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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
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|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
FOR THE FISCAL YEAR ENDED MARCH 31, 2003
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
COMMISSION FILE NUMBER: 0-30903
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VIRAGE, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 38-3171505
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
411 BOREL AVENUE, 100 SOUTH
SAN MATEO, CALIFORNIA 94402-3116
(650) 573-3210
(Address, including zip code, and telephone number,
including area code, of the registrant's principal executive offices)
------------------------
Securities Registered Pursuant to Section 12(b) of the Act: None
Securities Registered Pursuant to Section 12(g) of the Act:
Common Stock, $0.001 par value
(Title of Class)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. |X| Yes |_| No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. |_|
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). [ ] Yes [ X ] No
As of June 16, 2003, there were approximately 21,237,000 shares of the
registrant's Common Stock outstanding. The aggregate market value of the voting
and non-voting stock held by non-affiliates of the registrant, based on the
closing sale price of the Common Stock on September 30, 2002 as reported on the
Nasdaq National Market was approximately $9,716,000. Shares of Common Stock held
by each current executive officer and director have been excluded from this
computation in that such persons may be deemed to be affiliates of the Company.
This determination of affiliate status is not a conclusive determination for
other purposes.
Documents Incorporated by Reference
Portions of the registrant's Proxy Statement for the registrant's 2003 Annual
Meeting of Stockholders are incorporated by reference into Part III of this Form
10-K to the extent stated herein. The Proxy Statement will be filed within 120
days of registrant's fiscal year ended March 31, 2003.
VIRAGE, INC.
INDEX
PAGE
PART I
Item 1. Business...................................................................................1
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.....................22
Item 6. Selected Consolidated Financial Data......................................................24
Item 7. Management's Discussion and Analysis of Financial Condition and Results of
Operations...........................................................................25
Item 7A. Quantitative and Qualitative Disclosures About Market Risk................................41
Item 8. Financial Statements and Supplementary Data...............................................42
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial
Disclosure...........................................................................71
PART III
Item 10. Directors and Executive Officers of the Registrant........................................71
Item 11. Executive Compensation....................................................................71
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related
Stockholder Matters..................................................................71
Item 13. Certain Relationships and Related Transactions............................................71
Item 14. Controls and Procedures...................................................................71
PART IV
Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K...........................73
Signatures................................................................................74
PART I
This annual report on Form 10-K contains forward-looking statements within
the meaning of Section 27A of the Securities Act of 1933 (the "Securities Act"),
as amended, and Section 21E of the Securities Exchange Act of 1934, as amended
(the "Exchange Act"), including statements using terminology such as "can,"
"may," "believe," "designed to," "will," "expect," "plan," "anticipate,"
"estimate," "potential," or "continue," or the negative thereof or other
comparable terminology regarding beliefs, plans, expectations or intentions
regarding the future. Forward-looking statements involve risks and uncertainties
and actual results could differ materially from those discussed in the
forward-looking statements. All forward-looking statements and risk factors
included in this document are made as of the date hereof, based on information
available to the Company as of the date thereof, and the Company assumes no
obligation to update any forward-looking statement or risk factors.
Item 1. Business
Overview
Virage, Inc. is a provider of video and rich media communication software
products, professional services and application services. We sell these products
and services to corporations, media and entertainment companies, government
agencies, and universities worldwide.
Our application products became an increasingly significant part of our
revenues during our fiscal year ended March 31, 2003, following their
introduction to the marketplace late in our fiscal year ended March 31, 2002.
Our strongest performing application product was VS Webcasting(TM), which allows
corporations to schedule and manage live webcast events and then easily turn
each into a searchable, on-demand presentation. Our other application products
include VS Publishing(TM), a complete workflow solution that allows media and
entertainment companies and others with branded content to turn their content
into compelling, rich media programming for the Internet or corporate intranet;
and VS Production(TM), an integrated software solution that automates a
customer's video production process from acquisition to distribution.
All of our application products are built around, and work in conjunction
with, certain of our platform products, which provide much of the underlying
technology and core functionality. More specifically, our platform products
provide the video encoding, indexing and content management capabilities that
are shared by each of our application products. In addition to providing core
functionality to our application products, our platform products are marketed
and sold as stand-alone products. Historically, these products have represented
the majority of our revenues. Our platform products include our SmartEncode(TM)
products, which encode and index video within a single automated process, and
our server products, which provide basic content management capabilities for
video and rich media.
Owners of rich media content can leverage our technology and know-how
either by licensing our products and engaging our professional services or by
employing our application services to outsource their needs.
We are based in San Mateo, California. We were founded in April 1994 and
incorporated in Delaware in March 1995. In this report, "Virage," "the Company,"
"our," "us," "we" and similar expressions refer to Virage, Inc. Our principal
executive offices are located at 411 Borel Avenue, 100 South, San Mateo,
California 94402 and our telephone number is (650) 573-3210.
1
Business Background and Strategy
Our application products became an increasingly significant part of our
total revenues during our fiscal year ended March 31, 2003. We first introduced
these products late in our fiscal year ended March 31, 2002 in order to expand
the market for our technology and to provide customers with complete software
solutions. Our application products are designed to work "out-of-the-box" for a
specific video or rich media workflow, such as training, communications,
Internet and intranet publishing, or video production. Our development efforts
for these application products focus on functions, features, and intuitive user
interfaces that allow our customers to implement the intended workflow quickly
and easily. Our application products include VS Webcasting, VS Publishing and VS
Production.
Our application products are marketed directly to users such as executives
and managers in sales, marketing, communication and training positions, in
addition to information technology executives. For example, we market our VS
Webcasting product to sales and marketing executives to assist with new product
introductions and sales training. The VS Webcasting product can be used for a
live event transmission to a widely distributed field sales team, and also can
provide an on-demand playback capability for later viewing or review. An
investment in VS Webcasting can thus save travel time and costs, and allow a
sales representative to review materials or topics of interest whenever more
information is required. We market and sell our application products by
demonstrating both cost savings and productivity increases for the users, thus
establishing a quantifiable return on our customer's investment.
We were able to demonstrate this return on investment for our application
products to a number of corporate enterprise customers during our fiscal year
ended March 31, 2003, particularly our VS Webcasting product for which demand
was strongest. As a result, corporate enterprise customers accounted for the
greatest percentage of our total revenues of any of our targeted marketplaces.
This was a measurable shift in the results of our business as, historically,
customers within the media and entertainment marketplace purchased our platform
products and contributed most significantly to our revenues.
Our application products are designed to further our enterprise strategy
and to provide enhanced solutions to customers in all of our target markets. In
addition to licensing our products, we offer our customers the option of
outsourcing their requirements to us by leveraging our application services
offerings. We believe our application services offerings are an important,
initially lower-cost, easily deployable alternative to licensing our products.
These outsourced offerings are a fast and efficient way for a customer to obtain
the functionality and value that our technology offers. As a key customer
acquisition tool, our application services offerings enable our customers to
choose either a longer-term application services contract or a licensed software
solution that may be deployed by the customer in-house.
2
In addition, we continue to derive a significant portion of our revenues
from our platform products. Our platform products include our SmartEncode
products, which encode and index video within a single automated process, and
our server products, which enable the publishing and distribution of streaming
video. Users of our platform products typically have some in-house video
expertise or are willing to invest in consulting or other resources in order to
use our platform as part of a video and rich media solution. During our fiscal
year ended March 31, 2003, we experienced the strongest demand for our platform
products from government customers, particularly defense and security agencies,
who often purchased our platform products and engaged our professional services
to build highly sophisticated computer systems, including video-monitoring
systems. This demand by government customers for our platform products was
offset by weakness from customers within the media and entertainment
marketplace. Historically, media and entertainment companies purchasing our
platform products have comprised a substantial portion of our total revenues.
However, during our fiscal year ended March 31, 2003, we experienced a
measurable decline in purchases from our media and entertainment customers. We
believe this is primarily a function of unfavorable global macroeconomic
conditions affecting a number of our potential customers in markets such as
media and entertainment and resulting in weak demand for information technology
products. We expect that a significant portion of our revenues will continue to
be derived from our platform products. However, if demand for our platform
products does not improve, particularly with respect to our media and
entertainment customers, we may not be able to grow our revenues to levels
required to develop a profitable and sustainable business.
We actively market our products and services to new prospects as well as to
our installed base of customers. We believe that successful development and
marketing of our products is critical to increasing our future sales to a level
required for profitability. We have focused our sales force on establishing new
relationships and developing existing relationships by offering application
services and other programs in order to demonstrate the value proposition that
our products offer. In addition, we are working with strategic channel partners
such as Sony, RealNetworks, and Sumitomo to extend our sales reach beyond our
own sales force. There is no guarantee that our products will succeed in the
marketplace or grow to levels required for profitability. If our products do not
succeed, we may not be able to develop a profitable and sustainable business.
Products and Services
We are a provider of video and rich media communication software products,
professional services and application services. We sell these products and
services to corporations, media and entertainment companies, government
agencies, and universities worldwide.
APPLICATION PRODUCTS
VS Webcasting
VS Webcasting allows corporations to schedule and manage live webcast
events--and then turn each quickly and easily into a searchable on-demand event.
VS Webcasting enriches the live experience by integrating streaming video with
slides, documents, surveys and other pertinent online media. At the same time,
it automatically creates a searchable, on-demand presentation that can be
available for review within minutes after an event's conclusion.
VS Publishing
VS Publishing is a complete workflow solution that allows media and
entertainment companies and others with branded content to turn their content
into compelling rich media programming for the Internet or corporate intranet.
With VS Publishing, video can be processed, assembled, reviewed and published
minutes after its creation. Whether content comes from an archive or direct from
on-air production, VS Publishing streamlines the workflow to the Internet and
lets content owners deliver video where and when it is most valuable to their
viewers.
3
VS Production
VS Production is an integrated software solution that automates the
professional video production process from acquisition to distribution. By
transforming video into a digital asset that is easy to manage, access, share
and distribute, VS Production helps content owners streamline the process of
producing high-quality video content for on-air, tape or digital distribution.
PLATFORM PRODUCTS
SMARTENCODE PRODUCTS
VideoLogger(R) and Media Analysis Plug-ins
Our VideoLogger product indexes video while simultaneously encoding (or
digitizing) the source video into multiple digital formats - all in real time.
The resulting video index and digital video files are time synchronized,
allowing the index data to reference particular moments in the video. The
indexing process converts video into data that computers can recognize. The
index, or video database, acts like an index found at the back of a book,
allowing pinpoint access into video content. Indexing information can be derived
from automated analysis of the video stream, from external sources of time-coded
data, or from information entered by a user. Our customers can elect to leverage
our media analysis plug-ins in order to automatically extract information such
as a visual storyboard of scene changes, a transcription of spoken words (via
speech recognition), audio classification, closed captioning or teletext, names
of recognized faces and speakers, on-screen text, and time code. External
sources of data could include an "edit decision list" from non-linear video
editing software, a transcript of words spoken, or a real-time statistics feed
from a sports stadium. User entered information can include clip titles, clip
descriptions, categories, clip in and out points, event dates, and other custom
descriptions. Once the index is produced, it can be integrated with a number of
different back-end solutions, including the Virage Solution Server. The Virage
SmartEncode process is available either through the latest release of the Virage
VideoLogger product or in an outsourced fashion through our application
services.
Customers or third-party developers can enhance the SmartEncode process
through the VideoLogger Software Developer Kit (SDK). The VideoLogger SDK
provides developers and systems integrators access to the full range of
VideoLogger functions through a programming interface. This enables reliable
integration into a wide variety of automated workflows and allows developers to
add additional indexing and encoding functionality to VideoLogger as necessary.
Virage ControlCenter(TM)
The Virage ControlCenter product is a workflow application that remotely
schedules, controls, and manages the SmartEncode process for multiple
VideoLoggers from a central console. Capture of the source video signal is the
starting point. Virage software can accept video from a multitude of analog or
digital sources: camera, satellite feed, television, videotape, or digital file.
Capture of multiple video feeds can be automated and managed centrally via
ControlCenter for greater efficiency.
MediaSync(TM)
Our MediaSync product provides a fully integrated, end-to-end solution for
rapidly assembling, synchronizing and publishing streaming video with PowerPoint
slides to a website.
Database Plug-Ins
Virage Database Plug-Ins for Oracle(R) and Informix(R) products help system
integrators build sophisticated video management solutions with the Virage
VideoLogger and relational databases.
4
SERVER PRODUCTS
Virage Solution Server(TM)
The Virage Solution Server provides a comprehensive platform for
publishing, managing and distributing Virage-enabled content on the web. The
Virage Solution Server hosts the video index generated by the SmartEncode
process. It is designed for high performance and can scale to enterprise-wide
and Internet-wide deployments. The Virage Solution Server content management
capabilities include account setup, deleting or inserting video assets from the
databases, editing existing video assets, and managing multiple video
collections.
The Virage Solution Server is used to publish and distribute content to
video-rich websites. With the Virage Solution Server, a customer can efficiently
publish on-demand video throughout a website, seamlessly integrated with the
existing website look and feel. Sample web templates provide an easy
"out-of-the-box" experience, or customers can develop their own HTML templates
to create search and results pages and player windows tailored to their specific
needs. The Virage Solution Server supports all common streaming formats
including RealVideo, Windows Media, QuickTime, and MPEG. It can also extend the
viewing experience beyond the PC-based Internet to set top boxes, game consoles
and handheld and wireless devices.
Key features of the Virage Solution Server include:
o Search: with Virage Solution Server, content owners can deliver video
content to end-users through well-understood navigation paradigms. This
allows users to quickly find the content of interest;
o Dynamic Publishing: Virage Solution Server can automate the process of
delivering video clips throughout a web site. Content can be
automatically published based on its category or keywords.
o Content Distribution Network Management: because many content owners
use multiple content distribution networks (CDNs), the Virage Solution
Server provides an abstraction layer to simplify content distribution;
o Personalization: Virage Solution Server provides a range of
capabilities that allow content owners to deploy personalized viewing
experiences;
o Syndication: Because Virage Solution Server separates the content
database from the HTML templates, it allows a single content collection
to be syndicated to multiple sites, each with a unique look and feel.
Virage Solution Server SDK
The Virage Solution Server Software Developer Kit (SDK) allows developers
and systems integrators to build custom applications on the Virage Solution
Server to suit any publishing environment.
SERVICE OFFERINGS
Software installation and training
Licensed software customers have the option to contract with Virage for
generally basic software installation and training support. These services
ensure that customers can begin to use Virage software as quickly as possible.
These services are typically billed on an hourly or daily basis.
5
Development and implementation services
Virage offers a variety of professional services aimed at helping customers
to implement, integrate or customize our commercial software. The services
typically consist of building custom web templates, implementing our products,
building specialized plug-ins to our products and integrating our products with
websites or existing customer infrastructure. We offer these services to
customers regardless of whether they license software products, or opt for our
application services. These services are typically billed on an hourly or daily
basis, though in some cases we offer a fixed fee project based upon the size of
the project.
Application services
Our application services consist of SmartEncode services and application
hosting services. These services allow customers to outsource their needs to
Virage, in lieu of purchasing our software and installing and managing it
themselves.
Using our own SmartEncode products, we process content on behalf of
customers from a variety of analog or digital sources. As part of the service,
we produce multiple formats and bit rates of high quality encoded video files
along with a rich video database. Our editorial services include custom
headlines, descriptions, keywords, and other useful information added by our
expert content editors to suit a customer's requirements. We can also transcribe
content to produce an exact text of the speech. We typically bill for such
services as a charge per hour of video processed depending upon the level of
services required.
Customers interested in our application products can also opt for
Virage-hosted offerings. These services allow customers to access Virage
software directly from a Virage datacenter. For example, some customers have
chosen to deliver live or on-demand webcasts by leveraging our VS Webcasting
software, hosted in a Virage datacenter.
As part of most application service agreements, we provide daily, weekly,
and monthly traffic reports to the content owner. We also provide a secure
administration and publishing interface that provides our customers complete
control of how and where their content gets published. We typically charge a
fixed monthly minimum charge for our application hosting services that increases
based upon accesses to our video database. Our data center provides
fault-tolerant servers and 24-by-7 monitoring to ensure reliable and scalable
hosting.
We believe our application services offerings are an important, lower-cost,
easily deployable alternative to demonstrate the functionality and value that
our technology and services bring to the customer. We also believe that these
service offerings will help us engage our customers in longer-term application
services contracts for these solutions or in a comprehensive end-to-end software
licensing sale.
Sales and Marketing
Sales and distribution strategy
We sell our products and application services through a direct sales force
and through indirect distribution channels. We currently target customers in
several markets including corporate enterprises, media and entertainment
companies, government entities and educational institutions. Our sales strategy
is to pursue multiple opportunities for large-scale deployments within each
customer account. We want to provide business users with a quick, reliable and
scalable solution to their problems and afford them a definitive return on their
investment.
6
Through our direct sales force in Boston, Chicago, Houston, London, Los
Angeles, Miami, New York, San Francisco, Singapore, Houston, and Washington
D.C., we focus on larger customers in North America, Europe, Latin America, and
Asia. In addition, our direct sales force manages local relationships with key
resellers. Our indirect distribution channels include major high-technology
industry vendors, domestic and international distributors, system integrators
and value-added resellers. Together, these distributors and value-added
resellers accounted for approximately 26% of total revenues for the year ended
March 31, 2003. If we were to lose one of our channel partners or any of our
channel partners were to delay or default on obligations under their contracts
with us, our future operating results could be significantly harmed.
Marketing activities
Since our inception, we have invested a substantial percentage of our
revenues in a broad range of marketing activities to generate demand, gain
corporate brand identity and educate the market about our products and services.
These activities have focused primarily on direct marketing, direct mail and
email, webinars, seminars, telemarketing, public relations, co-marketing and
branding with our major customer accounts and strategic partners, targeted trade
shows, conferences, speaking engagements, and product information through print
collateral and our Internet site. In addition, we have an established developer
relationship function to encourage independent software developers to develop
products and solutions that are compatible with our products and technologies.
Recently, we have decided to focus a large percentage of our marketing program
spending on telemarketing campaigns. We have significantly reduced our spending
budgets for trade shows and other areas in order to fund an increased investment
in these campaigns. Should our recent focus on telemarketing campaigns fail to
attract new customers, our revenues may be adversely impacted.
Customers
Our customers represent large global enterprises, media and entertainment
corporations, educational institutions and government entities. No customer
accounted for more than 10% of our total revenues in either of the years ended
March 31, 2003 or 2001. For the year ended March 31, 2002, one customer
accounted for 14% of our total revenues.
International revenues represented 25%, 24% and 29% of our total revenues
during the years ended March 31, 2003, 2002 and 2001, respectively.
Research and Development
We believe that our future success will depend in part on our ability to
continue to develop new, and to enhance existing, products and services.
Accordingly, we invest a significant amount of our resources in research and
product development activities. Our research and development expenses totaled
$9,248,000, $9,172,000, and $9,101,000 for the years ended March 31, 2003, 2002
and 2001, respectively. Our focus on application product development has
increased the complexity and difficulty of our product development efforts. In
particular, we now have several small application product development teams who
must coordinate their efforts with each other and with our platform product
development teams. Our ability to successfully manage product development in a
more complex environment is important in our ability to execute our product
plans, which we believe will help to improve our revenues.
7
Competition
The digital media marketplace is new, rapidly evolving and intensely
competitive. As more companies begin to leverage streaming video technologies,
we expect competition to intensify. We currently compete directly with other
providers in the market for web-based video solutions including Convera
Corporation, Sonic Foundry, Inc. and Yahoo! Broadcast Solutions. We may also
compete indirectly with larger system integrators who embed or integrate these
directly competing technologies into their product offerings. It is possible
that we may work with these same larger companies on one customer bid and
compete with them on another. In the future, we may compete with other video
services vendors as well as web conferencing vendors. In addition, we may
compete with our current and potential customers who may develop software or
perform application services internally.
We believe we compete favorably with our competitors. However, the market
for our products is relatively small today, and therefore even continued success
against competitors does not guarantee that we can grow our business to
profitable levels. Our ability to become a profitable and sustainable business
is highly dependent on the growth of the Internet and intranet streaming video
business.
Intellectual Property
We depend on our ability to develop and maintain the proprietary aspects of
our technology. To protect our proprietary technology, we rely primarily on a
combination of patent, trademark and copyright laws, as well as confidentiality
and license agreements with our employees and others. We actively seek patent
protection for our intellectual property. We have filed 20 U.S. patent
applications on our proprietary technology. Eight patents have been issued by
the Patent and Trademark Office. Our remaining twelve patent applications are
currently pending. In 2002, we renewed a five-year patent cross-licensing
agreement with IBM. The terms of this agreement include our nonexclusive license
of IBM's multimedia software patents in return for an annual fee and a license
to IBM of all of our current patents as described above and any patents that may
be issued to us in the future.
We have twenty trademarks, four of which are registered. We seek to avoid
disclosure of our trade secrets by limiting access to our proprietary technology
and restricting access to our source code. Despite these precautions, it may be
possible for unauthorized third parties to copy particular portions of our
technology or reverse engineer or obtain and use information that we regard as
proprietary. In addition, the laws of some foreign countries do not protect
proprietary rights to the same extent as the laws of the United States. Our
means of protecting our proprietary rights in the United States or abroad may
not be adequate and competing companies may independently develop similar
technology.
Employees
As of March 31, 2003, we had 108 employees and 6 full-time contractors. Of
our 114 total staff, 20 were employed in services, 41 were employed in
engineering, 38 were employed in sales and marketing, and 15 were employed in
general and administrative positions. None of our employees are subject to a
collective bargaining agreement, and we have never experienced a work stoppage.
We consider our relations with our employees to be good.
8
Risk Factors
The occurrence of any of the following risks could materially and adversely
affect our business, financial condition and operating results. In this case,
the trading price of our common stock could decline and you might lose all or
part of your investment.
Risks Related to Our Business
We have not been profitable and if we do not achieve profitability, our business
may fail. If we need additional financing we may not obtain the required
financing on favorable terms and conditions.
We have experienced operating losses in each quarterly and annual period
since we were formed and we expect to incur significant losses in the future. As
of March 31, 2003, we had an accumulated deficit of $107,044,000. We have made
efforts to reduce our expenses over the past several quarters, but it is
possible that we could incur increasing research and development, sales and
marketing and general and administrative expenses at some point in the future.
Our revenues have been relatively flat for the past four quarters and any
inability to increase our revenues significantly in the future will result in
continuing losses and a deteriorating cash position, which will harm our
business. In addition, our cash, cash equivalent and short-term investment
resources (collectively, "cash resources") totaled $16,317,000 as of March 31,
2003 and we used $14,510,000 in our operating activities during the year ended
March 31, 2003. We anticipate that our operating activities will use a
substantial portion of our remaining cash resources over the next 12 months.
Absent a significant interim improvement in our operating results or a
successful effort to raise additional capital, this will leave us with a
deteriorated cash position in comparison to our cash position as of March 31,
2003 and this may affect our ability to transact future strategic operating and
investing activities, which may harm our business and cause our stock price to
fall. In addition, we may experience reluctance on the part of prospects to
purchase from us if they believe our financial viability is in question. The
current business environment is not conducive to raising additional financing.
If we require additional financing, the terms of such financing may heavily
dilute the ownership interests of current investors, and cause our stock price
to fall significantly or we may not be able to secure financing upon acceptable
terms at all. Accordingly, our stock price and business' viability is heavily
dependent upon our ability to grow our revenues and manage our costs in order to
preserve cash resources.
Failure to comply with NASDAQ's listing standards could result in our delisting
by NASDAQ from the NASDAQ National Market and severely limit the ability to sell
any of our common stock.
Our stock is currently traded on the NASDAQ National Market and the bid
price for our common stock has been under $1.00 per share for over 30
consecutive trading days. Under NASDAQ's listing maintenance standards, if the
closing bid price of our common stock is under $1.00 per share for 30
consecutive trading days, NASDAQ may choose to notify us that it may delist our
common stock from the NASDAQ National Market.
We received a NASDAQ letter on May 1, 2003 that we were not in compliance
with the NASDAQ's minimum bid price listing requirement and that we had seven
calendar days to do one of the following:
o Submit an application for transfer of our securities for trading to the
NASDAQ SmallCap Market;
o Request a hearing to appeal the delisting notice; or
o Have our securities delisted from the NASDAQ National Market.
9
We decided to initiate an appeal process with NASDAQ whereby we have
requested an in-person hearing with NASDAQ regulators to present relevant
measures the Company is taking in order to improve its operating results and, as
a result, bolster its stock price to levels required by NASDAQ. Should NASDAQ
dismiss our appeal, we believe we will submit an application for transfer to the
NASDAQ SmallCap Market, where we believe we will have at least 180 days from the
date of transfer to attempt to regain compliance with NASDAQ's listing
requirements. If we transfer to the NASDAQ SmallCap Market, we may be eligible
to transfer back to the NASDAQ National Market if our bid price maintains the
$1.00 per share requirement for 30 consecutive trading days and we have
maintained compliance with all other continued listing requirements for the
NASDAQ National Market.
There can be no assurance that the NASDAQ will approve our appeal, that we
will comply with other non-bid price related listing criteria or that our common
stock will remain eligible for trading on the NASDAQ National Market or the
NASDAQ SmallCap Market. If our stock were delisted, the ability of our
stockholders to sell any of our common stock at all would be severely, if not
completely, limited.
Our revenues, cost of revenues, expense and cash balance/cash usage forecasts
are based upon the best information we have available, but our operating results
have historically been volatile and there are a number of risks that make it
difficult for us to foresee or accurately evaluate factors that may impact our
forecasts.
Our quarterly and annual operating results have varied significantly in the
past and are likely to vary significantly in the future. We believe that
period-to-period comparisons of our results of operations are not meaningful and
should not be relied upon as indicators of future performance. Our operating
results have in past quarters fallen below securities analyst expectations and
will likely fall below their expectations in some future quarter or quarters.
We have limited visibility into future demand, and our limited operating
history makes it difficult for us to foresee or accurately evaluate factors that
may impact such future demand. Our visibility over our potential sales is
typically limited to the current quarter and our visibility for even the current
quarter is rather limited. In order to provide a revenue forecast for the
current quarter, we must make assumptions about conversion of sales prospects
into current quarter revenues. Such assumptions may be materially incorrect due
to competition for the customer order, pricing pressures, sales execution
issues, customer selection criteria or length of the customer selection cycle,
the failure of sales contracts to meet our revenue recognition criteria, our
inability to timely perform professional services, our inability to hire and
retain qualified personnel, our inability to develop new markets domestically
and internationally, the strength of information technology spending, and other
factors that may be beyond our control. In addition, our application products
are relatively early in their product life cycles and we cannot predict how the
market for these products will develop. Our assumptions about conversion of
potential application product sales and/or our potential platform product sales
into current quarter revenues could be materially incorrect. We are reliant on
third party resellers for a significant portion of our license revenues and we
have limited visibility into the status of orders from these third parties.
For quarters beyond the current quarter, we have very limited visibility
into potential sales opportunities, and thus we have a lower confidence level in
any revenue forecast or forward-looking guidance. In developing a revenue
forecast for such quarters, we assess any customer indications about future
demand, general industry trends, marketing lead development activities,
productivity goals for the sales force and expected growth in sales personnel,
and any demand for products that we may have. Because visibility into outlying
quarters is so limited, we have not provided guidance beyond the current quarter
for the past several quarters.
10
Our cost of sales and expense forecasts are based upon our budgets and
spending forecasts for each area of the Company. Circumstances we may not
foresee could increase cost and expense levels beyond the levels forecasted.
Such circumstances may include competitive threats in our markets which we may
need to address with additional sales and marketing expenses, severance for
involuntary reductions in headcount should we determine cost cutting measures
are necessary, write-downs of equipment and/or facilities in the event of
unforeseen excess capacity, legal claims, employee turnover, additional royalty
expenses should we lose a source of current technology, losses of key management
personnel, unknown defects in our products, and other factors we cannot foresee.
In addition, many expenditures are planned or committed in advance in
anticipation of future revenues, and if our revenues in a particular quarter are
lower than we anticipate, we may be unable to reduce spending in that quarter.
As a result, any shortfall in revenues or a failure to improve gross profit
margin would likely hurt our quarterly and/or annual operating results.
Our cash balance and cash usage forecasts are typically limited to the
current quarter and are based upon a number of factors including our revenue and
expense forecasts, which are also subject to a number of risks described above.
In addition, in deriving our cash forecasts, we make a number of assumptions
that are subject to other uncertainties including our expected cash payments to
employees, vendors and other parties, expected cash receipts from customers and
interest earned on our cash and investment balances. Such assumptions may be
materially incorrect due to unexpected payments that are required to be made to
employees or vendors, delayed payments from our customers, unfavorable
fluctuations in interest rates and other factors that may be beyond our control.
The failure of any significant contracts to meet our policies for recognizing
revenue may prevent us from achieving our revenue objectives for a quarter or a
fiscal year, which would hurt our operating results.
Our sales contracts are typically based upon standard agreements that meet
our revenue recognition policies. However, our future sales may include site
licenses, professional services or other transactions with customers who may
negotiate special terms and conditions that are not part of our standard sales
contracts. In addition, customers may insist on an extended payment schedule or
may delay payments to us, which may require us to recognize from sales to those
customers' when amounts become due, rather than upon delivery of our software to
the customer. If these special terms and conditions cause sales under these
contracts to not qualify under our revenue recognition policies, we would defer
revenues to future periods when all revenue recognition criteria are met, which
may impair our revenues and operating results.
In addition, customers that license our products may require consulting,
implementation, maintenance and training services and obtain them from our
internal professional services, customer support and training organizations.
When we provide significant services in connection with a software license
arrangement, our revenue recognition policy may require us to recognize the
software license fee as the implementation services are performed. Customers may
opt to defer the implementation of significant services, which will cause us to
recognize revenues from the license as we perform the services or we may be
required to defer revenues from the license until the completion of the
services. Either of these scenarios may impair our revenues and operating
results.
11
We have allocated significant product development, sales and marketing resources
toward the deployment of our application products, we face a number of risks
that may impede market acceptance of these products and such risks may
ultimately prove our business model invalid, thereby hurting our financial
results.
We have invested significant resources into developing and marketing our
application products and do not know whether our business model and strategy
will be successful. The market for these products is in a relatively early stage
and one of our key assumptions about the market is that digital video will
continue to develop as a more relevant communication medium. We cannot predict
how the market for our applications will develop, and part of our strategic
challenge will be to convince enterprise customers of the productivity, improved
communications, cost savings and other benefits of our application products. Our
future revenues and revenue growth rates will depend in large part on our
success in delivering these products effectively and creating market acceptance
for these products. If we fail to do so, our products and services will not
achieve widespread market acceptance, and we may not generate significant
revenues to offset our development and sales and marketing costs, which will
hurt our business. Additionally, our future success will continue to depend upon
our ability to develop new products or product enhancements that address future
needs of our target markets and to respond to these changing standards and
practices.
In addition, resources may be required to fund development of our
application products' feature-sets beyond what we have planned due to
unanticipated marketplace demands. We may determine that we are unable to fund
these additional feature-sets due to financial constraints and may halt the
development of a product at a stage that the marketplace perceives as immature.
We may also encounter that the marketplace for an application product is not as
robust as we had expected and we may react to this by leaving the development of
a product at an early stage or combining key features of one or more of our
application products into a single product. Either of these product development
scenarios may impede market acceptance of any of our application products and
therefore hurt our financial results.
The length of our sales and deployment cycle is uncertain, which may cause our
revenues and operating results to vary significantly from quarter to quarter and
year to year.
During our sales cycle, we spend considerable time and expense providing
information to prospective customers about the use and benefits of our products
and services without generating corresponding revenues. Our expense levels are
relatively fixed in the short-term and based in part on our expectations of
future revenues. Therefore, any delay in our sales cycle could cause significant
variations in our operating results, particularly because a relatively small
number of customer orders represent a large portion of our revenues.
Some of our largest sources of revenues are government entities and large
corporations that often require long testing and approval processes before
making a decision to license our products. In general, the process of entering
into a licensing arrangement with a potential customer may involve lengthy
negotiations. As a result, our sales cycle has been and may continue to be
unpredictable. In the past, our sales cycle has ranged from one to 12 months.
Our sales cycle is also subject to delays as a result of customer-specific
factors over which we have little or no control, including budgetary constraints
and internal approval procedures. In addition, because our technology must often
be integrated with the products and services of other vendors, there may be a
significant delay between the use of our software and services in a pilot system
and our customers' volume deployment of our products and services.
Our application products are aimed toward a broadened business user base
within our key markets. These products are relatively early in their product
life cycles and we are relatively inexperienced with their sales cycle. We
cannot predict how the market for our application products will develop and part
of our strategic challenge will be to convince targeted users of the
productivity, improved communications, cost savings and other benefits.
Accordingly, it is likely that delays in our sales cycles with these application
products will occur and this could cause significant variations in our operating
results.
12
We expect the market price of our common stock to be volatile.
The market price of our common stock has experienced significant swings in
price over short periods of time. We believe that factors such as announcements
of developments related to our business, fluctuations in our operating results,
failure to meet securities analysts' expectations, our ability to remain an
active listing on the NASDAQ National Market or NASDAQ Small Cap Market, general
conditions in the software and high technology industries and the worldwide
economy, announcements of technological innovations, new systems or product
enhancements by us or our competitors, acquisitions, changes in governmental
regulations, developments in patents or other intellectual property rights and
changes in our relationships with customers and suppliers could cause the price
of our common stock to continue to fluctuate substantially. Historically, there
has been a relatively small number of buyers and sellers of our common stock and
trading volume of our common stock is relatively low in comparison to many
companies listed on the NASDAQ National Market and other well-known stock
exchanges. This low trading volume contributes to the volatility of our stock.
In addition, in recent years the stock market in general, and the market for
small capitalization and high technology stocks in particular, has experienced
extreme price fluctuations. Any of these factors could adversely affect the
market price of our common stock.
Our revenues may be harmed if general economic conditions do not improve.
Our revenues are dependent on the health of the economy (in particular, the
robustness of information technology spending) and the growth of our customers
and potential future customers. The economic environment has not been favorable
to companies involved in information technology infrastructure for several
quarters. In addition, potential conflicts with countries such as North Korea
create a great deal of uncertainty for businesses and this uncertainty generally
results in businesses delaying investments in such areas as information
technology. If the economic trend continues, our customers and potential
customers may continue to delay or reduce their spending on our software and
service solutions. When economic conditions for information technology products
weaken, sales cycles for sales of software products and related services tend to
lengthen and companies' information technology and business unit budgets tend to
be reduced. We believe that global economic conditions have become progressively
weaker over the past 24 months and believe that this has contributed to our
decline in revenues for our current year periods in comparison to our prior year
periods. If global economic conditions continue to weaken or if potential
conflicts continue or worsen, our revenues could continue to suffer and our
stock price could decline further.
Our restructuring efforts may not result in the intended benefits. We may be
required to record additional restructuring charges and this may adversely
affect the morale and performance of our personnel we wish to retain and may
also adversely affect our ability to hire new personnel.
During the past several quarters, we took steps to better align the
resources required to operate efficiently in the prevailing market. Through
these steps, we reduced our headcount and incurred charges for employee
severance, excess facility capacity and excess equipment. While we believe that
these steps help us achieve greater operating efficiency, we have limited
history with such measures and the results of these measures are less than
predictable. We monitor our expenses closely and benchmark our expenses against
expected revenues. Should our revenues not meet internal or external
expectations or other circumstances arise that require us to better align
resources required to operate efficiently in the prevailing market, additional
restructuring efforts will be required. We believe workforce reductions,
management changes and facility consolidation create anxiety and uncertainty and
may adversely affect employee morale. These measures could adversely affect our
employees that we wish to retain and may also adversely affect our ability to
hire new personnel. They may also affect customers and/or vendors, which could
harm our ability to operate as intended and which would harm our business.
13
As we have better aligned our resources over the past several quarters, we
have consolidated our operations into facility space that is less than our
current facility commitment, resulting in excess operating lease capacity.
During the year ended March 31, 2003, we adopted the Financial Accounting
Standards Board's Statement No. 146, "Accounting for Costs Associated with Exit
and Disposal Activities" ("FAS 146"). We consolidated our space in March 2003
and recorded charges related to our consolidation of approximately $2,239,000 as
FAS 146 requires us to record a charge for excess space as of the date we cease
to use the space. This charge was our best estimate based upon a number of
assumptions and estimates that could prove inaccurate including length of period
that it will take to sublease our excess space, assumed sublease rate and other
collateral we expect to forfeit to our landlord upon commencement of a sublease.
In addition, should we continue to have excess operating lease capacity and we
are unable to find a sublessee at a rate equivalent to our operating lease rate,
we would be required to record additional charges for the rental payments that
we owe to our landlord relating to any excess facility capacity, which would
harm our operating results. Our management reviews our facility requirements and
assesses whether any excess capacity exists as part of our on-going financial
processes.
We have experienced rapid growth followed by substantial downsizing and we may
encounter difficulties in managing these size changes, which could adversely
impact our results of operations
We have experienced a period of rapid growth in our business and related
expenses, followed by a period of rapid and substantial downsizing of our
workforce and related expenses. These periods have placed a serious strain on
our managerial, administrative and financial personnel and our internal
infrastructure. To manage the changes these periods of expansion and contraction
of our business and personnel have brought to our operations and personnel, we
will be required to continue to improve existing and implement new operational,
financial and management controls, reporting systems and procedures. We may not
be able to install adequate management information and control systems in an
efficient and timely manner and our current or planned personnel systems,
procedures and controls may not be adequate to support our future operations. If
we are unable to manage further growth or reductions effectively, we may not be
able to capitalize on attractive business opportunities.
The prices we charge for our products and services may decrease or our pricing
assumptions may be incorrect, either of which may impact our ability to develop
a sustainable business.
The prices we charge for our products and services may decrease as a result
of competitive pricing pressures, promotional programs and customers who
negotiate price reductions. For example, we recently reduced the list price of
our VideoLogger product, one of our key platform products, in order to better
compete in the marketplace. In addition, some of our competitors have provided
their services without charge in order to gain market share or new customers and
key accounts. The prices at which we sell and license our products and services
to our customers depend on many factors, including:
o purchase volumes;
o competitive pricing;
o the specific requirements of the order;
o the duration of the licensing arrangement; and
o the level of sales and service support.
Our applications products are intended to increase both our revenues and
the average size of our customers' orders. These products have pricing models
based upon a number of assumptions about the market for our products. If our
assumptions are incorrect or our pricing does not work as intended, we may not
be able to increase the average size of our customer orders or reduce the costs
of selling and marketing for our products and, therefore, we may not be able to
develop a profitable and sustainable business.
Our sales and marketing costs are a high percentage of the revenues from
our orders, due partly to the expense of developing leads and relatively long
sales cycles involved in selling products that are not yet considered
"mainstream" technology investments. For the years ended March 31, 2003, 2002
and 2001, sales and marketing expenses were 91%, 103%, and 150% of our total
revenues, respectively.
14
Our service revenues have substantially lower gross profit margins than our
license revenues, and an increase in service revenues relative to license
revenues could harm our gross margins.
Our service revenues, which include fees for our application services as
well as professional services such as consulting, implementation, maintenance
and training, were 53%, 56% and 46% of our total revenues for the years ended
March 31, 2003, 2002 and 2001, respectively. Our service revenues have
substantially lower gross profit margins than our license revenues. Our cost of
service revenues for the years ended March 31, 2003, 2002 and 2001 were 67%, 94%
and 144% of service revenues, respectively. An increase in the percentage of
total revenues represented by service revenues could adversely affect our
overall gross profit margins.
Service revenues as a percentage of total revenues and cost of service
revenues as a percentage of total revenues have varied significantly from
quarter to quarter due to our relatively early stage of development. Recently,
we have experienced an increase in the percentage of license customers
requesting professional services. We expect that the amount and profitability of
our professional services will depend in large part on:
o the software solution that has been licensed;
o the complexity of the customers' information technology environments;
o the resources directed by customers to their implementation projects;
o the size and complexity of customer implementations; and
o the extent to which outside consulting organizations provide services
directly to customers.
The relative amount of service revenues as compared to license revenues has
also varied based on customer demand for our application services. Our
application services require a relatively fixed level of investment in staff,
facilities and equipment. In the past, we have operated our application service
business at a loss due to fixed investments that exceeded actual levels of
revenues realized. We have reduced the application service fixed investments
over the past year. However, there is no assurance that the current level of
application service revenues will continue to allow us to recover our fixed
costs and make a positive gross profit margin.
Service revenues from contracts with federal government agencies comprised
10% of total service revenues during the year ended March 31, 2003 (less than
10% for the years ended March 31, 2002 and 2001). Service revenues from
contracts with federal government agencies comprised less than 10% of total
revenues in each of the years ended March 31, 2003, 2002, and 2001. Contract
costs for service revenues to federal government agencies, including indirect
expenses, are subject to audit and subsequent adjustment by negotiation between
U.S. Government representatives and us. Service revenues are recorded in amounts
expected to be realized upon final settlement and in accordance with our revenue
recognition policies. While historically we have had no adverse impact related
to our revenues from such an audit and believes that the results of any future
audit will have no material effect on our financial position or results of
operations, there can be no assurance that no adjustment will be made and that,
if made, such adjustment will not have a material effect on our financial
position or results of operations (including our gross profit margin).
15
Because competition for qualified personnel is intense, we may not be able to
recruit or retain personnel, which could impact the development and acceptance
of our products and services.
Our future success depends to a significant extent on the continued
services of our senior management and other key personnel such as senior
development staff, product marketing staff and sales personnel. The loss of key
employees would likely have an adverse effect on our business. We do not have
employment agreements with most of our senior management team. If one or more of
our senior management team were to resign, the loss could result in loss of
sales, delays in new product development and diversion of management resources.
We may also be required to create additional performance and retention
incentives in order to retain our employees including the granting of additional
stock options to employees at or below current prices or issuing incentive cash
bonuses. Such incentives may either dilute our existing stockholder base or
result in unforeseen operating expenses, which may cause our stock price to
fall. For example, in February 2002, we introduced a Voluntary Stock Option
Cancellation and Re-grant Program in which a number of our employees cancelled
stock options that had significantly higher exercise prices in comparison to
where our common stock price currently trades. These employees received
2,538,250 shares at $0.59 per share in August 2002. This may cause dilution to
our existing stockholder base, which may cause our stock price to fall.
We may need to hire sales, development, marketing and administrative
personnel in the foreseeable future. We may be unable to attract or assimilate
other highly qualified employees in the future particularly given our continued
operating losses and weakening cash position. We have in the past experienced,
and we expect to continue to experience, difficulty in hiring highly skilled
employees with appropriate qualifications. In addition, new hires frequently
require extensive training before they achieve desired levels of productivity.
We may fail to attract and retain qualified personnel, which could have a
negative impact on our business.
If requirements relating to accounting treatment for employee stock options are
changed, we may be forced to change our business practices.
We currently account for the issuance of stock options under follow
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees." If proposals currently under consideration by administrative and
governmental authorities are adopted, we may be required to treat the value of
the stock options granted to employees as compensation expense. Such a change
could have a negative effect on our earnings. In response to a requirement to
expense the value of stock options, we could decide to decrease the number of
employee stock options granted to our employees. Such a reduction could affect
our ability to retain existing employees and attract qualified candidates, and
increase the cash compensation we would have to pay to them.
Recently enacted and proposed changes in securities laws and regulations will
increase our costs.
The Sarbanes-Oxley Act ("the Act") of 2002 that became law in July 2002
requires changes in some of our corporate governance and securities disclosure
and/or compliance practices. The Act also requires the SEC to promulgate new
rules on a variety of subjects, in addition to rule proposals already made, and
the NASDAQ National Market has proposed revisions to its requirements for
companies like Virage that are listed on NASDAQ. We believe these developments
will increase our legal and accounting compliance costs. We also expect these
developments to make it more difficult and more expensive for us to obtain
director and officer liability insurance, and we may be required to accept
reduced coverage or incur substantially higher costs to obtain coverage. These
developments could make it more difficult for us to attract and retain qualified
members of our board of directors, or qualified executive officers. We are
presently evaluating and monitoring regulatory developments and cannot reliably
estimate the timing or magnitude of additional costs we will incur as a result
of the Act or other, related legislation.
16
If the protection of our intellectual property is inadequate or third party
intellectual property is unavailable or if others bring infringement or other
claims against us, we may incur significant costs or lose customers.
We depend on our ability to develop and maintain the proprietary aspects of
our technology. Policing unauthorized use of our products is difficult and
software piracy may become a problem. We license our proprietary rights to third
parties, who may not abide by our compliance guidelines. To date, we have not
sought patent protection of our proprietary rights in any foreign jurisdiction,
and the laws of some foreign countries do not protect our proprietary rights to
as great an extent as do the laws of the United States. Our efforts to protect
our intellectual property rights may not be effective to prevent
misappropriation of our technology or may not prevent the development by others
of products competitive with those developed by us.
In addition, other companies may obtain patents or other proprietary rights
that would limit our ability to conduct our business and could assert that our
technologies infringe their proprietary rights. We could incur substantial costs
to defend any litigation, and intellectual property litigation could force us to
cease using key technology, obtain a license, or redesign our products. From
time to time, we have received notices claiming that our technology infringes
patents held by third parties and in addition may become involved in litigation
claims arising from our ordinary course of business. We believe that there are
no claims or actions pending or threatened against us, the ultimate disposition
of which would have a material adverse effect on us. However, in the event any
claim against us is successful, our operating results would be significantly
harmed.
Furthermore, we license technology from third parties, which may not
continue to be available on commercially reasonable terms, if at all. Although
we do not believe that we are substantially dependent on any licensed
technology, some of the software we license from third parties could be
difficult for us to replace. The loss of any of these licenses could result in
delays in the licensing of our products until equivalent technology, if
available, is developed or licensed for potentially higher fees and integrated.
In the event of any such loss, costs could be increased and delays could be
incurred, thereby harming our business. The use of additional third-party
software would require us to negotiate license agreements with other parties,
which could result in higher royalty payments and a loss of product
differentiation. In addition, the effective implementation of our products
depends upon the successful operation of third-party licensed products in
conjunction with our products, and therefore any undetected errors in these
licensed products could prevent the implementation or impair the functionality
of our products, delay new product introductions and/or damage our reputation.
Interruptions to our business or internal infrastructure from unforeseen,
adverse events or circumstances will disrupt our business and our operating
results will suffer.
The worldwide socio-political environment has changed dramatically since
September 11, 2001 and potential conflicts with countries such as North Korea
create a great deal of global uncertainty. Our customers, potential customers
and vendors are located worldwide and generally within major international
metropolitan areas. In addition, the significant majority of our operations are
conducted at offices within a 60-mile radius of the major metropolitan cities of
San Francisco, New York City, Boston and London. Our business also requires that
certain personnel, including our officers, travel in order to perform their jobs
appropriately. A terrorist attack or military conflict or adverse biological
event (such as the recent outbreak of SARS globally, and in particular, in Asia
and Canada) could reduce our ability to travel or could limit our ability to
enter foreign countries, either of which would diminish our effectiveness in
closing international customer opportunities. Should a major catastrophe occur
within the vicinity of any of our operations, our customers' and/or potential
customers' operations and/or vendors' operations, our operations may be
adversely impacted and our business may be harmed.
17
Our communications and network infrastructure are a critical part of our
business operations. Our application services business is dependent upon
providing our customers with fast, efficient and reliable services. To meet our
customers' requirements, we must protect our network against damage from any and
all sources, including among other things:
o human error;
o physical or electronic security breaches;
o computer viruses;
o fire, earthquake, flood and other natural disasters;
o power loss;
o telecommunications failure; and
o sabotage and vandalism.
We have communications hardware and computer hardware operations located at
third party facilities in Santa Clara, California and Palo Alto, California. We
do not have complete backup systems for these operations. A problem with, or
failure of, our communications hardware or operations could result in
interruptions or increases in response times on the Internet sites of our
customers. Furthermore, if these third party partners fail to adequately
maintain or operate our communications hardware or do not perform our computer
hardware operations adequately, our services to our customers may not be
available. We have experienced system failures in the past. Any disruptions
could damage our reputation, reduce our revenues or otherwise harm our business.
Our insurance policies may not adequately compensate us for any losses that may
occur due to any failures or interruptions in our systems.
Defects in our software products or services could diminish demand for our
products or could subject us to liability claims and negative publicity if our
customers' systems, information or video content is damaged through the use of
our products and/or our application services.
Our software products and related services are complex and may contain
errors that may be detected at any point in the life of the product or service.
Our software products must operate within our customers' hardware and network
environment in order to function as intended. We cannot assure you that, despite
testing by us and our current and potential customers, errors will not be found
in new products or releases after shipment or in the related services that we
perform for our customers. If our customers' systems, information or video
content is damaged by software errors or services that we perform for them, our
business may be harmed. In addition, these errors or defects or the
incompatibility of our products to work within a customers' hardware and network
environment may cause severe customer service and public relations problems.
Errors, bugs, viruses, incompatibility or misimplementation of our products or
services may cause liability claims and negative publicity ultimately resulting
in the loss of market acceptance of our products and services. Our agreements
with customers that attempt to limit our exposure to liability claims may not be
enforceable in jurisdictions where we operate.
We may need to make acquisitions or form strategic alliances or partnerships in
order to remain competitive in our market, and potential future acquisitions,
strategic alliances or partnerships could be difficult to integrate, disrupt our
business and dilute stockholder value.
We may acquire or form strategic alliances or partnerships with other
businesses in the future in order to remain competitive or to acquire new
technologies. As a result of these acquisitions, strategic alliances or
partnerships, we may need to integrate products, technologies, widely dispersed
operations and distinct corporate cultures. The products, services or
technologies of the acquired companies may need to be altered or redesigned in
order to be made compatible with our software products and services, 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, strategic alliances or
partnerships could seriously harm our operating results. In addition, our
stockholders would be diluted if we finance the acquisitions, strategic
alliances or partnerships by incurring convertible debt or issuing equity
securities.
18
In addition to the above-stated risks, under the Financial Accounting
Standards Board's Statement of Financial Accounting Standards No. 142, "Goodwill
and Other Intangible Assets" ("FAS 142"), any future goodwill resulting from any
future acquisitions we may undertake will not be amortized but instead reviewed
at least annually for impairment. We will be required to test goodwill for
impairment using the two-step process prescribed in FAS 142. The first step is a
screen for potential impairment, while the second step measures the amount of
impairment, if any. Should we enter into any future acquisition transactions and
general macroeconomic conditions deteriorate subsequent to the acquisition,
which affects our business and operating results over the long-term, and/or
should the future acquisition target not provide the results that are
anticipated when the merger is consummated, we could be required to record
accelerated impairment charges related to goodwill, which could adversely affect
our financial results.
As we operate internationally, we face significant risks in doing business in
foreign countries.
We are subject to a number of risks associated with international business
activities, including:
o costs of customizing our products and services for foreign countries,
including localization, translation and conversion to international and
other foreign technology standards;
o compliance with multiple, conflicting and changing governmental laws
and regulations, including changes in regulatory requirements that may
limit our ability to enter or sell our products and services in
particular countries;
o import and export restrictions, tariffs and greater difficulty in
collecting accounts receivable; and
o foreign currency-related risks if a significant portion of our revenues
become denominated in foreign currencies.
Item 2. Properties
We currently lease approximately 48,000 square feet of our facility in San
Mateo, California for our principal administrative, research and development,
sales, services and marketing activities. This lease expires in September 2006.
In addition, we lease a property in New York City for services and sales under a
lease that expires in March 2005, a property near Boston, Massachusetts where
the Company performs research and development under a lease that expires in July
2003, a property near Chicago where the Company performs sales and marketing
activities that expires in September 2003 and a property near London, England
where the Company performs sales, services, and marketing activities and that
expires in June 2003.
In March 2003, we consolidated our employees at our San Mateo headquarters,
leaving approximately 24,000 square feet available for potential sublease. Our
lease for this excess property expires in September 2006. See Note 2 of Notes to
Consolidated Financial Statements for information regarding our lease
obligations.
19
Item 3. Legal Proceedings
Beginning on August 22, 2001, purported securities fraud class action
complaints were filed in the United States District Court for the Southern
District of New York. The cases were consolidated and the litigation is now
captioned as In re Virage, Inc. Initial Public Offering Securities Litigation,
Civ. No. 01-7866 (SAS) (S.D.N.Y.), related to In re Initial Public Offering
Securities Litigation, 21 MC 92 (SAS) (S.D.N.Y.). On or about April 19, 2002,
the plaintiffs electronically served an amended complaint. The amended complaint
is brought purportedly on behalf of all persons who purchased the Company's
common stock from June 28, 2000 through December 6, 2000. It names as defendants
the Company, one current and one former officer of the Company, and several
investment banking firms that served as underwriters of our initial public
offering. The complaint alleges liability under Sections 11 and 15 of the
Securities Act of 1933 and Sections 10(b) and 20(a) of the Securities Exchange
Act of 1934, on the grounds that the registration statement for the offering did
not disclose that: (1) the underwriters had agreed to allow certain customers to
purchase shares in the offerings in exchange for excess commissions paid to the
underwriters; and (2) the underwriters had arranged for certain customers to
purchase additional shares in the aftermarket at predetermined prices. The
amended complaint also alleges that false analyst reports were issued. No
specific damages are claimed.
We are aware that similar allegations have been made in other lawsuits
filed in the Southern District of New York challenging over 300 other initial
public offerings and secondary offerings conducted in 1999 and 2000. Those cases
have been consolidated for pretrial purposes before the Honorable Judge Shira A.
Scheindlin. On July 15, 2002, we (and the other issuer defendants) filed a
motion to dismiss. On February 19, 2003, the Court issued a ruling on the
motions. The Court denied the motions to dismiss the claims under the Securities
Act of 1933. The Court granted the motions to dismiss the claims under the
Securities Exchange Act of 1934 with prejudice. We believe we have meritorious
defenses to these claims and intend to defend against them vigorously.
From time to time, we may become involved in litigation claims arising from
its ordinary course of business. We believe that there are no claims or actions
pending or threatened against us, the ultimate disposition of which would have a
material adverse effect on us.
Item 4. Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of security holders during the fourth
quarter of our fiscal year ended March 31, 2003.
Executive Officers of the Registrant
The following table sets forth certain information regarding our executive
officers as of June 10, 2003:
Name Age Position
---- --- --------
Paul G. Lego............................. 44 President, Chief Executive Officer and Chairman of
the Board of Directors
Scott C. Gawel........................... 32 Vice President, Finance and Acting Chief
Financial Officer
Stanford S. Au........................... 43 Vice President, Engineering
David J. Girouard........................ 37 Senior Vice President, Marketing and Corporate
Strategy
Michael H. Lock.......................... 40 Senior Vice President, Worldwide Sales
Frank H. Pao............................. 34 Vice President, Business Affairs
20
Paul G. Lego, chairman of the board of directors, president and chief
executive officer, joined Virage in January 1996. From January 1995 to January
1996, Mr. Lego was an associate at Sutter Hill Ventures, a venture capital firm.
From June 1988 to December 1994, Mr. Lego was the chief operating officer at
Digidesign, a manufacturer of digital audio recording and editing systems, which
was acquired by Avid Technology in January 1995. Mr. Lego has also held various
marketing, manufacturing and engineering positions with Pyramid Technology
Corporation, the General Electric Company and Digital Equipment Corporation. Mr.
Lego holds a B.S. in electrical engineering from Cornell University and an
M.B.A. from Harvard Business School.
Scott C. Gawel has served as our vice president, finance and acting chief
financial officer since August 2002. Mr. Gawel joined Virage as the Company's
senior director of finance and corporate controller in January 2000. Prior to
joining Virage, Mr. Gawel worked with a wide array of high technology companies
while holding various staff and managerial positions within Ernst & Young's
Silicon Valley practice, most recently as an audit manager. Mr. Gawel is a
certified public accountant in the state of California and holds a B.S. in
Economics with honors from California Polytechnic State University, San Luis
Obispo.
Stanford S. Au, vice president, engineering, joined Virage in January 2002.
Mr. Au came to Virage from AOL-Time Warner's Netscape Communications, where he
held various positions from 1998 to 2002, most recently as vice president and
general manager of AOL's IBPP business unit. Prior to Netscape, he was an
original member of KIVA software's executive staff, which was acquired by
Netscape. Mr. Au has also held various engineering and senior management
positions at Apple Computer, Sun Microsystems, and Hewlett-Packard. Mr. Au holds
a B.S. in electrical engineering and computer science from the University of
California, Berkeley.
David J. Girouard, senior vice president, marketing and corporate strategy,
joined Virage in May 1997. Prior to becoming our senior vice president,
marketing and corporate strategy, Mr. Girouard was our vice president and
general manager, Virage Interactive, and was as a director of product marketing.
From December 1994 to April 1997, Mr. Girouard was a product manager in the
worldwide product marketing group at Apple Computer. Mr. Girouard holds a B.A.
in engineering sciences and a B.E. from Dartmouth College. He also holds an
M.B.A. from the University of Michigan.
Michael H. Lock, senior vice president, worldwide sales, joined Virage in
January 2001. Prior to joining Virage, Mr. Lock held various sales and marketing
positions at Oracle Corporation, most recently as Vice President, Sales and
Marketing, from 1996 to 2000. Mr. Lock also has served in a variety of sales,
marketing and general management positions with IBM, Dun and Bradstreet Software
and Drake International. Mr. Lock received a B.S. in Business Administration
from Wilfrid Laurier University in Ontario, Canada.
Frank H. Pao, vice president, business affairs, joined Virage in April
1997. From September 1994 to March 1997, Mr. Pao specialized in intellectual
property and licensing transactions at the law firm of Gray Cary Ware &
Freidenrich. He has also held various engineering positions at Advanced
Cardiovascular Systems and Lawrence Berkeley Laboratories. Mr. Pao holds a B.S.
in bioengineering from the University of California at Berkeley and a J.D. from
Boalt Hall School of Law at the University of California at Berkeley.
21
PART II
Item 5 Market for Registrant's Common Equity and Related Stockholder Matters
(a) Our stock is currently traded on the NASDAQ National Market under the
symbol "VRGE". The bid price for our common stock has been under $1.00
per share for over 30 consecutive trading days. Under NASDAQ's listing
maintenance standards, if the closing bid price of our common stock is
under $1.00 per share for 30 consecutive trading days, NASDAQ may choose
to notify us that it may delist our common stock from the NASDAQ
National Market.
We received a NASDAQ letter on May 1, 2003 that we were not in
compliance with the NASDAQ's minimum bid price listing requirement and
that we had seven calendar days to do one of the following:
o Submit an application to transfer our securities for to the
NASDAQ SmallCap Market;
o Request a hearing to appeal the delisting notice; or
o Have our securities delisted from the NASDAQ National Market.
We initiated an appeal process with NASDAQ whereby we have requested an
in-person hearing with NASDAQ regulators to present relevant measures
the Company is taking in order to improve its operating results and, as
a result, bolster its stock price to levels required by NASDAQ. Should
NASDAQ dismiss our appeal, we believe we will submit an application for
transfer to the NASDAQ SmallCap Market, where we believe we will have at
least 180 days from the date of transfer to attempt to regain compliance
with NASDAQ's listing requirements. If we transfer to the NASDAQ
SmallCap Market, we may be eligible to transfer back to the NASDAQ
National Market if our bid price maintains the $1.00 per share
requirement for 30 consecutive trading days and we have maintained
compliance with all other continued listing requirements for the NASDAQ
National Market.
There can be no assurance that the NASDAQ will approve our appeal, that
we will comply with other non-bid price related listing criteria or that
our common stock will remain eligible for trading on the NASDAQ National
Market or the NASDAQ SmallCap Market. If our stock were delisted, the
ability of our stockholders to sell any of our common stock at all would
be severely, if not completely, limited.
The following high and low closing sales prices were reported by NASDAQ
in each period indicated:
High Low
---- ---
Year Ended March 31, 2003
-------------------------
Fourth quarter.......................... $ 0.85 $ 0.56
Third quarter........................... $ 0.98 $ 0.50
Second quarter.......................... $ 1.20 $ 0.50
First quarter........................... $ 2.60 $ 0.75
Year Ended March 31, 2002
-------------------------
Fourth quarter.......................... $ 3.56 $ 2.00
Third quarter........................... $ 3.47 $ 1.61
Second quarter.......................... $ 4.15 $ 1.65
First quarter........................... $ 5.90 $ 1.81
22
The reported last sale price of our common stock on the Nasdaq National
Market on June 9, 2003 was $0.98. The approximate number of holders of
record of the shares of our common stock was 220 as of June 9, 2003.
This number does not include stockholders whose shares are held in trust
by other entities. Because many of our shares of common stock are held
by brokers and other institutions on behalf of stockholders, we are
unable to estimate the total number of stockholders represented by these
record holders.
We have not paid any cash dividends on our capital stock. We currently
intend to retain future earnings, if any, to fund the development and
growth of our business and, therefore, do not anticipate paying any cash
dividends in the foreseeable future. See Item 7, "Management's
Discussion and Analysis of Financial Condition and Results of
Operations-Liquidity and Capital Resources."
Equity Compensation Plans
At March 31, 2003, common stock reserved for future issuance was as
follows:
Number of Securities
to be Issued upon
Exercise of Weighted- Shares
Outstanding Options, Average Available
Warrants and Rights Exercise Price for Grant
------------------- -------------- ---------
Equity compensation plans approved
by stockholders ............................ 6,866,805 $ 1.96 2,832,050
Equity compensation plans not approved
by stockholders ............................ 1,200,020 $ 2.17 99,980
------------- -----------
Total..................................... 8,066,825 $ 1.99 2,932,030
============= ============ ===========
Included in the 2,832,050 shares available for grant for equity
compensation plans approved by stockholders are 1,401,184 shares
reserved pursuant to the Company's Employee Stock Purchase Plan.
(b) There has been no change to the disclosure contained in our report on
Form 10-Q for the nine months ended December 31, 2002 regarding the use
of proceeds generated by our initial public offering.
23
Item 6. Selected Consolidated Financial Data
SELECTED CONSOLIDATED FINANCIAL DATA
You should read the selected consolidated financial data set forth below in
conjunction with Item 7, "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and our Consolidated Financial Statements
and the Notes thereto included elsewhere in this annual report. Historical
results are not necessarily indicative of results that may be expected for any
future period. Certain prior year balances have been reclassified to conform
with current year presentation.
Fiscal Years Ended
March 31,
------------------------------------------------------
2003 2002 2001 2000 1999
-------- ---------- ---------- ---------- ----------
(in thousands, except per share data)
Consolidated Statements of Operations Data:
Revenues:
License revenues........................$ 6,029 $ 7,414 $ 6,161 $ 4,188 $ 1,956
Service revenues........................ 6,900 9,331 5,240 1,373 253
Other revenues.......................... -- -- -- -- 1,141
-------- ------- --------- -------- -------
Total revenues................... 12,929 16,745 11,401 5,561 3,350
Cost of revenues:
License revenues........................ 738 705 723 870 397
Service revenues........................ 4,601 8,760 7,530 2,660 426
Other revenues.......................... -- -- -- -- 859
-------- ------- --------- -------- -------
Total cost of revenues........... 5,339 9,465 8,253 3,530 1,682
-------- ------- --------- -------- -------
Gross profit.............................. 7,590 7,280 3,148 2,031 1,668
Operating expenses:
Research and development................ 9,248 9,172 9,101 4,182 2,325
Sales and marketing..................... 11,775 17,301 17,129 8,349 4,362
General and administrative.............. 3,935 4,985 5,298 2,653 1,273
Stock-based compensation................ 1,306 5,113 3,294 1,070 --
-------- ------- --------- -------- -------
Total operating expenses......... 26,264 36,571 34,822 16,254 7,960
-------- ------- --------- -------- -------
Loss from operations...................... (18,674) (29,291) (31,674) (14,223) (6,292)
Interest and other income, net............ 554 1,541 2,800 384 123
-------- ------- --------- -------- -------
Loss before income taxes.................. (18,120) (27,750) (28,874) (13,839) (6,169)
Provision for income taxes................ -- -- -- (36) --
-------- ------- --------- --------- -------
Net loss.................................. (18,120) (27,750) (28,874) (13,875) (6,169)
Series E convertible preferred stock
dividend................................ -- -- -- (4,544) --
-------- ------- --------- --------- -------
Net loss applicable to common
stockholders......................... $(18,120) $(27,750) $ (28,874) $(18,419) $(6,169)
======== ======== ========= ======== =======
Basic and diluted net loss per share
applicable to common stockholders.... $ (0.87) $ (1.37) $ (1.88) $ (8.06) $ (3.67)
======== ======== ========= ======== =======
Shares used in computation of basic and
diluted net loss per share applicable
to common stockholders................ 20,834 20,327 15,397 2,286 1,679
March 31,
-------------------------------------------------------
2003 2002 2001 2000 1999
-------- -------- --------- ---------- -------
(in thousands)
Consolidated Balance Sheets Data:
Cash, cash equivalents and short-term investments... $ 16,317 $ 30,694 $ 48,131 $ 10,107 $ 4,357
Working capital..................................... 11,061 24,077 40,588 8,101 3,879
Total assets........................................ 22,318 39,552 60,206 18,872 6,605
Long-term obligations, net of current portion....... -- -- -- 83 241
Redeemable convertible preferred stock.............. -- -- -- 36,995 17,936
Accumulated deficit................................. (107,044) (88,924) (61,174) (32,300) (13,881)
Total stockholders' equity (net capital deficiency). $ 13,701 $ 30,059 $ 49,706 $ (23,221) $ (13,326)
24
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following discussion and analysis of our financial condition and
results of operations should be read in conjunction with the "Selected
Consolidated Financial Data", the condensed consolidated financial statements
and related notes contained herein. This discussion contains forward-looking
statements within the meaning of Section 27A of the Securities Act and Section
21E of the Exchange Act. We may identify these statements by the use of words
such as "believe", "expect", "anticipate", "intend", "plan" and similar
expressions. These forward-looking statements involve several risks and
uncertainties. Our actual results may differ materially from those set forth in
these forward-looking statements as a result of a number of factors, including
those described under the caption "Risk Factors" herein. These forward-looking
statements speak only as of the date of this report, and we caution you not to
rely on these statements without also considering the risks and uncertainties
associated with these statements and our business as addressed elsewhere in this
report.
Fiscal Year 2003 Overview
Virage, Inc. is a provider of software products, professional services and
application services that enable owners of rich media and video assets to more
effectively communicate, manage, retrieve and distribute these rich media assets
for improved productivity and communication. We sell to the corporate, media and
entertainment, government and educational marketplaces.
Application Products
During the past year, we continued to market and sell our new application
products that we introduced late in our fiscal year ended March 31, 2002: VS
Webcasting, VS Publishing, and VS Production. VS Webcasting allows corporations
to schedule and manage live webcast events and then easily turn each into a
searchable, on-demand event. VS Publishing is a complete workflow solution that
allows media and entertainment companies to turn their content into compelling,
rich media programming for the Internet. VS Production is an integrated software
solution that automates a customer's video production process from acquisition
to distribution.
Though we have sold each of these products to date, our VS Webcasting
product has received the greatest level of interest from its target markets. We
have sold it into various enterprise environments, including financial
institutions, high technology companies, and universities. The VS Publishing and
VS Production products were released at a later date than VS Webcasting and, as
a result, are newer in the marketplace. To date, VS Publishing and VS Production
have been sold into a wide array of corporate and media and entertainment
environments, but have not yet experienced the interest levels that our VS
Webcasting product has. We may discover that the marketplace for a product is
not as robust as we had expected. We monitor anticipated market demand and sales
success for our products as we evaluate the allocation and prioritization of our
resources amongst our various product lines. We may react to slack product
demand by leaving the development of a product at an early stage or combining
key features of one or more of our application products into a single product.
This may impede market acceptance of any of our products and therefore hurt our
financial results.
Our strategy of introducing an application product suite has had an
important impact on our business trends. First, our application products bring a
more readily identifiable value proposition and quantifiable
return-on-investment than our standard platform products. As a result, our
application products command a higher price point with our customers and we are
experiencing a gradual increase in our average license deal size. Historically,
our average license deal size was in the range of $50,000 to $100,000 per
customer. Because of our application products, we are now seeing an average deal
size of over $100,000 per customer.
25
Second, we are seeing a shift in the industry mix of our end users as more
corporate enterprise customers are purchasing our products and as we experience
weak sales to media and entertainment companies. Corporate customers accounted
for 31% of total revenues during the year ended March 31, 2003 versus 24% of
total revenues during the year ended March 31, 2002. Historically, the media and
entertainment marketplace has been our strongest market. Media and entertainment
customers declined from 44% of total revenues to 21% of total revenues during
the years ended March 31, 2002 and 2003, respectively. We believe the reduction
in revenues from media and entertainment customers during the year ended March
31, 2003 is primarily a function of unfavorable global macroeconomic conditions
affecting a number of our potential customers and resulting in weak demand for
information technology products. The corporate market is our primary target
market, followed by government, education, and media and entertainment.
We continue to believe that the success of our application products,
particularly VS Webcasting, is critical to our future and have heavily invested
our resources in the development, marketing, and sale of them. The market for
our application products is in a relatively early stage. We cannot predict how
much the market for our application products will develop, what our future
average deal sizes will be, or whether our target industries will increasingly
adopt our products, and part of our strategic challenge will be to convince
customers of the productivity, communications, cost, and other benefits of these
products. Our future revenues and revenue growth rates will depend in large part
on our success in creating market acceptance for our application products.
U.S. Government Defense and Security Business
As a result of an increased focus on national security due primarily to the
September 2001 terrorist attacks and the war in Iraq, we saw higher demand from
U.S. Government Defense and Security Agencies, either from direct arrangements
or subcontracts with other U.S. Government contractors. We generally perform
these services in conjunction with existing or potential software license sales.
Our success is due, in large part, to the efforts of our Advanced Technology
Group. During fiscal 2003, our Advanced Technology Group obtained over
$1,000,000 in funds for sophisticated projects such as news monitoring and
motion mining. This funding represents a 143% increase over the $422,000 in
funding signed in fiscal 2002. Service revenues from these agencies represented
10% of total service revenues in the year ended March 31, 2003 (less than 10%
for the years ended March 31, 2002 and 2001).
Operating Lease Amendment
In December 2002, we amended our lease for our headquarters (the "Lease
Amendment"). The Lease Amendment reduces, from December 2002 until December
2003, our rent rate to half of what the rent rate was under the original
operating lease agreement. In December 2003, and on each annual anniversary
thereafter through the Amendment's termination date of September 2006, our rent
rate will be adjusted to fair market value as to be mutually determined between
us and our landlord, subject to a minimum rate that is equivalent to the Lease
Amendment's initial reduced rate discussed above (the "Minimum Rate").
In addition we, and our landlord, will use best efforts to have the
landlord lease, to a third party, certain space that we abandoned in March 2003.
If the space is leased to a third party, the space will be excluded from the
Lease Amendment as of the date an agreement for the third party lease is
executed, subject to us guaranteeing our landlord the Minimum Rate for the
leased space. This guarantee will continue for a minimum of 24 months after the
date of execution for the leased space.
Furthermore, if we are acquired by an unrelated entity, the acquirer may
terminate the lease obligation for a termination fee equal to 67% of the total
minimum monthly rent payable for the remaining term of the lease subsequent to
such acquisition.
26
In consideration for the above, we issued our landlord a warrant to
purchase 200,000 shares of the Company's common stock at $0.57 per share. The
fair value of this warrant was determined to be $86,000 and pro-rata amounts are
being expensed over the earlier of the life of the operating lease (September
2006) and the date that we abandoned certain excess facilities (March 2003). In
addition, we forfeited $1,250,000 of $2,000,000 of restricted cash used to
collateralize a letter of credit. We also forgave approximately $240,000 of
security deposits. The $2,000,000 of restricted cash and $240,000 of security
deposits were classified as other assets on the Company's consolidated balance
sheet at March 31, 2002.
We are obligated to forfeit $750,000 of restricted cash, which
collateralizes our obligation and is classified as other assets on our
consolidated balance sheet, to our landlord if our landlord is able to lease our
excess space. We estimate we will also incur approximately $359,000 of other
collateral forfeitures relating to certain provisions set forth within the Lease
Amendment.
In addition, the landlord, under certain limited conditions and exceptions
specified in the Lease Amendment, may have the option to extend the term of the
Lease Amendment for an additional five (5) years, with the base rent for the
renewal term based on fair market value.
We are amortizing the payments and other collateral described above as rent
expense over the life of the lease. In March 2003, we abandoned approximately
half of our headquarters facility to facilitate the leasing of the excess space
to a third party. As a result of this, we incurred charges of approximately
$2,239,000 (including $89,000 of equipment write-downs) during the year ended
March 31, 2003. The charges are related to the write-off of approximately half
of the unamortized portion of payments and other collateral forfeiture described
above and the accrual of approximately $1,026,000 relating to the expected
leasing of the excess space to a third party at a rate that is below the Minimum
Rate guarantee.
We have made a number of assumptions, such as length of time required to
engage a sublessee, and estimates, such as the assumed sublease rate, in
deriving the accounting for our lease amendment and excess facility space. Our
assumptions and estimates are based upon the best information that we have at
the time any charges are derived. There are a number of external factors outside
of our control that could materially change our assumptions and require us to
record additional charges in future periods. We monitor all of these external
factors and the impact on our assumptions and estimates as part of our on-going
financial reporting processes.
Business Restructuring Charges
During the year ended March 31, 2003, we implemented additional
restructuring programs to better align operating expenses with anticipated
revenues. We recorded a $3,215,000 restructuring charge, which consisted of
$2,150,000 of excess facility charges (recorded in our fiscal fourth quarter of
the year ended March 31, 2003), $849,000 in employee severance costs (the
significant majority of which was recorded during the three months ended June
30, 2002) and $216,000 in equipment write-downs across most of the expense line
items in our consolidated statement of operations for the year ended March 31,
2003. The restructuring programs resulted in a reduction in force across all
company functions of approximately 50 employees. At March 31, 2003, we had
$1,515,000 of accrued restructuring costs related to rent for excess facility
capacity, and potential cash payments and potential forfeiture of cash-based
collateral in conjunction with the Lease Amendment described above. We expect to
pay out the excess facility charges accrued as of March 31, 2003 over the life
of the operating lease, which runs through September 2006. We expect to forfeit
our cash-based collateral and pay out cash payments related to our Lease
Amendment over the course of the next twelve months.
During the year ended March 31, 2003, we made an adjustment of $66,000 to
accrued excess facilities costs. The excess facility accrual was originally
recorded pursuant to the FASB's Emerging Issues Task Force Issue 94-3,
"Liability Recognition for Certain Employee Termination Benefits and Other Costs
to Exit an Activity ("EITF 94-3")." The adjustment is a result of us
re-occupying certain space in March 2003 that we had previously written-off and
had not intended to use until April 2003.
27
It is difficult for us to precisely quantify the material effects of our
fiscal 2003 restructuring plans on our future operating results and cash flows.
However, for the fourth quarter of our fiscal 2003 our cost of sales and
operating expenses totaled $7,842,000 (including non-cash, stock-based charges
of $356,000 and net charges of $1,413,000) and compared to our cost of sales and
operating expenses during our fourth quarter of fiscal 2002 totaling $12,433,000
(including non-cash, stock-based charges of $3,865,000 and other net charges of
$396,000). Excluding non-cash, stock-based charges and other net charges
totaling $1,769,000 and $4,261,000 during our fiscal fourth quarters ended March
31, 2003 and 2002, respectively, our total cost of sales and operating expenses
totaled $6,073,000 and $8,172,000 during our fiscal fourth quarters ended March
31, 2003 and 2002, respectively. We believe these numbers are useful in order to
calculate the decrease in our expenses associated with our restructuring plans.
Based upon the previous, we believe our restructuring plans implemented during
fiscal 2003 will reduce our total expenses and cash usage on an annual basis in
comparison to our expense rate and cash usage prior to implementing these plans.
The significant majority of these expense reductions are cash based.
The following table depicts the restructuring activity during the year
ended March 31, 2003 (in thousands):
Expenditures
Balance at ------------------- Balance at
Category March 31, 2002 Additions Cash Non-cash Adjustments March 31, 2003
-------- -------------- --------- ---- -------- ----------- --------------
Excess facilities and
other exit costs..... $ 504 $ 2,150 $1,073 $ -- $ 66 $ 1,515
Employee severance....... 259 849 1,108 -- -- --
Equipment write-downs.... -- 216 -- 216 -- --
-------- --------- ------- -------- -------- -----------
Total................ $ 763 $ 3,215 $ 2,181 $ 216 $ 66 $ 1,515
======== ========= ======= ======== ======== ===========
Excess Facilities and Other Exit Costs: Excess facilities and other exit
costs relate to lease obligations and closure costs associated with offices we
have vacated as a result of our cost reduction initiatives and the restructuring
of our San Mateo office lease (see "Operating Lease Amendment" discussion
above). Cash expenditures for excess facilities and other exit costs during the
year ended March 31, 2003 represent the forfeiture of security deposi