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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
FOR ANNUAL AND TRANSITION REPORTS PURSUANT
TO SECTIONS 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934
(MARK ONE)
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934 FOR THE FISCAL YEAR ENDED MAY 31, 2000
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934 FOR THE TRANSITION PERIOD FROM ________ TO ________
COMMISSION FILE NUMBER 000-26565
LIBERATE TECHNOLOGIES
(Exact Name of Registrant as Specified in Its Charter)
DELAWARE 94-3245315
(State or Other Jurisdiction of (I.R.S. Employer Incorporation or
Incorporation) Organization
Identification No.)
2 CIRCLE STAR WAY, SAN CARLOS, CALIFORNIA 94070-6200
(Address of Principal Executive Offices) (Zip Code)
(650) 701-4000
Registrant's Telephone Number, Including Area Code
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
COMMON STOCK, $0.01 PAR VALUE PER SHARE
(TITLE OF CLASS)
Indicate by check mark whether the Company (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 Company
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 the Company's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendments to
this Form 10-K. / /
The aggregate market value of the voting stock held by non-affiliates of the
Company was approximately $2,354,751,000 based on the last reported sale price
of the Company's common stock on the Nasdaq National Market System on July 31,
2000. There were 102,659,427 shares of common stock outstanding as of July 31,
2000.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Company's Proxy Statement for the Annual Meeting of
Stockholders to be held on October 24, 2000 are incorporated by reference in
Items 10, 11, 12 and 13 of Part III of this Report.
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LIBERATE TECHNOLOGIES
ANNUAL REPORT ON FORM 10-K
FOR THE FISCAL YEAR ENDED MAY 31, 2000
TABLE OF CONTENTS
PAGE
----
PART I
Item 1. Business.................................................... 3
Item 2. Properties.................................................. 19
Item 3. Legal Proceedings........................................... 20
Item 4. Submission of Matters to a Vote of Security Holders......... 20
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters......................................... 21
Item 6. Selected Financial Data..................................... 22
Item 7. Management's Discussion and Analysis of Financial Condition
and
Results of Operations....................................... 24
Item 7A. Quantitative and Qualitative Disclosures About Market
Risk........................................................ 37
Item 8. Financial Statements and Supplementary Data................. 38
Item 9. Changes in and Disagreements with Accountants on Accounting
and
Financial Disclosure........................................ 38
PART III
Item 10. Directors and Executive Officers of the Registrant.......... 39
Item 11. Executive Compensation...................................... 40
Item 12. Stock Ownership of Certain Beneficial Owners and
Management.................................................. 40
Item 13. Certain Relationships and Related Transactions.............. 40
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form
8-K......................................................... 41
Signatures............................................................... 45
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS............................... F-1
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
Some of the statements in the Annual Report on Form 10-K, constitute
forward-looking statements. These statements involve known and unknown risks,
uncertainties and other factors that may cause our or our industry's actual
results, levels of activity, performance or achievements to be materially
different from any future results, levels of activity, performance or
achievements expressed or implied by such forward-looking statements. These
factors include those listed under Part I "Business--Risk Factors."
Forward-looking statements relate to future events or our future financial
performance. In some cases, you can identify forward-looking statements by
terminology such as "may," "will," "should," "expects," "plans," "anticipates,"
"believes," "estimates," "predicts," "potential" or "continue" or the negative
of such terms or other comparable terminology. These statements are only
predictions. Actual events or results may differ materially. In evaluating these
statements, you should specifically consider various factors, including the
risks outlined under Part I "Business--Risk Factors." These factors may cause
our actual results to differ materially from any forward-looking statement.
Although we believe that the expectations reflected in the forward-looking
statements are reasonable, we cannot guarantee future results, levels of
activity, performance or achievements. Moreover, neither we nor any other person
assumes responsibility for the accuracy and completeness of such statements. We
are under no duty to update any of the forward-looking statements after the date
of this Annual Report on Form 10-K to conform such statements to actual results.
2
PART I
ITEM 1. BUSINESS
OVERVIEW
Liberate, incorporated in Delaware in April 1996, is a leading provider of a
comprehensive software platform for delivering content, services and
applications to a broad range of information appliances. Information appliances,
which include television set-top boxes, game consoles and personal digital
assistants, are devices that are enhanced by Internet capability. Network
operators, such as telecommunications companies, cable and satellite television
operators and Internet service providers, or ISPs, can use our server software
to deliver Internet-enhanced services to numerous information appliances and
millions of consumers. Information appliance manufacturers can use our client
software to Internet-enable their products. Our open platform also provides a
uniform environment for developers to enhance existing content and create new
Internet applications and services for delivery on multiple platforms. Our
software platform is designed to enable network operators to provide consumers
with universal access to these Internet-enhanced applications and services. To
extend the functionality of our software platform, we have also developed
strategic alliances with leading technology vendors such as Cisco Systems,
Inktomi, Netscape, Oracle, Sun Microsystems, Scientific-Atlanta and General
Instrument (recently acquired by Motorola). We also have established commercial
relationships with numerous large network operators, such as America Online,
Cable & Wireless Communications (portions of which were recently acquired by
NTL), Comcast, Cox Communications, Insight Communications, NTL, Shaw
Communications and US WEST.
PRODUCTS AND TECHNOLOGY
Our information appliance software platform includes a full range of client
and server products, tools and applications. We offer network operators a suite
of server solutions tailored to the cable, satellite, telecommunications and ISP
markets. We deliver client products targeted for the needs of information
appliance manufacturers with a current focus on television-related devices. Our
tools and pre-configured applications allow network operators and information
appliance manufacturers to offer a fully customizable client and server
platform.
Our client and server software platform incorporates proprietary technology
that we have developed to address the needs of network operators and information
appliance manufacturers, including the following technologies:
- EXPERTISE IN DIGITAL TELEVISION AND INTERNET TECHNOLOGY. We have spent
over three years developing fundamental expertise in working with Internet
browser and server software. This enables us to easily modify and enhance
our client software with critical third-party technologies such as Java
and Real Audio while maintaining compatibility with Internet standards. We
have also developed a wealth of expertise in the deployment of interactive
applications and services over various digital television network
architectures. We are also pioneering the development of key industry
standards in the Americas and in Europe.
- OPTIMIZED CLIENT TECHNOLOGY. In just 700Kb of memory, we offer one of the
smallest, most efficient client engines available with HTML and JavaScript
capabilities, which allows it to be used in a wide variety of information
appliances. Additionally, we offer client engines as small as 300Kb that
utilize Internet-based server engines to support low-end set-top boxes
such as the Motorola DCT-2000. In addition, we have developed a
proprietary display technology called IQView, which optimizes Internet
content for delivery on virtually any display device without specialized
graphics hardware.
- PORTABLE CLIENT ARCHITECTURE. We have developed our client software with
the flexibility to operate on a wide variety of information appliances.
Our client software currently supports processors
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from, among others, STMicrotechnology, Motorola, ARM, Hitachi, IBM, Intel,
National Semiconductor, MIPS and Sun Microsystems, and runs on multiple
operating systems, including Microsoft Windows CE, PowerTV, VxWorks and
Linux.
- RELIABLE SERVER ARCHITECTURE. We have based our server software on open
Internet standards and subsequently enjoy a scalable, secure and
expandable platform. In addition, we have pre-integrated our server
technology with industry leading server solutions to make integration with
our network operator customers faster and easier.
The following table provides a list of our principal products and a brief
description of the features and benefits to our customers of each.
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SELECTED PRODUCTS SELECTED FEATURES SELECTED BENEFITS
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LIBERATE SERVER PRODUCTS
LIBERATE CONNECT-TM- Subscriber and application management Network operators can control
subscriber access to applications and
services and can access subscriber data
for efficient customer support
Internet standard security Network operators can offer subscribers
and external e-commerce providers
highly secure transactions
Open standards integration interfaces Network operators can seamlessly
integrate our servers with existing
subscriber management, database and
billing systems
Device management tools Network operators can distribute
software updates automatically and
efficiently to all network devices and
restore services rapidly in case of
client or network failure
Highly scalable architecture Network operators can scale networks to
support millions of subscribers by
simply installing more servers on the
system
LIBERATE MEDIACAST-TM- Content and application broadcasting Network operators can utilize existing
network infrastructure to broadcast
Internet content and interactive
applications
Multiple transport stream capability Network operators can more fully
utilize infrastructure assets by
transmitting data over different
networks
LIBERATE TRANSCODER-TM- Reduced processing and memory load Network operators can deliver rich
Internet content and applications to a
broad range of information appliances
Internet content error checking Network operators can ensure accurate
rendering of HTML, image and audio
content
LIBERATE DATAPOINT-TM- Storage of consumer and set-top box Network operators can store their
related information users' service and applications
preferences on the headend, as well as
key technical data on their users'
set-top boxes
Reliance on proven, scalable database Liberate Datapoint is ported on the
Oracle 8i database, ensuring
scalability and reliability of the
architecture in volume deployments
LIBERATE COMMAND-TM- Server and applications management Network operators can manage and
through Internet browser-based monitor all our server systems and
interface applications throughout their network
from any Internet connected workstation
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SELECTED PRODUCTS SELECTED FEATURES SELECTED BENEFITS
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LIBERATE APPLICATIONS
LIBERATE TV INFO-TM- XML-based architecture receives, Network operators can combine and
integrates and exports multiple TV deliver TV program data and Internet
and Internet data sources to multiple data to various applications, including
clients and applications interactive program guides, channel
bars and pay-per-view applications
LIBERATE TV MAIL-TM- TV-based e-mail application Network operators can offer customized
e-mail services using existing
infrastructure
Picture and video e-mail Network operators are able to offer
rich multimedia content which enhances
the e-mail experience
LIBERATE TV CHAT-TM- Online discussion application Network operators can promote
integrated with TV programming subscriber communities by supplementing
existing TV programming with
interactive online discussion
capabilities
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LIBERATE CLIENT PRODUCTS
LIBERATE TV Small memory requirement, 700Kb Information appliance manufacturers can
NAVIGATOR-TM--CABLE, STANDARD reduce costs by reducing memory and
PROFILE processing component costs, and
software runs on memory-constrained
devices, including digital set-top
boxes
Integrated video and data path Network operators can use existing high
bandwidth video delivery systems to
deliver Internet-based interactive
television content and applications,
such as TV-based browsers and e-mail
HTML and JavaScript support Network operators can deliver Internet
standards-based applications, content
and services to their customer base
Highly portable Information appliance manufacturers can
easily add our software platform to a
variety of existing and next-generation
information appliances
Customizable user interface Network operators and information
appliance manufacturers can brand and
control the user interface associated
with the service and of applications
offered
LIBERATE TV Small memory requirements, starting Network operators can deliver
NAVIGATOR-TM--CABLE, COMPACT at 300Kb, capability to run with less interactive services to set-top boxes
PROFILE than 10 MIPS of CPU performance that have memory and processor
constraints
Support of MPEG I-Frames Network operators can maximize
bandwidth to the box with existing
network infrastructure
Headend based HTML to MPEG I-Frames Information appliance manufacturers and
transcoding network operators can use existing
content development tools to build
interactive applications
LIBERATE TV Support of more client focused Network operators can deliver services
NAVIGATOR-TM--TELCO, STANDARD architectures where the network through telecommunications networks
PROFILE bandwidth is limited, such as using phone lines as a two-way path
narrowband fixed line ISP services
Support of Input Method Engine and Network operators can deliver services
double byte characters to a number of international markets
including the Japanese and Chinese
markets
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SELECTED PRODUCTS SELECTED FEATURES SELECTED BENEFITS
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LIBERATE TOOLS
LIBERATE TV PRODUCER-TM- Tools and tutorials for creating Developers can rapidly create Internet
applications content and applications targeted to a
television audience
LIBERATE TV EMULATOR-TM- Real-time client emulator running on Developers can inexpensively design and
the Windows platform test their application without a full
broadcast enabled environment
Suite of integrated debugging tools Developers can debug JavaScript and
HTML-based code in an easy to use
development environment
LIBERATE TV CUSTOMIZER-TM- Tool for modifying the look and feel Developers can create a customized look
of the user interface and and brand for a network operator
applications service which is consistent across the
entire service
LIBERATE TV PORTER-TM- A tool set for porting the Liberate Semiconductor companies and hardware
TV Navigator client to new or manufacturers can develop and deliver
existing set-top boxes drivers compliant with the Liberate
Porting API
Sample drivers developed in the Second source porting programs benefit
course of a porting project network operators by enabling a wide
choice of our enabled set-top boxes
that result in lower hardware costs and
accelerate volume deployments
LIBERATE TV EXTENDER-TM- A set of extension APIs for Liberate Along with our partners, network
TV Navigator to add functionality operators and technology partners, we
beyond the core platform can plug in specific software modules
to address applications such as Video
On Demand and Conditional Access
interfaces
Generic extension interfaces make our
solution open, maximizing network
operators' freedom to choose their
technology vendors
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SERVICES
We provide a comprehensive set of consulting, engineering, training and
maintenance services to our customers. The deployment by network operators of
Internet standards-based services and the development by information appliance
manufacturers of new products require a high level of customer service and
support. We believe that our consulting and engineering services organizations
are critical to the successful sale and deployment of our products. We typically
charge customers on a time and materials basis for our services.
CONSULTING AND ENGINEERING SERVICES. As of May 31, 2000, our consulting and
engineering services groups consisted of 65 full-time employees. These
organizations provide project management support, which includes service
implementation guidance, product customization and product configuration
support. These organizations also provide project management and engineering
assistance to information appliance manufacturers, as well as assistance with
custom application development. To help ensure seamless product deployments,
these organizations may work closely, often onsite, with network operators to
integrate and install our software.
MAINTENANCE AND TRAINING. As of May 31, 2000, our customer service, support
and training organizations consisted of 25 full-time employees that provide
worldwide support and services. Outside of the United States, we have worked
with Oracle to augment our service capability. We run a technical training
program for our worldwide customers and developers. Curriculum and training
classes are available for most of our products.
SALES AND MARKETING
We sell products primarily through our direct sales force. Indirect
resellers are utilized in certain developing markets such as Latin America and
Australia. We intend to increase the number of indirect distribution partners.
Our sales force, which consisted of 33 individuals as of May 31, 2000, is
organized into teams consisting of sales representatives and systems engineers.
As of May 31, 2000, direct sales professionals were located in North America,
Europe and Asia/Pacific. We use our direct sales force to target the customers
that we believe provide the highest potential for service deployment and
revenues.
More specifically, we sell our server products either directly to network
operators or to system integrators who then resell to network operators. We sell
our client products to both information appliance manufacturers and network
operators. Information appliances containing our software platform are
distributed by the manufacturer to the end user either through a retail channel
or through network operators.
To complement the direct sales and distribution efforts, we utilize an
integrated marketing approach focused on identifying customer needs, defining
products and stimulating demand. We participate in tradeshows worldwide, arrange
speaking engagements for key personnel, sponsor conferences and run a program
for developers. An internal creative production group supports the marketing
effort by helping to define the next generation of interfaces for our products.
Actual consumer and usage feedback based on our current deployments is used to
provide feedback for the development of future products or enhancement of
current products.
During fiscal year 2000, we launched our PopTV-TM- Program, which is a
developer and technology partner program designed to help bring complete
interactive TV offerings to market sooner by providing end-to-end solutions.
CUSTOMERS
As of May 31, 2000, we have achieved over 30 network operator design wins,
and information appliance manufacturers have shipped over 500,000 units,
including units from previous product lines, that incorporate our software. Our
software, depending on the version, is either localized or in the
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process of being localized for a number of international markets and languages,
including Chinese and Japanese.
COMPETITION
Competition in the information appliance software market is intense. Our
principal competitors on the client software side include Microsoft, OpenTV
(which recently acquired another former competitor, Spyglass), Canal+
Technologies and PowerTV. On the server side, our primary competitor is
Microsoft. We also expect additional competition from other established and
emerging companies. We expect competition to persist and intensify as the
information appliance market develops and competitors focus on additional
product and service offerings. We believe that the principal competitive factors
in our industry are the quality and breadth of product and service offerings,
the ease and speed with which a product can be integrated into network
operators' existing internal systems and deployed to network operators'
customers, the efficiency with which our software platform operates with
numerous information appliances, the adequacy of financial resources, the
competitiveness of product pricing, the length of time-to-market and the
effectiveness of sales and marketing efforts. We believe that we presently
compete favorably with our competitors in these areas. However, the market for
information appliances is evolving, and we cannot be certain that we will
compete successfully in the future. See "Risk Factors--Competition From Bigger,
Better Capitalized Competitors Could Result In Price Reductions, Reduced Gross
Margins And Loss Of Market Share."
PROPRIETARY RIGHTS
We seek to protect our proprietary rights and our other intellectual
property through a combination of copyrights, trademarks, patents and trade
secret protection, as well as through contractual protections such as
proprietary information agreements and nondisclosure agreements. However, we
cannot guarantee that the steps we have taken to protect our proprietary rights
will be adequate to deter misappropriation of our proprietary information, and
we may not be able to detect unauthorized use and take appropriate steps to
enforce our intellectual property rights. See "Risk Factors--Our Limited Ability
To Protect Our Intellectual Property And Proprietary Rights May Harm Our
Competitiveness."
EMPLOYEES
As of May 31, 2000, we had 414 employees, including 225 in engineering, 61
in sales and marketing, 90 in services and 38 in administration. None of our
employees is represented by a collective bargaining agreement. We have never
experienced a work stoppage, and we consider our relations with our employees to
be good.
Our future operating results depend in significant part on the continued
service of our key technical, sales and senior management personnel, none of
whom, except Mitchell E. Kertzman, Coleman Sisson and Philip A. Vachon, are
party to an employment agreement. Our future success also depends on our
continuing ability to attract and retain highly qualified technical, sales and
senior management personnel. Competition for these personnel is intense, and we
may not be able to retain the key members of our technical, sales and senior
management staff or attract these personnel in the future. We have experienced
difficulty in recruiting qualified technical, sales and senior management
personnel, and we expect to experience these difficulties in the future. If we
are unable to hire and retain qualified personnel in the future, our business
could be seriously harmed.
RISK FACTORS
IN ADDITION TO OTHER INFORMATION IN THIS FORM 10-K, THE FOLLOWING RISK
FACTORS SHOULD BE CAREFULLY CONSIDERED IN EVALUATING OUR COMPANY AND OUR
BUSINESS BECAUSE SUCH FACTORS CURRENTLY MAY HAVE A
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SIGNIFICANT IMPACT ON OUR BUSINESS, OPERATING RESULTS AND FINANCIAL CONDITION.
AS A RESULT OF THE RISK FACTORS SET FORTH BELOW AND ELSEWHERE IN THIS
FORM 10-K, AND THE RISKS DISCUSSED IN OUR OTHER SECURITIES AND EXCHANGE
COMMISSION FILINGS, ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE PROJECTED
IN ANY FORWARD-LOOKING STATEMENTS.
RISKS RELATED TO OUR BUSINESS
WE HAVE A LIMITED OPERATING HISTORY THAT MAKES AN EVALUATION OF OUR BUSINESS
DIFFICULT
We were incorporated in April 1996 and began shipping our initial products
to customers in the last quarter of fiscal 1997. Our limited operating history
makes evaluation of our business and prospects difficult. Companies in an early
stage of development frequently encounter heightened risks and unexpected
expenses and difficulties. For us, these risks include:
- The limited number of network operators who have deployed products and
services incorporating our technology
- The limited number of information appliance manufacturers who have
incorporated our technology into their products
- Delays in deployment of high speed networks and Internet-enhanced services
and applications by our network operator customers
- Our unproven long-term business model, which depends on generating the
majority of our revenues from royalty fees paid by network operators and
information appliance manufacturers
These risks, expenses and difficulties apply particularly to us because our
market, the information appliance software market, is new and rapidly evolving.
WE HAVE A HISTORY OF LOSSES AND EXPECT TO INCUR LOSSES IN THE FUTURE
We incurred net losses of approximately $3.3 million in fiscal 1996,
$19.0 million in fiscal 1997, $94.4 million in fiscal 1998, $33.1 million in
fiscal 1999 and $80.8 million in fiscal 2000. Our net losses of $94.4 million in
fiscal 1998 included a $58.1 million charge for the Navio acquisition related to
acquired in-process research and development. Our net losses of $80.8 million in
fiscal 2000 included a $1.9 million charge for the SourceSuite acquisition
related to acquired in-process research and development, amortization of
purchased intangibles of $22.1 million and warrant amortization of
$10.8 million. As of May 31, 2000, we had an accumulated deficit of
approximately $230.5 million. In addition, subsequent to our fiscal year end, we
completed the MoreCom acquisition resulting in a charge of $22.4 million related
to acquired in-process research and development and capitalization of up to
$520.2 million of purchased intangibles, which will be amortized over three
years.
Since our inception, we have not had a profitable quarter and may never
achieve or sustain profitability. Although our revenues increased for each of
the last three fiscal years, we may not be able to sustain our historical
revenue growth rates. We also expect to continue to incur increasing cost of
revenues, research and development, sales and marketing and general and
administrative expenses. If we are to achieve profitability given our planned
expenditure levels, we will need to generate and sustain substantially increased
license and royalty revenues; however, we are unlikely to be able to do so for
the foreseeable future. As a result, we expect to incur significant and
increasing losses and negative cash flows for the foreseeable future. In
addition, from the beginning of fiscal 1997 through May 31, 2000, approximately
64% of our revenues have been derived from services provided by us and not from
license and royalty fees paid by network operators and information appliance
manufacturers in conjunction with the deployment of products and services
incorporating our software products. If we are unable to derive a greater
proportion of our revenues from these license and royalty fees, our losses will
likely continue indefinitely.
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OUR QUARTERLY REVENUES AND OPERATING RESULTS ARE VOLATILE AND MAY CAUSE OUR
STOCK PRICE TO FLUCTUATE
Our quarterly operating results have varied in the past and are likely to
vary significantly from quarter to quarter. As a result, we believe that period
to period comparisons of our operating results are not a good indication of our
future performance. Moreover, we expect to derive substantially all of our
revenues for the near term from license fees and related consulting and support
services. Over the longer term, to the extent deployments increase, we expect to
derive an increasing portion of our revenues from royalties paid by network
operators and information appliance manufacturers. If deployments do not
increase or this transition otherwise does not occur, we are unlikely to be able
to generate or sustain substantially increased revenue, and our operating
results will be seriously harmed.
In the short term, we expect our quarterly revenues to be significantly
dependent on a small number of relatively large orders for our products and
services, which generally have a long sales cycle. As a result, our quarterly
operating results may fluctuate significantly if we are unable to complete one
or more substantial sales in any given quarter. In some cases, we recognize
revenues from services on a percentage of completion basis. Our ability to
recognize these revenues may be delayed if we are unable to meet service
milestones on a timely basis. Moreover, because our expenses are relatively
fixed in the near term, any shortfall from anticipated revenues could result in
losses for the quarter.
Although we have limited historical financial data, in the past we have
experienced seasonality in our quarter ending August 31. These seasonal trends
may continue to affect our quarter to quarter revenues.
THE MARKET FOR INFORMATION APPLIANCES IS NEW AND MAY NOT DEVELOP AS WE
ANTICIPATE
Because the information appliance market is emerging, the potential size of
this new market opportunity and the timing of its development are uncertain. As
a result, our profit potential is unproven. We are dependent upon the
commercialization and broad acceptance by consumers and businesses of a wide
variety of information appliances including, among others, television set-top
boxes, game consoles, smart phones and personal digital assistants. Initial
commercialization efforts in this industry have been primarily focused on
television set-top boxes. Broad acceptance of all information appliances,
particularly television set-top boxes, will depend on many factors. These
factors include:
- The willingness of large numbers of consumers to use devices other than
personal computers to access the Internet
- The development of content and applications for information appliances
- The emergence of industry standards that facilitate the distribution of
content over the Internet to these devices
If the market for information appliances does not develop or develops more
slowly than we anticipate, our revenues will not grow as fast as anticipated, if
at all.
OUR SUCCESS DEPENDS ON NETWORK OPERATORS INTRODUCING, MARKETING AND PROMOTING
PRODUCTS AND SERVICES FOR INFORMATION APPLIANCES BASED ON OUR TECHNOLOGY
Our success depends on large network operators introducing, marketing and
promoting products and services based on our technology. There are, however,
only a limited number of large network operators worldwide. Moreover, only a
limited number of network operators have introduced or are in the process of
deploying products and services incorporating our technology and services for
information appliances. In addition, none of our network operator customers is
contractually obligated to introduce, market or promote products and services
incorporating our technology, nor are any of our network operator customers
contractually required to achieve any specific introduction schedule.
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Accordingly, even if a network operator initiates a customer trial of products
incorporating our technology, that operator is under no obligation to continue
its relationship with us or to launch a full-scale deployment of these products.
Further, our agreements with network operators are not exclusive, so network
operators with whom we have agreements may enter into similar license agreements
with one or more of our competitors.
Moreover, because the large scale deployment of products and services
incorporating our technology by network operators is complex, time consuming and
expensive, each deployment of these products and services requires our expertise
to tailor our technology to the customer's particular product offering. This
process requires a lengthy and significant commitment of resources by our
customers and us. This commitment of resources may slow deployment, which could,
in turn, delay market acceptance of these products and services. Unless network
operators introduce, market and promote products and services incorporating our
technology in a successful and timely manner, our software platform will not
achieve widespread acceptance, information appliance manufacturers will not use
our software in their products and our revenues will not grow as fast as
anticipated, if at all.
IF INFORMATION APPLIANCE MANUFACTURERS DO NOT MANUFACTURE PRODUCTS THAT
INCORPORATE OR OPERATE WITH OUR TECHNOLOGY, OR IF THESE PRODUCTS DO NOT ACHIEVE
ACCEPTANCE, WE MAY NOT BE ABLE TO SUSTAIN OR GROW OUR BUSINESS
We do not manufacture hardware components that incorporate our technology.
Rather, we license software technology to information appliance manufacturers or
work with them to ensure that our products operate together. Accordingly, our
success will depend, in part, upon our ability to convince a number of
information appliance manufacturers to manufacture products that incorporate or
operate with our technology and the successful introduction and commercial
acceptance of these products. Our efforts also significantly depend on network
operators deploying services using our server software.
While we have entered into a number of agreements with information appliance
manufacturers, none of these manufacturers is contractually obligated to
introduce or market information appliances incorporating our technology, nor is
any of them contractually required to achieve any specific production schedule.
Moreover, our agreements with information appliance manufacturers are not
exclusive, so information appliance manufacturers with whom we have agreements
may enter into similar license agreements with one or more of our competitors.
Our failure to convince information appliance manufacturers to incorporate our
software platform into their products or modify their products to operate with
our software, or the failure of these products to achieve broad acceptance with
consumers and businesses, will result in revenues that do not grow as fast as
expected, if at all.
COMPETITION FROM BIGGER, BETTER CAPITALIZED COMPETITORS COULD RESULT IN PRICE
REDUCTIONS, REDUCED GROSS MARGINS AND LOSS OF MARKET SHARE
Competition in the information appliance software market is intense. Our
principal competitors on the client software side include Microsoft, OpenTV
(which recently acquired another former competitor, Spyglass), Canal+
Technologies and PowerTV. On the server side, our primary competitor is
Microsoft. We expect additional competition from other established and emerging
companies. We expect competition to persist and intensify as the information
appliance market develops and competitors focus on additional product and
service offerings. Increased competition could result in price reductions, fewer
customer orders, reduced gross margins, longer sales cycles, reduced revenues
and loss of market share.
Many of our existing and potential competitors, particularly Microsoft, have
longer operating histories, a larger customer base, greater name recognition and
significantly greater financial, technical, sales and marketing and other
resources than we do. This may place us at a disadvantage in responding to our
competitors' pricing strategies, technological advances, advertising campaigns,
strategic
11
partnerships and other initiatives. In addition, many of our competitors have
well-established relationships with our current and potential customers.
Moreover, some of our competitors, particularly Microsoft, have significant
financial resources, which have enabled them in the past and may enable them in
the future to make large strategic investments in our current and potential
customers. Such investments may enable competitors to strengthen existing
relationships or quickly establish new relationships with our current or
potential customers. For example, as a result of an investment in AT&T,
Microsoft obtained a nonexclusive licensing agreement under which AT&T will
purchase at least 7.5 million licenses of Microsoft software for television
set-top boxes. Investments such as this may discourage our potential or current
customers who receive these investments from deploying our information appliance
software, regardless of their views of the relative merits of our products and
services.
ORACLE'S OWNERSHIP OF OUR STOCK COULD LIMIT THE ABILITY OF OTHER STOCKHOLDERS TO
INFLUENCE THE OUTCOME OF DIRECTOR ELECTIONS AND OTHER TRANSACTIONS SUBMITTED FOR
A VOTE OF OUR STOCKHOLDERS
Based on 102,659,427 shares outstanding on July 31, 2000, Oracle
beneficially owned 35,374,843 shares, or approximately 34% of our outstanding
common stock. In addition, Comcast, Cox and MediaOne--each a network operator
and an investor in us--and Oracle have agreed to vote the shares of our common
stock held by them to elect one representative designated by such network
operators and one representative designated by Oracle to our Board of Directors.
As of May 31, 2000, there were no designees of Oracle on our Board of Directors.
Oracle, through its ownership of our capital stock, may exert significant
influence over us, including; influence over matters that require stockholder
approval, the election of directors, significant corporate transactions, such as
acquisitions, and efforts to block an unsolicited tender offer. This
concentration of ownership could also have the effect of delaying or preventing
a third party from acquiring control over us at a premium above the then current
market price of our common stock.
WE HAVE RELIED AND EXPECT TO CONTINUE TO RELY ON A LIMITED NUMBER OF CUSTOMERS
FOR A SIGNIFICANT PORTION OF OUR REVENUES
We currently derive, and we expect to continue to derive, a significant
portion of our revenues from a limited number of customers. In fiscal 2000, our
five largest customers accounted for approximately 51% of our revenues, with
Cable & Wireless Communications accounting for 18% of our total revenues and
Wind River Systems accounting for 15% of our total revenues. For fiscal 1999,
our five largest customers accounted for approximately 54% of our total
revenues, with Wind River Systems accounting for 23% of our total revenues and
Cable & Wireless Communications accounting for 10% of our total revenues. We
expect that we will continue to be dependent upon a limited number of customers
for a significant portion of our revenues in future periods, although the
customers may vary from period to period. As a result, if we fail to
successfully sell our products and services to one or more customers in any
particular period, or if a large customer purchases fewer of our products or
services, defers or cancels orders, or terminates its relationship with us, our
revenues could decline significantly.
OUR LENGTHY SALES CYCLE MAY CAUSE FLUCTUATIONS IN OUR OPERATING RESULTS, WHICH
COULD CAUSE OUR STOCK PRICE TO DECLINE
We believe that the purchase of our products and services involves a
significant commitment of capital and other resources by a customer. In many
cases, the decision for our customers to use our products and services requires
them to change their established business practices and conduct their business
in new ways. As a result, we may need to educate our potential customers on the
use and benefits of our products and services. In addition, our customers
generally must consider a wide range of other issues before committing to
purchase and incorporate our technology into their offerings. As a
12
result of these and other factors, including the approval at a number of levels
of management within a customer's organization, our sales cycle averages from
six to twelve months and may sometimes be significantly longer. Because of the
length of our sales cycle, we have a limited ability to forecast the timing and
amount of specific sales.
In addition, we base our quarterly revenue projections, in part, upon our
expectation that specific sales will occur in a particular quarter. In the past,
our sales have occurred in quarters other than those anticipated by us. If our
expectations, and thus our revenue projections, are not accurate for a
particular quarter, our actual operating results for that quarter could fall
below the expectations of financial analysts and investors.
DEMAND FOR OUR PRODUCTS AND SERVICES WILL DECLINE SIGNIFICANTLY IF OUR SOFTWARE
CANNOT SUPPORT AND MANAGE A SUBSTANTIAL NUMBER OF USERS
Despite frequent testing of our software's scalability in a laboratory
environment, the ability of our software platform to support and manage a
substantial number of users in an actual deployment is uncertain. If our
software platform does not efficiently scale to support and manage a substantial
number of users while maintaining a high level of performance, demand for our
products and services and our ability to sell additional products to our
existing customers will be significantly reduced.
INTERNATIONAL REVENUES ACCOUNT FOR A SIGNIFICANT PORTION OF OUR REVENUES;
ACCORDINGLY, IF WE ARE UNABLE TO EXPAND OUR INTERNATIONAL OPERATIONS IN A TIMELY
MANNER, OUR GROWTH IN INTERNATIONAL REVENUES WILL BE LIMITED
International revenues accounted for approximately 53% of our total revenues
for fiscal 2000, and approximately 51% for fiscal 1999. We anticipate that a
significant portion of our revenues for the foreseeable future will be derived
from sources outside the United States, especially as we increase our sales and
marketing activities with respect to international licensing of our technology.
Accordingly, our success will depend, in part, upon international economic
conditions and upon our ability to manage international sales and marketing
operations. To successfully expand international sales, we must establish
additional foreign operations, hire additional personnel and increase our
foreign direct and indirect sales forces. This expansion will require
significant management attention and resources, which could divert attention
from other aspects of our business. To the extent we are unable to expand our
international operations in a timely manner, our growth in international sales,
if any, will be limited.
Moreover, substantially all of our revenues and costs to date have been
denominated in U.S. dollars. However, expanded international operations may
result in increased foreign currency payables. Although we may from time to time
undertake foreign exchange hedging transactions to cover a portion of our
foreign currency transaction exposure, we do not currently attempt to cover
potential foreign currency exposure. Accordingly, any fluctuation in the value
of foreign currency could seriously harm our ability to increase international
revenues.
WE MAY HAVE TO CEASE OR DELAY PRODUCT SHIPMENTS IF WE ARE UNABLE TO OBTAIN KEY
TECHNOLOGY FROM THIRD PARTIES
We rely on technology licensed from third parties, including applications
that are integrated with internally developed software and used in our products.
Most notably, we license certain Java and Jini technologies from Sun
Microsystems, VxWorks real-time operating system from Wind River Systems, font
technology from BitStream, multimedia architecture from RealNetworks and
security from RSA. These third party technology licenses may not continue to be
available to us on commercially reasonable terms, or at all, and we may not be
able to obtain licenses for other existing or future technologies that we desire
to integrate into our products. If we cannot maintain existing third party
technology licenses or enter into licenses for other existing or future
technologies needed for our
13
products we would be required to cease or delay product shipments while we seek
to develop alternative technologies.
WE DO NOT CURRENTLY HAVE LIABILITY INSURANCE TO PROTECT AGAINST THIRD PARTY
INTELLECTUAL PROPERTY INFRINGEMENT CLAIMS THAT COULD BE EXPENSIVE TO DEFEND
We expect that, like other software product developers, we will increasingly
be subject to infringement claims as the number of products and competitors
developing information appliance software grows and the functionality of
products in different industry segments overlaps. From time to time, we hire or
retain employees or external consultants who have worked for independent
software vendors or other companies developing products similar to those offered
by us. These prior employers may claim that our products are based on their
products and that we have misappropriated their intellectual property. We cannot
guarantee that:
- An infringement claim will not be asserted against us in the future
- The assertion of such a claim will not result in litigation
- We would prevail in such litigation
- We would be able to obtain a license for the use of any infringed
intellectual property from a third party on commercially reasonable terms,
or at all
We currently do not have liability insurance to protect against the risk
that licensed third party technology infringes the intellectual property of
others. Any claims relating to our intellectual property, regardless of their
merit, could seriously harm our ability to develop and market our products and
manage our day to day operations because they could:
- Be time consuming and costly to defend
- Divert management's attention and resources
- Cause product shipment delays
- Require us to redesign our products
- Require us to enter into royalty or licensing agreements
WE COULD SUFFER LOSSES AND NEGATIVE PUBLICITY IF OUR TECHNOLOGY CAUSES A FAILURE
OF OUR NETWORK OPERATOR CUSTOMERS' SYSTEMS
Our technology is integrated into the products and services of our network
operator customers. Accordingly, a defect, error or performance problem with our
technology could cause our customers' telecommunication, cable or satellite
television or Internet service systems to fail for a period of time. Any such
failure will cause severe customer service and public relations problems for our
customers. As a result, any failure of our network operator customers' systems
caused by our technology could result in:
- Delayed or lost revenue due to adverse customer reaction
- Negative publicity regarding us and our products and services
- Claims for substantial damages against us, regardless of our
responsibility for such failure
Any claim could be expensive and require the expenditure of a significant amount
of resources regardless of whether we prevail. We currently do not have
liability insurance to protect against this risk.
14
OUR SUCCESS DEPENDS ON OUR ABILITY TO KEEP PACE WITH THE LATEST TECHNOLOGICAL
CHANGES BUT WE HAVE EXPERIENCED AND MAY IN THE FUTURE EXPERIENCE DELAYS IN
COMPLETING DEVELOPMENT AND INTRODUCTION OF NEW SOFTWARE PRODUCTS
The market for information appliance software is characterized by evolving
industry standards, rapid technological change and frequent new product
introductions and enhancements. Our technology enables network operators to
deliver content and applications to information appliances over the Internet.
Accordingly, our success will depend in large part upon our ability to adhere to
and adapt our products to evolving Internet protocols and standards. Therefore,
we will need to develop and introduce new products that meet changing customer
requirements and emerging industry standards on a timely basis. In the past, we
have experienced delays in completing the development and introduction of new
software products. We may encounter such delays in the development and
introduction of future products as well. In addition, we may:
- Fail to design our current or future products to meet customer
requirements
- Fail to develop and market products and services that respond to
technological changes or evolving industry standards in a timely or cost
effective manner
- Encounter products, capabilities or technologies developed by others that
render our products and services obsolete or noncompetitive or that
shorten the life cycles of our existing products and services
OUR LIMITED ABILITY TO PROTECT OUR INTELLECTUAL PROPERTY AND PROPRIETARY RIGHTS
MAY HARM OUR COMPETITIVENESS
Our ability to compete and continue to provide technological innovation is
substantially dependent upon internally developed technology. We rely primarily
on a combination of patents, trademark laws, copyright laws, trade secrets,
confidentiality procedures and contractual provisions to protect our proprietary
technology. While we have numerous patent applications pending, patents may not
issue from these or any future applications. In addition, our existing and
future patents may not survive a legal challenge to their validity or provide
significant protection for us.
The steps we have taken to protect our proprietary rights may not be
adequate to prevent misappropriation of our proprietary information. Further, we
may not be able to detect unauthorized use of, or take appropriate steps to
enforce, our intellectual property rights. Our competitors may also
independently develop similar technology. In addition, the laws of many
countries do not protect our proprietary rights to as great an extent as do the
laws of the United States. Any failure by us to meaningfully protect our
intellectual property could result in competitors offering products that
incorporate our most technologically advanced features, which could seriously
reduce demand for our products and services.
FAILURE TO MANAGE OUR GROWTH MAY SERIOUSLY HARM OUR ABILITY TO DELIVER PRODUCTS
IN A TIMELY MANNER, FULFILL EXISTING CUSTOMER COMMITMENTS AND ATTRACT AND RETAIN
NEW CUSTOMERS
Our rapid growth has placed, and is expected to continue to place, a
significant strain on our managerial, operational and financial resources,
especially as more network operators and information appliance manufacturers
incorporate our software into their products and services. This potential for
rapid growth is particularly significant in light of the large customer bases of
network operators and information appliance manufacturers and the frequent need
to tailor our products and services to our customers' unique needs. To the
extent we add several customers simultaneously or add customers whose product
needs require extensive customization, we may need to significantly expand our
operations. Moreover, we expect to significantly expand our domestic and
international operations by,
15
among other things, expanding the number of employees in professional services,
research and development and sales and marketing.
This additional growth will place a significant strain on our limited
personnel, financial and other resources. Our future success will depend, in
part, upon the ability of our senior management to manage growth effectively.
This will require us to implement additional management information systems, to
further develop our operating, administrative, financial and accounting systems
and controls, to hire additional personnel, to develop additional levels of
management within the corporation, to locate additional office space in the
United States and internationally and to maintain close coordination among our
research and development, sales and marketing, services and support and
administrative organizations. Failure to accomplish any of these requirements
would seriously harm our ability to deliver products in a timely fashion,
fulfill existing customer commitments and attract and retain new customers.
THE LOSS OF ANY OF OUR KEY PERSONNEL WOULD HARM OUR COMPETITIVENESS
We believe that our success will depend on the continued employment of our
senior management team and key technical personnel, none of whom, except
Mitchell E. Kertzman, our President and Chief Executive Officer, Coleman Sisson,
our Chief Operating Officer, and Philip A. Vachon, our Senior Vice President of
Worldwide Sales, has an employment agreement with us. If one or more members of
our senior management team or key technical personnel were unable or unwilling
to continue in their present positions, these individuals would be very
difficult to replace and our ability to manage day to day operations, develop
and deliver new technologies, attract and retain customers, attract and retain
other employees and generate revenues, would be seriously harmed.
OUR PLANNED EXPANSION OF OUR INDIRECT DISTRIBUTION CHANNELS WILL BE EXPENSIVE
AND MAY NOT SUCCEED
To date, we have sold our products and services principally through our
direct sales force. In the future, we intend to expand the number and reach of
our indirect channel partners, primarily overseas, through distribution
agreements. The development of these indirect channels will require the
investment of significant company resources, which could seriously harm our
business if our efforts do not generate significant revenues. Moreover, we may
not be able to attract indirect channel partners that will be able to
effectively market our products and services. The failure to recruit indirect
channel partners that are able to successfully market our products and services
could seriously hinder the growth of our business.
WE MAY NEED TO MAKE ACQUISITIONS IN ORDER TO REMAIN COMPETITIVE IN OUR MARKET
AND ACQUISITIONS COULD BE DIFFICULT TO INTEGRATE, DISRUPT OUR BUSINESS AND
DILUTE STOCKHOLDER VALUE
We may acquire other businesses in the future in order to remain competitive
or to acquire new technologies. As a result of future acquisitions, we may need
to integrate product lines, technologies, widely dispersed operations and
distinct corporate cultures. In addition, the product lines or technologies of
future acquisitions may need to be altered or redesigned in order to be made
compatible with our software products or the software architecture of our
customers. These integration efforts may not succeed or may distract our
management from operating our existing business. Our failure to successfully
manage future acquisitions could seriously harm our operating results. In
addition, our stockholders would be diluted if we finance acquisitions by
incurring convertible debt or issuing equity securities.
16
WE MAY BE UNABLE TO SUCCESSFULLY INTEGRATE ACQUISITIONS INTO OUR BUSINESS OR
ACHIEVE THE EXPECTED BENEFITS OF THE ACQUISITIONS
Our acquisitions of SourceSuite and MoreCom will require integrating our
business with their businesses, including integrating product lines,
technologies, widely-dispersed operations and distinct corporate cultures. We
may not be able to successfully assimilate the personnel, operations and
customers of these acquired companies into our business. Additionally, we may
fail to achieve the anticipated synergies from these acquisitions, including
product development and other operational synergies. The integration process may
further strain our existing financial and managerial controls and reporting
systems and procedures. This may result in the diversion of management and
financial resources from our core business objectives. In addition, we are not
experienced in managing significant facilities or operations in geographically
distant areas. We may not be able to retain various individuals who provide
services to these acquired companies that we intend to hire in connection with
these acquisitions. Our failure to successfully manage these acquisitions could
seriously harm our operating results.
WE MAY INCUR NET LOSSES OR INCREASED NET LOSSES WHEN WE ARE REQUIRED TO RECORD A
SIGNIFICANT ACCOUNTING EXPENSE RELATED TO THE ISSUANCE OF WARRANTS
In fiscal year 1999, we entered into letter agreements with several network
operators whereby we agreed to issue warrants to purchase up to an aggregate of
4,599,992 shares of common stock which are exercisable if those network
operators satisfy certain milestones. The value of the warrants is estimated
using the Black-Scholes model as of the earlier of the grant date or the date
that it becomes probable that the warrants will be earned. Pursuant to the
requirements of Emerging Issues Task Force No. 96-18, the warrants will continue
to be revalued in situations where they are granted prior to the establishment
of a performance commitment. The value of the warrants is recorded primarily as
a noncurrent asset on the accompanying consolidated balance sheets and will be
amortized over the estimated economic life of the arrangements with the network
operators.
As of May 31, 2000, warrants to purchase up to 2,336,660 shares of our
common stock were earned by these network operators. The fair market value of
these warrants at the time they were earned was $117.2 million. As of May 31,
2000, accumulated amortization for the warrants was $10.8 million.
If the remaining warrants are earned, we will be required to record
significant non-cash accounting expenses related to these warrants. As a result,
we could incur net losses or increased net losses for a given period and this
could seriously harm our operating results and stock price.
DEMAND FOR OUR PRODUCTS AND SERVICES WILL NOT INCREASE IF THE INTERNET DOES NOT
CONTINUE TO GROW AND IMPROVE
Acceptance of our software platform depends substantially upon the
widespread adoption of the Internet for commerce, communications and
entertainment. As is typical in the case of an emerging industry characterized
by rapidly changing technology, evolving industry standards and frequent new
product and service introductions, demand for and acceptance of recently
introduced Internet products and services are subject to a high level of
uncertainty. In addition, critical issues concerning the commercial use of the
Internet remain unresolved and may affect the growth of Internet use, especially
in the consumer markets we target. The adoption of the Internet for commerce,
communications and access to content and applications, particularly by those
that have historically relied upon alternative means of commerce, communications
and access to content and applications, generally requires understanding and
acceptance of a new way of conducting business and exchanging information.
Moreover, widespread application of the Internet outside of the United States
will require reductions in the cost of Internet access to prices affordable to
the average consumer.
17
To the extent that the Internet continues to experience an increase in
users, an increase in frequency of use or an increase in the amount of data
transmitted by users, we cannot guarantee that the Internet infrastructure will
be able to support the demands placed upon it. In addition, the Internet could
lose its viability as a commercial medium due to delays in development or
adoption of new standards or protocols required to handle increased levels of
Internet activity, or due to increased government regulation. Changes in, or
insufficient availability of, telecommunications or similar services to support
the Internet could also result in slower response times and could adversely
impact use of the Internet generally. If use of the Internet does not continue
to grow or grows more slowly than expected, or if the Internet infrastructure,
standards, protocols or complementary products, services or facilities do not
effectively support any growth that may occur, demand for our products and
services will decline significantly.
INCREASING GOVERNMENT REGULATION COULD CAUSE DEMAND FOR OUR PRODUCTS AND
SERVICES TO DECLINE SIGNIFICANTLY
We are subject not only to regulations applicable to businesses generally,
but also laws and regulations directly applicable to the Internet. Although
there are currently few such laws and regulations, state, federal and foreign
governments may adopt a number of these laws and regulations governing any of
the following issues:
- User privacy
- Copyrights
- Consumer protection
- Taxation of e-commerce
- The online distribution of specific material or content
- The characteristics and quality of online products and services
We do not engage in e-commerce, nor do we distribute content over the
Internet. However, one or more states or the federal government could enact
regulations aimed at companies, like us, which provide software that facilitates
e-commerce and the distribution of content over the Internet. The likelihood of
such regulation being enacted will increase as the Internet becomes more
pervasive and extends to more people's daily lives. Any such legislation or
regulation could dampen the growth of the Internet and decrease its acceptance
as a communications and commercial medium. If such a reduction in growth occurs,
demand for our products and services will decline significantly.
WE EXPECT OUR OPERATIONS TO CONTINUE TO PRODUCE NEGATIVE CASH FLOW;
CONSEQUENTLY, IF WE CANNOT RAISE ADDITIONAL CAPITAL, WE MAY NOT BE ABLE TO FUND
OUR CONTINUED OPERATIONS
Since our inception, cash used in our operations has substantially exceeded
cash received from our operations, and we expect this trend to continue for the
foreseeable future. We believe that our existing cash balances will be
sufficient to meet our working capital and capital expenditure needs for at
least the next 12 months. After that, we may need to raise additional funds, and
we cannot be certain that we will be able to obtain additional financing on
favorable terms, or at all. If we need additional capital and cannot raise it on
acceptable terms, we may not be able to, among other things:
- Develop or enhance our products and services
- Acquire complementary technologies, products or businesses
- Open new offices, in the United States or internationally
- Hire, train and retain employees
- Respond to competitive pressures or unanticipated requirements
18
PROVISIONS OF OUR CORPORATE DOCUMENTS AND DELAWARE LAW COULD DETER TAKEOVERS AND
PREVENT YOU FROM RECEIVING A PREMIUM FOR YOUR SHARES
Certain provisions of our certificate of incorporation and bylaws may
discourage, delay or prevent a change in control of our company that a
stockholder may consider favorable. These provisions include:
- Authorizing the issuance of "blank check" preferred stock that could be
issued by our Board of Directors to increase the number of outstanding
shares and thwart a takeover attempt
- Requiring super-majority voting to effect certain amendments to our
certificate of incorporation and bylaws
- Limitations on who may call special meetings of stockholders
- Prohibiting stockholder action by written consent, which requires all
actions to be taken at a meeting of the stockholders
- Establishing advance notice requirements for nominations of candidates for
election to the Board of Directors or for proposing matters that can be
acted upon by stockholders at stockholder meetings
In addition, Section 203 of the Delaware General Corporation Law and
provisions in our stock incentive plans may discourage, delay or prevent a
change in control of our company.
WE ARE AT RISK OF SECURITIES CLASS ACTION LITIGATION DUE TO OUR EXPECTED STOCK
PRICE VOLATILITY
In the past, securities class action litigation has often been brought
against a company following periods of volatility in the market price of its
securities. This risk is especially acute for us because technology companies
have experienced greater than average stock price volatility in recent years
and, as a result, have been subject to, on average, a greater number of
securities class action claims than companies in other industries. Due to the
potential volatility of our stock price, we may in the future be the target of
similar litigation. Securities litigation could result in substantial costs and
divert management's attention and resources.
OUR STOCK PRICE COULD DECLINE BY SHARES BECOMING AVAILABLE FOR SALE IN THE
FUTURE
Shares of our common stock that are restricted, either by law or otherwise,
will become available for resale in the future. This includes the eligibility
for sale of 3,963,780 shares on July 19, 2001, pursuant to Rule 144, upon the
satisfaction of the Rule 144 holding period. These resales could adversely
affect the market price of our common stock and could impair our ability to
raise capital through the sale of additional equity securities.
ITEM 2. PROPERTIES
We lease approximately 181,000 square feet of office space for our
headquarters in San Carlos, California, approximately 17,000 square feet of
office space in London, Ontario, Canada, and approximately 5,000 square feet of
office space in Salt Lake City, Utah. In addition, we lease approximately 1,100
square feet in London, United Kingdom and office suites in both Bellevue,
Washington and Tokyo, Japan, primarily for sales offices. The acquisition of
MoreCom on June 22, 2000 added approximately 16,000 square feet of additional
leased office space in Horsham, Pennsylvania.
We sublease approximately 79,000 square feet of our headquarters office
space to third parties, approximately 26,000 square feet of which was subleased
subsequent to our fiscal year end. In addition,
19
we lease approximately 45,000 square feet in Sunnyvale, California, which is
subleased from us by a third party.
Subsequent to our fiscal year end, we committed to a lease in London, United
Kingdom, for approximately 17,000 square feet. The lease is expected to be
effective October 2000 and is coincident with termination of our current London,
United Kingdom facility lease. We also entered into an additional facility lease
for approximately 10,000 square feet in Salt Lake City, Utah. Upon commencement
of this lease in October 2000, we intend to sublease our current 5,000 square
foot facility.
ITEM 3. LEGAL PROCEEDINGS
In December 1998, a former employee of ours filed an action in the
California Superior Court for the County of San Mateo against us for, among
other things, unpaid commissions of approximately $1.5 million, constructive
employment termination, intentional misrepresentation and negligent
misrepresentation. In October 1999, the plaintiff amended his complaint against
us, adding claims for damages for failure to pay wages under the California
Labor Code and common law retaliation, and sought to impose a constructive trust
on the allegedly withheld commissions and any enhancement in value of that
money. In December 1999, we filed a motion for summary judgment/summary
adjudication to dismiss all of the claims brought by the plaintiff. In
January 2000, the Court dismissed eight of the ten claims brought against us
leaving only the claims of intentional and negligent misrepresentation for
trial. In February 2000, we settled this matter, obtaining the complete
dismissal of all claims against us in exchange for the payment of a nominal
amount of cash and the issuance of a nominal number of shares of our common
stock.
As part of our acquisition of the Virtual Modem software product and related
assets and technology of SourceSuite described in Notes 4 and 6 to Consolidated
Financial Statements, we acquired certain patents that were the subject of a
patent infringement lawsuit. This lawsuit was initially brought by Interactive
Channel Technologies and SMI Holdings, affiliated companies of SourceSuite,
against Worldgate Communications in May 1998. The patent infringement claims
have been assigned to us as a result of the merger with SourceSuite. In
June 1998, Worldgate filed a counterclaim against the plaintiffs and Source
Media, a shareholder of SourceSuite, alleging among others, violations of the
Lanham Act and Delaware's Uniform Deceptive Trade Practices Act, common law
unfair competition, tortious interference with existing and prospective business
relationships and misappropriation of confidential information and trade
secrets. The case is still in the discovery stage. Briefing on the patent claim
construction issues has commenced, and a hearing on such claims has been
scheduled for September 25, 2000. We believe that the patent infringement claims
against Worldgate are valid and intend to continue to vigorously prosecute this
action. In addition, we have agreed to defend Interactive Channel, SMI Holdings
and Source Media against the cross-complaint brought by Worldgate.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
20
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
PRICE RANGE OF COMMON STOCK
Our common stock has been quoted on the Nasdaq National Market System
("Nasdaq") under the symbol LBRT since our initial public offering on July 28,
1999. The following table sets forth, for the periods indicated, the high and
low closing sale prices per share of our common stock as reported on the Nasdaq
(as adjusted for our two-for-one stock split effected on January 14, 2000):
FISCAL YEAR 2000 HIGH LOW
- ---------------- -------- --------
First Quarter (beginning July 28, 1999).................... $ 13.50 $ 7.69
Second Quarter............................................. $ 84.19 $13.63
Third Quarter.............................................. $128.53 $69.06
Fourth Quarter............................................. $114.50 $21.87
On July 31, 2000, the last reported sales price of our common stock was
$22.94, and there were 330 holders of record of our common stock. This does not
include the number of persons whose stock is in nominee or "street name"
accounts through brokers.
RECENT SALE OF UNREGISTERED SECURITIES
During our fiscal year ended May 31, 2000, we have issued and sold the
following unregistered securities, all of which reflect the one-for-six reverse
stock split effected in July 1999 and the two-for-one stock split effected in
January 2000:
1. On August 2, 1999, we issued and sold 1,627,604 shares of our common
stock to Lucent Technologies for $7.68 per share or an aggregate of
$12,499,998.
2. On March 3, 2000, we issued 886,000 shares of common stock each to
Source Media and Insight Interactive or an aggregate of 1,772,000 shares
of common stock in connection with the acquisition of the Virtual Modem
assets and technologies via merger with SourceSuite, a joint venture
owned by Source Media and Insight Interactive.
The issuances of the securities described in Item 1, was deemed to be exempt
from registration under the Securities Act of 1933, as amended (the "Act"), in
reliance on Section 4(2) of the Act as transactions by an issuer not involving
any public offering. In addition, the recipient of securities in that
transaction represented its intention to acquire the securities for investment
only and not with a view to or for sale in connection with any distribution
thereof and appropriate legends were affixed to the share certificates issued in
that transaction. The recipient had adequate access, through its relationship
with our company, to information about our company.
The issuances of the securities described in Item 2, was deemed to be exempt
from registration in reliance on Section 3(a)(10) of the Act, where the terms
and conditions of the issuance and exchange of the securities in that
transaction were approved, after a hearing on the fairness of such terms and
conditions at which all persons receiving securities issued in such transaction
had the right to appear, by the California Commissioner of Corporations.
DIVIDEND POLICY
We have not paid any cash dividends since our inceptions and do not intend
to pay any cash dividends in the foreseeable future.
21
ITEM 6. SELECTED FINANCIAL DATA
The following selected consolidated financial data should be read in
conjunction with the Consolidated Financial Statements and Notes thereto and
with "Management's Discussion and Analysis of Financial Condition and Results of
Operations" and other financial data included elsewhere in this 10-K filing. The
consolidated statement of operations data for the years ended May 31, 1998, 1999
and 2000 and the consolidated balance sheet data at May 31, 1999 and 2000, are
derived from audited consolidated financial statements included elsewhere in
this 10-K filing. The consolidated statement of operations data for the period
from our inception on December 1, 1995 to May 31, 1996 and year ended May 31,
1997, and the consolidated balance sheet data at May 31, 1996, 1997 and 1998,
are derived from audited consolidated financial statements not included in this
10-K filing. The historical results are not necessarily indicative of results to
be expected in any future period.
PERIOD FROM
INCEPTION
(DECEMBER 1, YEARS ENDED MAY 31,
1995 TO --------------------------------------------
MAY 31, 1996 1997 1998 1999 2000
------------ --------- --------- -------- ---------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
CONSOLIDATED STATEMENT OF OPERATIONS DATA
Revenues:
License and royalty................................... $ -- $ 231 $ 4,162 $ 5,281 $ 10,233
Service............................................... -- 44 6,110 12,032 17,784
-------- --------- --------- -------- ---------
Total revenues...................................... -- 275 10,272 17,313 28,017
-------- --------- --------- -------- ---------
Cost of revenues:
License and royalty................................... -- -- 3,779 2,279 2,006
Service............................................... -- -- 2,230 8,247 21,738
-------- --------- --------- -------- ---------
Total cost of revenues.............................. -- -- 6,009 10,526 23,744
-------- --------- --------- -------- ---------
Gross margin............................................ -- 275 4,263 6,787 4,273
-------- --------- --------- -------- ---------
Operating expenses:
Research and development.............................. 5,479 21,721 19,981 18,171 32,271
Sales and marketing................................... -- 7,805 14,407 11,730 18,740
General and administrative............................ -- 1,023 2,453 3,975 7,837
Amortization of purchased intangibles................. -- -- 4,563 6,084 22,081
Amortization of warrants.............................. -- -- -- 18 10,776
Amortization of deferred stock compensation........... -- -- -- 507 2,053
Acquired in-process research and development.......... -- -- 58,100 -- 1,936
Restructuring charges................................. -- -- 1,175 -- --
-------- --------- --------- -------- ---------
Total operating expenses............................ 5,479 30,549 100,679 40,485 95,694
-------- --------- --------- -------- ---------
Loss from operations.................................... (5,479) (30,274) (96,416) (33,698) (91,421)
Interest and other income (expense), net................ -- (465) 10 59 10,787
-------- --------- --------- -------- ---------
Loss before income tax provision (benefit).............. (5,479) (30,739) (96,406) (33,639) (80,634)
Income tax provision (benefit).......................... (2,200) (11,750) (2,015) (586) 137
-------- --------- --------- -------- ---------
Net loss................................................ $ (3,279) $ (18,989) $ (94,391) $(33,053) $ (80,771)
======== ========= ========= ======== =========
Basic and diluted net loss per share.................... $ -- $ -- $ (890.48) $ (56.60) $ (1.14)
Shares used in computing basic and diluted net loss per
share................................................. -- -- 106 584 70,988
CONSOLIDATED BALANCE SHEET DATA
Cash and cash equivalents............................... $ -- $ 245 $ 12,138 $ 33,657 $ 132,962
Working capital (deficit)............................... (412) (23,180) (18,275) 5,446 232,579
Total assets............................................ 487 4,441 32,311 70,185 746,187
Deferred revenues....................................... -- 45 25,367 40,790 69,132
Total long-term liabilities............................. -- -- 4,115 4,315 1,929
Accumulated deficit..................................... (3,279) (22,268) (116,659) (149,712) (230,483)
Total stockholders' equity (deficit).................... 75 (19,256) (6,136) 12,226 658,167
22
The following table represents the respective balances as a percentage of total
revenues:
YEARS ENDED MAY 31,
------------------------------------
1998 1999 2000
-------- -------- --------
CONSOLIDATED STATEMENT OF OPERATIONS DATA
Revenues:
License and royalty....................................... 41% 31% 37%
Service................................................... 59 69 63
---- ---- ----
Total revenues.......................................... 100 100 100
---- ---- ----
Cost of revenues:
License and royalty....................................... 37 13 7
Service................................................... 22 48 78
---- ---- ----
Total cost of revenues.................................. 59 61 85
---- ---- ----
Gross margin................................................ 41 39 15
---- ---- ----
Operating expenses:
Research and development.................................. 195 105 115
Sales and marketing....................................... 140 68 67
General and administrative................................ 24 23 28
Amortization of purchased intangibles..................... 44 35 79
Amortization of warrants.................................. -- -- 38
Amortization of deferred stock compensation............... -- 3 7
Acquired in-process research and development.............. 566 -- 7
Restructuring charges..................................... 11 -- --
---- ---- ----
Total operating expenses................................ 980 234 341
---- ---- ----
Loss from operations........................................ (939) (195) (326)
Interest and other income, net.............................. -- -- 39
---- ---- ----
Loss before income tax provision (benefit).................. (939) (195) (287)
Income tax provision........................................ (20) (3) --
---- ---- ----
Net loss.................................................... (919)% (192)% (287)%
==== ==== ====
23
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
THE FOLLOWING DISCUSSION AND ANALYSIS OF THE FINANCIAL CONDITION AND RESULTS
OF OPERATIONS OF OUR COMPANY SHOULD BE READ IN CONJUNCTION WITH "SELECTED
FINANCIAL DATA" AND OUR FINANCIAL STATEMENTS AND NOTES THERETO APPEARING
ELSEWHERE IN THIS 10-K FILING. THIS DISCUSSION AND ANALYSIS OF OUR FINANCIAL
RESULTS CONTAINS FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS, UNCERTAINTIES
AND ASSUMPTIONS. OUR ACTUAL RESULTS MAY DIFFER MATERIALLY FROM THOSE ANTICIPATED
IN THESE FORWARD-LOOKING STATEMENTS AS A RESULT OF CERTAIN FACTORS, INCLUDING,
BUT NOT LIMITED TO, THOSE SET FORTH UNDER "RISK FACTORS" AND ELSEWHERE IN THIS
10-K FILING.
OVERVIEW
We are a leading provider of a comprehensive software platform for
delivering content, services and applications to a broad range of information
appliances. We began operations in December 1995 as a division of Oracle to
develop server and client software for the consumer, corporate and educational
markets and began shipping our initial products and generating revenues in the
last quarter of fiscal 1997. In April 1996, we were incorporated as a Delaware
corporation.
We generate revenues by licensing our server and client products and
providing related services to network operators and information appliance
manufacturers. In addition, service revenues are generated from consulting,
training and maintenance provided in connection with client and server licenses.
License revenues consist principally of fees earned from the licensing of
our software, as well as royalty fees earned upon the shipment or activation of
products which incorporate our software. Revenues from up-front software license
fees are typically recognized upon final delivery of the licensed product, when
collection is probable and when the fair market value and the fee for each
element of the transaction is fixed and determinable. In addition to up-front
license fees, network operators typically pay per subscriber server royalty
fees. We recognize revenue on these server subscriber fees when a network
operator reports to us that a user of an information appliance has activated the
operators' service. We also license our client software to either network
operators or information appliance manufacturers. They typically pay us client
royalties on a per unit basis. We typically recognize revenue when they report
to us that an information appliance owner has activated the operators' service,
or in the case of an information appliance manufacturer, we generally recognize
these fees upon shipment of the device by the manufacturer.
Service revenues consist of consulting, engineering, training and
maintenance services. Maintenance services include both updates and technical
support. Consulting, engineering and training revenues are generally recognized
as services are performed. Maintenance revenue is recognized ratably over the
term of the agreement and typically ranges from 17% to 25% of annual license
fees and activation royalties. In instances where software license agreements
include a combination of consulting services, training, and maintenance, these
separate elements are unbundled from the arrangement based on each element's
relative fair value. For fiscal 2000, total service revenues were
$17.8 million, representing 63.5% of our total revenues. We expect service
revenues to continue to account for a significant portion of total revenues
until customers begin deploying services and information appliances
incorporating our software on a large scale.
A significant event in our history was the acquisition of Navio
Communications in August 1997. Navio was a development stage company involved in
designing Internet application and server software for the consumer market. In
connection with the acquisition, we changed our strategic direction and
restructured our operations. Prior to the acquisition, we focused on selling
software to original equipment manufacturers of network computer products for
corporate customers. Following the acquisition, we focused our development and
marketing efforts on fewer products targeted primarily at the consumer
information appliance market and aggressively pursued sales to a limited number
of large network operators and information appliance manufacturers. As a result
of this strategic shift, we
24
significantly reduced our sales and engineering operations for corporate
products and increased investment in the development of client and server
software for the consumer market.
To more closely align our product offerings with this strategic shift in
direction, we entered into an agreement with Sun Microsystems in May 1999 to
transfer our NC Navigator and NC Administration Server technology to Sun while
retaining the right to ship, support and maintain these products for existing
customers using this technology. In addition, we have agreed not to compete in
the corporate network computer market and, specifically, network computers
intended to displace personal computers or terminals, until May 2002. However,
outside of this market, we intend to continue developing new products based on
network computer technology. In each of fiscal 1999 and fiscal 2000, sales of NC
Navigator and NC Desktop products and related services accounted for
$2.5 million of our total revenues.
We have also agreed with Sun to co-develop television set-top box
technology. We will distribute the co-developed technology pursuant to a
nonexclusive license with Sun. In addition, under this license, we have agreed
to incorporate Sun's Personal Java technology, television interface software and
Jini technology in our software products and to pay Sun a royalty. Sun has also
agreed to promote us as one of its preferred channel partners within the TV
devices market. We believe this relationship will result in co-marketing and
co-selling efforts with Sun of the jointly-developed technology on a worldwide
basis.
To date, we have completed three acquisitions. For further detail on all
three transactions, see Notes 4 and 14 to Consolidated Financial Statements. The
first acquisition, as mentioned above, was Navio Communications in August 1997.
The acquisition was accounted for as a purchase. In connection with the
acquisition, we wrote off approximately $58.1 million of acquired in-process
research and development in fiscal 1998. Purchased intangibles of approximately
$18.3 million were recorded in connection with the acquisition and are being
amortized on a straight-line basis over an estimated useful life of three years.
In March 2000, we acquired the Virtual Modem assets of SourceSuite in
exchange for 1,772,000 shares of our common stock or approximately
$190.5 million based on a common stock price of $107.53 per share. The
acquisition was accounted for as a purchase. In connection with the acquisition,
we hired various individuals who provided services to SourceSuite. We expensed
approximately $1.9 million of acquired in-process research and development,
which in the opinion of our management, had not reached technological
feasibility and had no alternative future use. We also recorded goodwill and
other intangibles of approximately $192.0 million, which is being amortized over
an estimated useful life of three years.
In March 2000, we entered into a Merger Agreement and Plan of Reorganization
to acquire MoreCom. The acquisition was completed in June 2000 for 8,030,059
shares of our common stock, or approximately $504.2 million based on a common
stock price of $69.86 per share. The acquisition will be accounted for as a
purchase. In connection with the acquisition, we expect to expense up to
$22.4 million of acquired in-process research and development, which in the
opinion of our management, has not reached technological feasibility and has no
alternative future use. We also expect to record goodwill and other intangibles
of up to $520.2 million to be amortized over an estimated useful life of three
years.
In addition, in January 2000, we terminated negotiations involving our
proposed acquisition of another company. Costs related to this terminated
acquisition totaled approximately $624,000 and were expensed in fiscal 2000.
We have also made several equity investments:
- In February 2000, we made a strategic investment in ICE Interactive of
Sydney, Australia, a venture formed to bring wide-scale deployment of
interactive TV services to Australia and New
25
Zealand. Along with our company, Oracle and Burdekin Pacific are also
investors in the new company.
- In May 2000, we made a strategic investment of approximately $4.0 million
in DIVA Systems in exchange for 444,445 shares of Series E preferred
stock.
- In August 2000, we made a strategic investment of approximately
$3.0 million in Everypath in exchange for 179,425 shares of Series C
preferred stock.
In July 2000, Cisco Systems agreed to purchase 3,963,780 shares of our
common stock at approximately $25.23 per share, resulting in aggregate cash
proceeds to us of $100.0 million.
In fiscal 1998, Wind River Systems accounted for 16% of our total revenues
and Thomson Multimedia accounted for 10% of our total revenues. In fiscal 1999,
Wind River Systems accounted for 23% of our total revenues and Cable & Wireless
Communications accounted for 10% of our total revenues. In fiscal 2000, Cable &
Wireless Communications accounted for 18% of our total revenues and Wind River
Systems accounted for 15% of our total revenues. Revenues attributable to Wind
River Systems relate to a source code license we granted Wind River Systems in
December 1997. Wind River Systems paid us a license fee of $10.0 million for
this license which was recorded as deferred revenues and is being amortized over
a 30-month period as license, royalty and service revenues. Revenues
attributable to Cable & Wireless Communications in fiscal 1999 and in fiscal
2000 relate to license, royalty and service revenues. Revenues from Thomson
Multimedia related to a one-time paid-up software license. We expect that we
will continue to be dependent upon a limited number of customers for a
significant portion of our revenues in future periods, although the customers
may vary from period to period.
Deferred revenues consist primarily of payments received from customers for
prepaid license and royalty fees and prepaid services for undelivered product
and services. Deferred revenues increased from $40.8 million at May 31, 1999 to
$69.1 million at May 31, 2000. This increase resulted largely from prepayments
from network operators. Deferred revenues can fluctuate significantly. These
fluctuations are the result of:
- when we record deferred revenues, which depends on the timing of large
prepaid license and royalty fees and service contracts
- when we recognize deferred revenues, which depends on when services are
performed and when network operators and information appliance
manufacturers deploy products and services based on our technology
International revenues accounted for approximately 50% of our total revenues
in fiscal 1998, 51% of our total revenues in fiscal 1999 and 53% of our total
revenues in fiscal 2000. We anticipate international revenues to continue to
represent a significant portion of total revenues for the foreseeable future.
In fiscal year 1999, we entered into letter agreements with several network
operators whereby we agreed to issue warrants to purchase up to an aggregate of
4,599,992 shares of common stock which are exercisable if those network
operators satisfy certain milestones. The value of the warrants is estimated
using the Black-Scholes model as of the earlier of the grant date or the date
that it becomes probable that the warrants will be earned. Pursuant to the
requirements of Emerging Issues Task Force No. 96-18, the warrants will continue
to be revalued in situations where they are granted prior to the establishment
of a performance commitment. The value of the warrants is recorded primarily as
a noncurrent asset on the accompanying consolidated balance sheet and will be
amortized over the estimated economic life of the arrangements with the network
operators.
As of May 31, 2000, warrants to purchase up to 2,336,660 shares of our
common stock were earned by these network operators. The fair market value of
these warrants at the time they were earned was $117.2 million. As of May 31,
2000, accumulated amortization for the warrants was $10.8 million.
26
If the remaining warrants are earned, we will be required to record
significant non-cash accounting expenses related to these warrants. As a result,
we could incur net losses or increased net losses for a given period and this
could seriously harm our operating results and stock price.
Since inception, we have incurred net losses of $230.5 million. These losses
include write-offs totaling $60.0 million of acquired in-process research and
development related to our acquisitions, $97.6 million of research and
development expenditures, $32.7 million of amortization of purchased intangibles
and $10.8 million of amortization of warrants. We anticipate incurring
significant operating losses for the foreseeable future as we:
- continue to invest in research and development and professional and
engineering services to support new devices for our software platform and
large-scale deployments by our network operator customers
- record non-cash expenses related to the acquired in-process research and
development and amortization of purchased intangibles associated with our
acquisitions and amortization of warrant expense associated with the
issuance of performance warrants to various network operators
YEAR ENDED MAY 31, 1999 AND YEAR ENDED MAY 31, 2000
REVENUES
Total revenues increased 62% from $17.3 million for fiscal 1999 to
$28.0 million for fiscal 2000.
LICENSE AND ROYALTY. License and royalty revenues increased 94% from
$5.3 million for fiscal 1999 to $10.2 million for fiscal 2000. This increase was
due primarily to increased royalty revenues resulting from increased
deployments, primarily from existing customers, and the expiration of
prepayments associated with previous product lines.
SERVICE. Service revenues increased 48% from $12.0 million for fiscal 1999
to $17.8 million for fiscal 2000. This increase was due primarily to the
continued expansion of our professional services organization, created in the
beginning of fiscal 1999. To a lesser extent, the increase was due to the
overall increase in maintenance revenues.
COST OF REVENUES
Total cost of revenues increased 126% from $10.5 million for fiscal 1999 to
$23.7 million for fiscal 2000. We anticipate that total cost of revenues will
increase in dollar amounts in future periods as we provide continued services to
support customer implementations and as we experience higher third party license
costs as deployments increase.
LICENSE AND ROYALTY. Cost of license and royalty revenues decreased 12%
from $2.3 million for fiscal 1999 to $2.0 million for fiscal 2000. These amounts
represented 43% and 20% of license and royalty revenues over the respective
periods. The decrease in cost of license and royalty revenues in dollar amounts
was due primarily to a one-time credit received from a third party vendor
related to maintenance and support and lower costs related to final amortization
of certain prepaid in-bound licenses. We expect the cost of license and royalty
revenues, as a percentage of license and royalty revenues, to fluctuate in
future periods. Amortization of certain third party costs will have the effect
of decreasing license and royalty costs as a percentage of related revenues.
However, introduction of new third party technology may offset the effect of the
amortized costs or increase license and royalty cost as a percentage of related
revenues.
SERVICE. Cost of service revenues increased 164% from $8.2 million for
fiscal 1999 to $21.7 million for fiscal 2000. These amounts represented 69% and
122% of service revenues over the respective periods. The increase in dollar
amounts and as a percentage of service revenues was due primarily to our
continued investment in our professional services organization, necessary to
meet the growth in
27
customer installation, training and deployment of our products, as well as an
increase in the level of billable custom development projects. We expect cost of
service revenues to increase in dollar amounts to the extent existing and new
customers install and deploy our products. We also expect the cost of service
revenues, as a percentage of service revenues, to fluctuate in future periods.
These costs may increase in the near term due to continued expansion of services
as existing and new customers install and deploy our products and we continue to
provide and support limited trial installations of our products at discounted
prices to network operators in order to continue to increase our market share.
OPERATING EXPENSES
RESEARCH AND DEVELOPMENT. Research and development expenses consist
primarily of salary and other related costs for personnel and external
contractors as well as costs related to outsourced development projects to
support product development. Research and development expenses increased 78%
from $18.2 million for fiscal 1999 to $32.3 million for fiscal 2000. These
amounts represented 105% and 115% of total revenues over the respective periods.
The increase in dollar amounts and as a percentage of total revenues was due
primarily to higher personnel and related expenses resulting from increased
staffing, increased use of external contractors and an increase in outsourced
development projects, in particular a project with General Instrument (recently
acquired by Motorola). The classification of costs between research and
development and cost of service revenues may fluctuate between categories
depending on the level of projects that are billable at any point in time. We
believe that continued investment in research and development is critical to
attaining our strategic objectives. Consequently, we expect research and
development expenses to increase significantly in dollar amounts in future
periods. However, if revenues increase, we expect research and development
expenses to decline as a percentage of total revenues in the long term.
SALES AND MARKETING. Sales and marketing expenses consist primarily of
salaries and other related costs for sales and marketing personnel, sales
commissions, travel, facilities for regional offices, public relations,
marketing materials and tradeshows. Sales and marketing expenses increased 60%
from $11.7 million for fiscal 1999 to $18.7 million for fiscal 2000. These
amounts represented 68% and 67% of total revenues over the respective periods.
The increase in dollar amounts was due primarily to increased employee related
expenses including higher headcount, commission costs and travel related
expenses. In addition, the increase in marketing activities, including our PopTV
program and our increased tradeshow presence, also contributed to this increase.
We believe these expenses will increase in dollar amounts in future periods as
we expand our direct sales and marketing efforts domestically and abroad.
However, if revenues increase, we expect these costs to decrease as a percentage
of total revenues in the long term.
GENERAL AND ADMINISTRATIVE. General and administrative expenses consist
primarily of salaries and other employee related costs for corporate
development, finance, human resources and legal, as well as outside legal and
other professional fees. General and administrative expenses increased 97% from
$4.0 million for fiscal 1999 to $7.8 million for fiscal 2000. These amounts
represented 23% and 28% of total revenues over the respective periods. The
increase in dollar amounts and as a percentage of total revenues was due
primarily to increased staffing, including the formation of our corporate
development organization, the establishment of the infrastructure necessary to
support our obligations as a public company and merger termination costs of
approximately $624,000. In addition, we incurred costs related to our expansion
into international markets. We believe these expenses will increase in dollar
amounts as we continue to add personnel. However if revenues increase, we expect
these costs to decrease as a percentage of total revenues in the long term.
28
AMORTIZATION OF PURCHASED INTANGIBLES. Purchased intangibles represent the
purchase price of Navio and SourceSuite in excess of identified tangible assets
and are amortized over three years. In August 1997, we recorded approximately
$18.3 million of purchased intangibles related to the Navio acquisition. In
March 2000, we recorded approximately $192.2 million of purchased intangibles
related to the SourceSuite acquisition. We recorded approximately $6.1 million
of amortization expense for fiscal 1999 and approximately $22.1 million of
amortization expense for fiscal 2000. We believe these expenses will increase in
dollar amounts as we continue to amortize these balances. In addition, the
acquisition of MoreCom in June 2000 will increase these expenses.
AMORTIZATION OF WARRANTS. As of May 31, 2000, warrants to purchase up to
2,336,660 shares of our common stock were earned by network operators. The fair
market value of these warrants at the time they were earned was $117.2 million.
We recorded warrant amortization expense of $18,000 and $10.8 million in fiscal
1999 and fiscal 2000, respectively. We expect warrant amortization to continue
to increase as additional warrants are earned.
AMORTIZATION OF DEFERRED STOCK COMPENSATION. Deferred stock compensation
represents the difference between the estimated fair value of our common stock
for accounting purposes and the option exercise price of such options at the
grant date. In fiscal 1999, we began recording deferred stock compensation for
stock options granted to employees and others. These amounts are amortized on a
straight-line basis over the 48-month vesting period of such options.
Amortization of deferred stock compensation was approximately $507,000 for
fiscal 1999 compared to $2.1 million for fiscal 2000. The majority of the stock
option grants being amortized were granted in the latter half of fiscal 1999. We
anticipate that deferred stock compensation expense will remain relatively
stable from year to year, with decreases resulting from the effect of employee
terminations.
ACQUIRED IN-PROCESS RESEARCH AND DEVELOPMENT. In connection with the
SourceSuite acquisition in March 2000, we expensed approximately $1.9 million of
acquired in-process research and development which, in the opinion of
management, had not reached technological feasibility and had no alternative
future use. See Note 4 to Consolidated Financial Statements.
INTEREST AND OTHER INCOME (EXPENSE), NET
Net interest and other income includes interest income on our cash, cash
equivalents, short-term and long-term investments partially offset by interest
expense on capital leases, bank charges and losses on disposals of fixed assets.
Net interest and other income increased from approximately $59,000 for fiscal
1999 to $10.8 million for fiscal 2000. The increase is primarily due to interest
income on proceeds from our private placement offering in May 1999, our initial
public offering of common stock in August 1999 and our secondary offering in
February 2000. This was partially offset by losses on disposal of fixed assets.
INCOME TAX PROVISION (BENEFIT)
Income tax provision (benefit) includes income tax benefit and foreign
withholding tax expense. Income tax provision of approximately $137,000 for
fiscal 2000, consisted primarily of foreign withholding tax expense for royalty
revenue. Income tax benefit of approximately $586,000 for fiscal 1999 was
comprised of the benefits received under a tax-sharing agreement with Oracle
that provides for our consolidation into Oracle's tax group for certain state
income tax payment purposes. Since the effective date of our initial public
offering, upon which Oracle's ownership percentage was reduced to less than 50%,
our results are no longer included in any of Oracle's consolidated state tax
returns and we will no longer receive a tax benefit from Oracle. See Note 10 to
Consolidated Fin