,778
========
</TABLE>
53
<PAGE>
OPEN MARKET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(In Thousands, except Share and Per Share Data)
Rent expense included in the accompanying consolidated statements of
operations was approximately $2,911, $2,670, and $1,903 for the years ended
December 31, 1998, 1997, and 1996, respectively. The Company subleases a
portion of its Burlington office space. Additionally, the Company sublet the
remaining portion of its Cambridge facility in 1998.
(b) Sale of Accounts Receivable
The Company has a non-recourse factoring agreement under which it can factor
up to $8,000 of qualified accounts receivable, as defined. The Company sold
approximately $3,000 of accounts receivable during the second quarter of 1998.
There was $1,750 of accounts receivable outstanding under the factoring
agreement at December 31, 1998. The Company sold no accounts receivable during
the third and fourth quarters of 1998. As of December 31, 1998 the Company had
$6,250 available under this agreement. The Company records these transactions
as a sale of financial assets in accordance with SFAS No. 125, Accounting for
Transfers and Servicing of Financial Assets and Extinguishment of Liabilities,
as it surrenders control over these receivables upon transfer.
(c) Employment Agreements
The Company has entered into an employment agreement with an executive
officer that provides for bonus and severance benefits for a year upon
termination of employment, under certain circumstances, as defined. In
connection with the ICentral and Waypoint acquisitions (see Note 4(a and b)),
the Company entered into certain employment agreements.
(9) Related Party Transactions
The Company has entered into agreements with certain stockholders that
provide for product and service revenues. The Company believes that the terms
of these transactions are on terms no less favorable to the Company than could
be obtained from unaffiliated third parties. The Company recognized product
and service revenues from related parties of approximately $208, $6,129 and
$2,500 during the years ended December 31, 1998, 1997 and 1996, respectively.
The Company had related party accounts receivable of approximately $5, and
$182 and related party deferred revenue of approximately $196 and $81 included
in the accompanying consolidated balance sheets as of December 31, 1998 and
1997, respectively, from certain stockholders.
On February 5, 1996, the Company loaned $1,500 to a founder and director of
the Company. The loan was nonrecourse and was secured by a pledge of 375,000
shares of common stock and bore interest at a rate of 5.61% per annum. The
founder and director repaid the principal and interest in full during 1998.
(10) Employee Benefit Plan
In October 1995, the Company adopted a 401(k) savings and investment plan
(the 401(k) Plan) for eligible employees. Each participant may elect to
contribute up to 15% of his or her compensation for the plan year, subject to
certain limitations, as defined. Company matching contributions are made to
the 401(k) Plan at the discretion of the Board of Directors. To date there
have been no discretionary contributions made by the Company to the 401(k)
Plan.
54
<PAGE>
OPEN MARKET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(In Thousands, except Share and Per Share Data)
(11) Accrued Expenses
Accrued expenses consist of the following:
<TABLE>
<CAPTION>
December 31,
---------------
1998 1997
------- -------
<S> <C> <C>
Payroll and related expenses................................ $ 5,801 $ 6,169
Professional and consulting fees............................ 1,588 1,899
All other................................................... 6,303 6,372
------- -------
$13,692 $14,440
======= =======
</TABLE>
(12) Deferred Revenues
Deferred revenues consist of the following:
<TABLE>
<CAPTION>
December 31,
-------------
1998 1997
------ ------
<S> <C> <C>
Future product deliverables................................... $ 104 $ 726
Sublicense fees............................................... -- 1,601
Prepaid service revenues...................................... 4,444 2,603
------ ------
$4,548 $4,390
====== ======
</TABLE>
(13) Subsequent Events
In March 1999, the Company restated its June 30, 1998 and September 30, 1998
financial statements to reflect a change for the purchase price allocation
related to the 1998 acquisition of ICentral and the related amortization of
intangibles. This adjustment decreased the amount previously allocated to in-
process technology by $5,100, which has been capitalized as developed
technology and goodwill and will be amortized on a straight-line basis over
five years. The restatement was the result of concerns presented by the
Securities and Exchange Commission (SEC) regarding the valuation methodology
used for the determination of charges for acquired in-process research and
development costs. The Company believes that its periodic reports filed June
30, 1998 and September 30, 1998, which included such charges related to the
acquisition costs for ICentral, were made in accordance with generally
accepted accounting principles and established industry practices at the time.
In addition, the valuation of the acquired in-process research and development
was supported by an independent evaluation by Arthur Andersen LLP.
The Company has not been contacted by the SEC regarding its valuation
methodology. However, in response to the SEC's new guidelines, the Company has
decided to proactively move to the new valuation methodology for its 1998
acquisition of ICentral. Therefore, the Company expensed $5,700 to in-process
research and development in the second quarter of 1998, capitalized $6,300 of
developed technology and goodwill, and amortized the developed technology and
goodwill over the 5-year estimated useful life.
55
<PAGE>
OPEN MARKET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(In Thousands, except Share and Per Share Data)
PART III
The information required by Items 10 through 13 are incorporated by
reference to the Company's Definitive Proxy Statement for its 1999 Annual
Meeting of Stockholders' scheduled for May 12, 1999.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) The following documents are filed as part of this report:
(1) Financial Statements
Report of Independent Accountants
Consolidated Balance Sheet as of December 31, 1998 and 1997
Consolidated Statement of Operations for the years ended December 31,
1998, 1997 and 1996
Consolidated Statement of Stockholders Equity for the years ended
December 31, 1998, 1997 and 1996
Consolidated Statement of Cash Flows for the years ended December 31,
1998, 1997 and 1996
Notes to Consolidated Financial Statements
(2) Financial Statement Schedules
Schedule II--Valuation and Qualifying Accounts
Exhibits. The Exhibits listed in the Exhibit Index immediately
preceding such Exhibits are filed as part of this Annual Report on Form
10-K.
(b) Reports on Form 8-K.
None
56
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this Amendment No. 1
to be signed on its behalf by the undersigned, thereunto duly authorized.
Open Market, Inc.
/s/ Gary B. Eichhorn
By: _________________________________
Gary B. Eichhorn
President, Chief Executive
Officer
Date: April 2, 1999
57
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON SCHEDULE
To Open Market, Inc.:
We have audited, in accordance with generally accepted auditing standards, the
financial statements of Open Market, Inc. and subsidiaries included in this
10-K and have issued our report thereon dated February 2, 1999. Our audits
were made for the purpose of forming an opinion on the basic consolidated
financial statements taken as a whole. This schedule is the responsibility of
the Company's management and is presented for purposes of complying with the
Securities and Exchange Commission's rules and is not part of the basic
financial statements. This schedule has been subjected to the auditing
procedures applied in the audits of the basic consolidated financial
statements and, in our opinion, fairly states, in all material respects, the
financial data required to be set forth therein in relation to the basic
consolidated financial statements taken as a whole.
/s/ Arthur Andersen LLP
Boston, Massachusetts
February 2, 1999
<PAGE>
Schedule II
OPEN MARKET, INC.
Valuation and Qualifying Accounts
(In Thousands)
Allowance for doubtful accounts
<TABLE>
<CAPTION>
Balance at Balance at
Beginning End of
of Period Additions Deductions Other* Period
---------- --------- ---------- ------ ----------
<S> <C> <C> <C> <C> <C>
Year Ended December 31,
1996....................... $ 25 $ 175 $-- $-- $ 200
====== ====== ==== ==== ======
Year Ended December 31,
1997....................... $ 200 $1,473 $733 $530 $1,470
====== ====== ==== ==== ======
Year Ended December 31,
1998....................... $1,470 $1,504 $451 $-- $2,523
====== ====== ==== ==== ======
* Other represents allowance for doubtful accounts acquired in the Folio
acquisition.
Restructuring charge
Year Ended December 31,
1998....................... $ -- $2,042 $954 $-- $1,088
====== ====== ==== ==== ======
</TABLE>
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibit
No. Description
------- -----------
<C> <S>
2.1 Stock Purchase Agreement, dated as of February 4, 1997, among Waypoint
Software Corporation, the stockholders listed on Schedule I attached
thereto and Registrant.(1)
2.2+ Stock Purchase Agreement, dated as of February 20, 1997, among Folio
Corporation, Reed Elsevier, Inc. and Registrant.(2)
2.3 Agreement and Plan of Merger, dated as April 29, 1998, among the
Registrant, Norway Acquisition Corporation, a wholly owned subsidiary
of the Registrant and ICentral, Incorporated.(3)
3.1 Amended and Restated Certificate of Incorporation of the Registrant.(4)
3.2 Amended and Restated By-laws of the Registrant.(4)
4.1 Specimen Certificate for shares of Common Stock, $.001 par value, of
the Registrant.(4)
4.2 Form of Rights Certificate.(5)
4.3 Rights Agreement, dated as of January 26, 1998 between the Registrant
and BankBoston N.A.(6)
4.4 Amendment No. 1, dated as of February 17, 1999, to the Rights
Agreement dated as of January 26, 1998, between the Registrant and
BankBoston N.A., as Rights Agent.(7)
10.1 1994 Stock Incentive Plan, as amended.(4)#
10.2 1996 Employee Stock Purchase Plan.(4)#
10.3 1996 Director Option Plan.(4)#
10.4 Employment Agreement between the Registrant and Gary B. Eichhorn,
dated November 7, 1995.(4)#
10.5 Amendment No. 1, dated as of April 15, 1998, to Employment Agreement
between the Registrant and Gary B. Eichhorn, dated November 7,
1995.(8)#
10.6 Invention and Non-Disclosure Agreement dated November 10, 1995,
between the Registrant and Gary B. Eichhorn.(4)
10.7 Promissory Note dated February 5, 1996 in the principal amount of
$1,500,000 issued by David K. Gifford to the Registrant.(4)
10.8 Pledge Agreement dated February 5, 1996, between the Company and David
K. Gifford.(4)
10.9 Allonge to Term Note between David K. Gifford and Registrant dated
November 19, 1997.(11)
10.10+ Master Agreement, dated as of August 23, 1995, by and between FTP
Software, Inc. and the Registrant.(4)
10.11+ Development and Services Agreement dated as of January 1, 1995 by and
between Time Inc. New Media and the Registrant, as amended.(4)
10.12+ Master Development Agreement, dated as of February 21, 1995, by and
between Conde Net, Inc. and the Registrant.(4)
10.13+ TMS Software License Agreement, dated as of February 27, 1996, by and
between Tribune Interactive Network Services and the Registrant.(4)
10.14+ License Agreement dated October 17, 1994 by and between Massachusetts
Institute of Technology and the Registrant.(4)
10.15+ Software License Agreement, effective March 15, 1996, by and between
Novell, Inc. and the Registrant.(4)
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
Exhibit
No. Description
------- -----------
<C> <S>
10.16+ Master Development Agreement, dated as of May 22, 1995, by and
between Parade Net, Inc. and the Registrant.(4)
10.17+ OEM Master License Agreement, dated June 30, 1995, by and between
RSA Data Security, Inc. and the Registrant.(4)
10.18+ Public Key Patent License, effective as of September 6, 1995, by
and between Caro-Kann Corporation and the Registrant.(4)
10.19 Start-Up Services Agreement, dated as of February 27, 1996, by and
between the Registrant and Tribune Interactive Network Services.(4)
10.20 Founder's Agreement dated June 8, 1994 by and between David K.
Gifford and the Registrant.(4)#
10.21+ License and Exclusive Distribution Agreement dated as of April 10,
1996 by and between Time Inc. New Media and the Registrant.(4)
10.22+ Promissory Note dated as of March 7, 1997 by and between Reed
Elsevier, Inc. and Registrant.
10.23 Lease between Wayside Realty Trust and Registrant dated March 11,
1997.(11)
10.24 Loan and Security Agreement between Silicon Valley Bank and
Registrant dated
September 26, 1997.(9)
10.25 Export-Import Bank Loan and Security Agreement between Silicon
Valley Bank and Registrant dated September 26, 1997.(9)
10.26 Securities Purchase Agreement, dated as of July 30, 1998, by and
among the Registrant and CMG Information Services, Inc.(10)
10.27 Securities Purchase Agreement dated as of July 30, 1998, by and
among the Registrant and Capital Ventures International.(10)
10.28 Stock Purchase Warrant, dated July 30, 1998, by and between the
Registrant and CMG Information Services, Inc.(10)
10.29 Stock Purchase Warrant, dated July 30, 1998, by and between the
Registrant and Capital Ventures International.(10)
10.30 Registration Rights Agreement, dated as of July 30, 1998, by and
among the Registrant and CMG Information Services, Inc.(10)
10.31 Registration Rights Agreement, dated as of July 30, 1998, by and
among the Registrant and Capital Ventures International.(10)
10.32 Form of Executive Retention Agreement entered into by the
Registrant on one hand, and each of the following executive
officers of the Registrant, Thomas A. Nephew, Regina O. Sommer,
Peter Y. Woon, Gregory Pope, Michael S. Messier, Jeff Bussgang and
James Keller, on the other hand.(11)
10.33* Severance Agreement dated December 14, 1998 between the Registrant
and Shikhar Ghosh.
21.1* Subsidiaries of the Registrant.
23.1* Consent of Arthur Andersen LLP.
27.1* Financial Data Schedule
</TABLE>
- --------
* Filed herewith.
# Denotes management contract or compensatory plan or arrangement.
+ Confidential treatment requested as to certain portions which have been
omitted and filed separately with the Securities and Exchange Commission.
(1) Incorporated by reference to the Registrant's Current Report on Form 8-K
dated February 27, 1997.
(2) Incorporated by reference to the Registrant's Current Report on Form 8-K
dated March 24, 1997.
(3) Incorporated by reference to the Registrant's Current Report on Form 8-K
dated April 30, 1998.
<PAGE>
(4) Incorporated by reference to the Registrant's Registration Statement on
Form S-1 as filed with the Securities and Exchange Commission on April 10,
1996 and amended on April 29, 1996 and May 14, 1996 (File No. 333-03340).
(5) Incorporated by reference to Exhibit B to Exhibit1 to the Registrant's
Form 8-A filed January 30, 1998.
(6) Incorporated by reference to the Registrant's Current Report on Form 8-K
dated January 30, 1998.
(7) Incorporated by reference to the Registrant's Current Report on Form 8-K
dated February 17, 1999.
(8) Incorporated by reference to the Registrant's Quarterly Report on Form 10-
Q for the quarter ended March 31, 1998.
(9) Incorporated by reference to the Registrant's Quarterly Report on Form 10-
Q for the quarter ended September 30, 1997.
(10) Incorporated by reference to the Registrant's Current Report on Form 8-K,
dated July 30, 1998.
(11) Incorporated by reference to the Registrant's Annual Report on Form 10-K
for the year ended December 31, 1997.
<PAGE>
Exhibit 10.33
December 14, 1998
Shikhar Ghosh
388 Warren Street
Brookline, MA 02146
Dear Shikhar:
This letter will confirm that your employment with Open Market, Inc. will end
effective December 31, 1998. This letter will also serve as a separation
agreement between you and Open Market, Inc. Open Market is interested in
establishing an amicable arrangement for ending your employment relationship and
therefore makes the proposal contained in this letter.
In consideration of your agreement to the terms described here, Open Market will
pay you as severance a sum equal to 52 weeks salary at your current rate of base
pay and actual variable compensation earned in 1998 (less appropriate federal,
state, FICA, and other deductions) in accordance with the regular payday
schedule. Your coverage under any company-sponsored insurance plans will expire
on December 31, 1998 with the following exception. Open Market will pay for
extension of your medical and dental coverage under COBRA through December 31,
1999. Open Market will deduct the regular employee payroll contribution for
these coverages from each check through your severance period. You will be
entitled to further continue your medical and dental coverage beyond your
severance period under the Consolidated Budget Reconciliation Act of 1985 (often
referred to as COBRA). You will receive explanation of your COBRA rights under
separate cover. The amount of your current rate of base pay and actual variable
compensation earned in 1998 will be confirmed to you in writing separately.
Except for unused, accrued vacation pay, funds that may have vested in Open
Market's benefit plans, any outstanding sales commission due to you under the
terms of Open Market's Sales Compensation Plan Terms and Conditions document, or
stock options vested as of the date of termination, the severance payment and
other benefits described above are in lieu of any other compensation or payment.
You will not be entitled to any other compensation or benefits, except for those
explicitly described in this letter. You also understand that you remain bound
by the restrictions contained in the Invention and Non-Disclosure Agreement that
you executed. Among other things, that Agreement requires that you surrender
all Proprietary Information and materials upon your separation from the company.
The Invention and Non-Disclosure Agreement also requires that for a period of
one year after your termination, you will not compete with
<PAGE>
Open Market. Open Market confirms its intent to enforce all other terms of your
Invention and Non-Disclosure Agreement as written. Notwithstanding the above,
Open Market acknowledges that you will continue to require access to Open Market
Proprietary Information in connection with your role as Chairman of the Board of
the Company. In addition, Open Market hereby confirms to you that your
activities in connection with ibelong Networks, Inc. (fka Affinity-Net, Inc.) as
described to the Board will not constitute a corporate opportunity of Open
Market or violate your non-competition agreement.
In consideration of Open Market's commitments to you under this letter, you
agree to release Open Market, its parent, subsidiaries and affiliates, and its
past and present officers, directors, shareholders and employees from any and
all claims you may have against us arising out of the course of your employment
and the termination of your employment with Open Market. Those claims include,
but are not limited to any you may arguably have or have had under Title VII of
the Civil Rights Act of 1964, as amended, the Americans with Disabilities Act,
the Age Discrimination in Employment Act of 1967, as amended, the Family and
Medical Leave Act, the Massachusetts Anti-Discrimination Act (G.L.c. 151B), and
any other applicable federal, state or local law.
In addition, you acknowledge that this is a full and final settlement with Open
Market and agree that you will not bring or file any lawsuit or administrative
charge against Open Market or any of its agents, or employees, or allow others
to bring such an action on your behalf. You also agree not to disclose the
terms of this agreement to anyone outside your immediate family, your attorney
and your financial advisors, and you will insure that they keep this information
confidential. Notwithstanding the foregoing, all rights of indemnification
previously provided by Open Market to you by Open Market's certificate of
incorporation, by-laws and/or any indemnification agreement shall continue in
full force and effect in accordance with their terms, following the date of this
Agreement.
Finally, you represent to us that you have entered into this agreement based
upon your own judgment, that you are fully aware of the contents and legal
effect of this letter, that you have been given the opportunity, if you so
desire, to consider this agreement for twenty-one (21) days before executing it
and that, by this letter, we have advised you to consult with an attorney about
its terms. In the event that you have executed this agreement within less than
the twenty-one (21) days of the date of its delivery to you, you acknowledge
that your decision to do so was entirely voluntary and that you had the
opportunity to consider this agreement for the entire twenty-one (21) day
period. Open Market acknowledges that for a period of seven (7) days from the
date of the execution of this agreement, you may revoke this agreement by
written notice to me at the following address:
Open Market, Inc.
One Wayside Road
Burlington, MA 01803
<PAGE>
This agreement shall not become effective or enforceable until the expiration of
this revocation period. You also represent that the terms of this agreement set
forth our entire understanding regarding this subject. You agree that
Massachusetts law shall govern this agreement and that the terms of this
agreement shall be construed as a whole and not for or against either party.
This agreement supersedes all prior discussions, understandings and agreements
with respect to your termination.
To confirm that you understand and agree to these terms, please sign both
originals in the space provided below and return one to use for our files.
Sincerely, Agreed to and accepted:
/s/ William Kaiser /s/ Shikhar Ghosh
- ------------------ ------------------
William Kaiser Shikhar Ghosh
Chairman of the Compensation Committee
Open Market, Inc. Board of Directors
1/8/99
-----------------------
Date
<PAGE>
EXHIBIT 21.1
SUBSIDIARIES OF THE REGISTRANT
State or country of incorporation
---------------------------------
1) Open Market Securities, Inc. Massachusetts
One Wayside Road
Burlington, Massachusetts
2) Open Market UK Limited United Kingdom
Arundell House
1 Farm Yard, 1st Floor
Windor SL4 1QL, UK
3) Open Market France SARL France
8 Rue de Berri
Paris, France
4) Open Market Germany GmbH Germany
Merkurhaus Frankfurt
Hessenring 121
61348 Bad Homburg
Germany
5) Open Market Pty Limited Australia
P.O. Box R1608
Royal Exchange NSW
Sydney, Australia
6) Open Market Internet Software B.V. The Netherlands
Wegalaan 32
2132 JC Hoofddorp
The Netherlands
7) Folio Corporation Utah
5072 North 300 West
Provo, Utah
8) Waypoint Software Corporation Massachusetts
1 Wayside Road
Burlington, Massachusetts
9) Open Market Japan KK Japan
No. 2 Okamotoya Bldg.
4F 1-22-16 Toranomon, Minato-ku
Tokyo, Japan
10) Open Market Italy s.r.l. Italy
Corso Novara 2
27029 Vigevano-PV
Italy
(11) ICentral Incorporated Utah
5072 North 300 West
Provo, Utah
<PAGE>
EXHIBIT 23.1
CONSENT OF INDEPENDENT ACCOUNTANTS
As independent public accountants, we hereby consent to the incorporation
of our reports included in this Form 10-K/A into the Company's previously filed
registration statements File No. 333-06821 on Form S-8, File No. 333-28323 on
Form S-3, File No. 333-32447 on Form S-3, File No. 333-32448 on Form S-8 File
No. 333-45973 on Form S-3, File No. 333-60041 on Form S-8, File No. 333-61013 on
Form S-3 and File No. 333-64937 on Form S-3.
/s/ ARTHUR ANDERSEN LLP
Boston, Massachusetts
April 2, 1999
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
COMPANY'S FORM 10-K AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C> <C>
<PERIOD-TYPE> YEAR YEAR
<FISCAL-YEAR-END> DEC-31-1998 DEC-31-1997
<PERIOD-START> JAN-01-1998 JAN-01-1997
<PERIOD-END> DEC-31-1998 DEC-31-1997
<CASH> 19,921 19,966
<SECURITIES> 14,958 10,972
<RECEIVABLES> 28,250 23,102
<ALLOWANCES> 2,523 1,470
<INVENTORY> 0 0
<CURRENT-ASSETS> 65,021 56,156
<PP&E> 26,521 21,513
<DEPRECIATION> 11,093 6,356
<TOTAL-ASSETS> 94,958 80,874
<CURRENT-LIABILITIES> 37,176 37,316
<BONDS> 0 0
0 0
0 0
<COMMON> 35 31
<OTHER-SE> 54,958 43,428
<TOTAL-LIABILITY-AND-EQUITY> 94,958 80,874
<SALES> 42,245 48,168
<TOTAL-REVENUES> 62,145 61,260
<CGS> 2,767 2,477
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<OTHER-EXPENSES> 74,984 108,871
<LOSS-PROVISION> 0 0
<INTEREST-EXPENSE> 1,097 777
<INCOME-PRETAX> (30,147) (57,422)
<INCOME-TAX> 325 584
<INCOME-CONTINUING> (30,472) (58,006)
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> (30,472) (58,006)
<EPS-PRIMARY> (0.91) (1.87)
<EPS-DILUTED> (0.91) (1.87)
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