UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-Q
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[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2001
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)
177 BOVET ROAD, SUITE 520
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)
------------------------
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
The number of outstanding shares of the registrant's Common Stock, $0.001
par value, was 20,516,177 as of November 1, 2001.
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1
VIRAGE, INC.
INDEX
PAGE
PART I: FINANCIAL INFORMATION
Item 1. Financial Statements (unaudited)
Condensed Consolidated Balance Sheets - September 30, 2001 and March 31, 2001......... 3
Condensed Consolidated Statements of Operations -- Three and Six Months Ended
September 30, 2001 and 2000 ............................................... 4
Condensed Consolidated Statements of Cash Flows -- Six Months Ended
September 30, 2001 and 2000 ............................................... 5
Notes to Condensed Consolidated Financial Statements ................................. 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations ................................................... 13
Item 3. Quantitative and Qualitative Disclosures About Market Risk ..................... 31
PART II: OTHER INFORMATION
Item 1. Legal Proceedings ............................................................... 32
Item 2. Changes in Securities and Use of Proceeds ....................................... 32
Item 3. Defaults Upon Senior Securities ................................................. 32
Item 4. Submission of Matters to a Vote of Security Holders ............................. 33
Item 5. Other Information ............................................................... 33
Item 6. Exhibits and Reports on Form 8-K ................................................ 33
Signature ............................................................................... 34
2
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
VIRAGE, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
(UNAUDITED)
SEPTEMBER 30, MARCH 31,
2001 2001
------------- ----------
ASSETS
Current assets:
Cash and cash equivalents ....................... $ 4,700 $ 19,680
Short-term investments .......................... 32,409 28,451
Accounts receivable, net ........................ 2,857 2,331
Prepaid expenses and other current assets ....... 642 515
--------- ---------
Total current assets ........................ 40,608 50,977
Property and equipment, net ....................... 5,520 6,692
Other assets ...................................... 2,520 2,537
--------- ---------
Total assets ................................ $ 48,648 $ 60,206
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable ................................ $ 932 $ 1,153
Accrued payroll and related expenses ............ 3,264 3,279
Accrued expenses ................................ 2,802 3,003
Deferred revenue ................................ 2,454 2,954
--------- ---------
Total current liabilities ................... 9,452 10,389
Deferred rent ..................................... 222 111
Commitments and contingencies
Stockholders' equity:
Preferred stock ................................. -- --
Common stock .................................... 20 20
Additional paid-in capital ...................... 121,183 120,707
Deferred compensation ........................... (7,475) (9,847)
Accumulated deficit ............................. (74,754) (61,174)
--------- ---------
Total stockholders' equity .................. 38,974 49,706
--------- ---------
Total liabilities and stockholders' equity .. $ 48,648 $ 60,206
========= =========
See accompanying notes.
3
VIRAGE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
THREE MONTHS ENDED SIX MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------- ----------------------
2001 2000 2001 2000
-------- -------- -------- --------
Revenues:
License revenues ....................... $ 2,932 $ 1,373 $ 4,814 $ 2,466
Service revenues ....................... 1,663 1,202 3,710 2,021
Other revenues ......................... 151 4 212 23
-------- -------- -------- --------
Total revenues ....................... 4,746 2,579 8,736 4,510
Cost of revenues:
License revenues ....................... 178 164 332 312
Service revenues(1) .................... 2,405 1,781 4,937 3,262
Other revenues ......................... 91 24 148 79
-------- -------- -------- --------
Total cost of revenues ............... 2,674 1,969 5,417 3,653
-------- -------- -------- --------
Gross profit ............................. 2,072 610 3,319 857
Operating expenses:
Research and development(2) ............ 2,344 2,231 4,817 4,264
Sales and marketing(3) ................. 4,423 4,255 8,862 8,238
General and administrative(4) .......... 1,330 1,302 2,662 2,544
Stock-based compensation ............... 756 856 1,538 1,692
-------- -------- -------- --------
Total operating expenses ............. 8,853 8,644 17,879 16,738
-------- -------- -------- --------
Loss from operations ..................... (6,781) (8,034) (14,560) (15,881)
Interest and other income, net ........... 412 927 980 1,039
-------- -------- -------- --------
Net loss ................................. $ (6,369) $ (7,107) $(13,580) $(14,842)
======== ======== ======== ========
Basic and diluted net loss per share ..... $ (0.31) $ (0.38) $ (0.67) $ (1.36)
======== ======== ======== ========
Shares used in computation of basic and
diluted net loss per share ............. 20,247 18,662 20,190 10,938
======== ======== ======== ========
(1) Excluding $69 and $143 in amortization of deferred stock-based compensation
for the three and six months ended September 30, 2001, respectively ($76 and
$152 for the three and six months ended September 30, 2000, respectively).
(2) Excluding $102 and $219 in amortization of deferred stock-based compensation
for the three and six months ended September 30, 2001, respectively ($136
and $274 the three and six months ended September 30, 2000, respectively).
(3) Excluding $227 and $459 in amortization of deferred stock-based compensation
for the three and six months ended September 30, 2001, respectively ($246
and $510 for the three and six months ended September 30, 2000,
respectively).
(4) Excluding $358 and $717 in amortization of deferred stock-based compensation
for the three and six months ended September 30, 2001, respectively ($398
and $756 for the three and six months ended September 30, 2000,
respectively).
See accompanying notes.
4
VIRAGE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
SIX MONTHS ENDED
SEPTEMBER 30,
-----------------------
2001 2000
-------- --------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss ........................................................ $(13,580) $(14,842)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization ................................. 1,481 766
Amortization of deferred compensation related to
stock options ............................................... 1,928 2,143
Amortization of deferred advertising costs and
technology right ........................................... 17 408
Amortization of warrant fair values ........................... 438 --
Changes in operating assets and liabilities:
Accounts receivable ......................................... (526) 143
Prepaid expenses and other current assets ................... (127) (310)
Other assets ................................................ -- 13
Accounts payable ............................................ (221) 33
Accrued payroll and related expenses ........................ (15) 1,598
Accrued expenses ............................................ (201) 982
Deferred revenue ............................................ (500) 1,101
Deferred rent ............................................... 111 --
-------- --------
Net cash used in operating activities ........................... (11,195) (7,965)
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment .............................. (309) (2,413)
Purchase of short-term investments .............................. (43,163) (5,633)
Sales and maturities of short-term investments .................. 39,205 --
-------- --------
Net cash used in investing activities ........................... (4,267) (8,046)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from bank line of credit ............................... -- 806
Principal payments on loans and capital leases .................. -- (1,047)
Proceeds from exercise of stock options, net of repurchases ..... (7) 531
Proceeds from employee stock purchase plan ...................... 489 --
Proceeds from issuance of common stock, net of
offering costs ................................................ -- 58,288
Proceeds from exercise of warrants to purchase
preferred and common stock .................................... -- 2,125
-------- --------
Net cash provided by financing activities ....................... 482 60,703
-------- --------
Net increase (decrease) in cash and cash equivalents ............ (14,980) 44,692
Cash and cash equivalents at beginning of period ................ 19,680 10,107
-------- --------
Cash and cash equivalents at end of period ...................... $ 4,700 $ 54,799
======== ========
SUPPLEMENTAL DISCLOSURES OF NONCASH OPERATING,
INVESTING AND FINANCING ACTIVITIES:
Deferred compensation related to stock options .................. $ 123 $ 70
Reversal of deferred compensation upon employee
termination ................................................... $ 567 $ 401
Conversion of prepaid offering costs to equity at IPO ........... $ -- $ 812
Conversion of redeemable preferred stock to equity at IPO ....... $ -- $ 36,995
See accompanying notes.
5
VIRAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2001
(UNAUDITED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The accompanying unaudited condensed consolidated financial statements have
been prepared in accordance with generally accepted accounting principles for
interim financial information and in accordance with the instructions to Form
10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of
the information and footnotes required by generally accepted accounting
principles for complete financial statements. In the opinion of management, all
adjustments (consisting of normal recurring accruals) necessary for a fair
presentation of the financial statements at September 30, 2001 and for the three
and six month periods ended September 30, 2001 and 2000 have been included.
The condensed consolidated financial statements include the accounts of
Virage, Inc. (the "Company") and its majority owned subsidiaries, Virage Europe,
Ltd. and Virage GmbH. All significant intercompany balances and transactions
have been eliminated in consolidation.
Results for the three and six months ended September 30, 2001 are not
necessarily indicative of results for the entire fiscal year or future periods.
These financial statements should be read in conjunction with the consolidated
financial statements and the accompanying notes included in the Company's Annual
Report on Form 10-K, dated June 20, 2001 as filed with the United States
Securities and Exchange Commission. The accompanying balance sheet at March 31,
2001 is derived from the Company's audited consolidated financial statements at
that date.
Revenue Recognition
The Company enters into arrangements for the sale of licenses of software
products and related maintenance contracts, application services and
professional services offerings; and also receives revenues under U.S.
government agency research grants. Service revenues include revenues from
maintenance contracts, application services, and professional services. Other
revenues are primarily U.S. government agency research grants.
The Company's revenue recognition policy is in accordance with the American
Institute of Certified Public Accountants' ("AICPA") Statement of Position No.
97-2 ("SOP 97-2"), "Software Revenue Recognition", as amended by Statement of
Position No. 98-4, "Deferral of the Effective Date of SOP 97-2, "Software
Revenue Recognition" ("SOP 98-4"), and Statement of Position No. 98-9,
"Modification of SOP No. 97-2 with Respect to Certain Transactions" ("SOP
98-9"). For each arrangement, the Company determines whether evidence of an
arrangement exists, delivery has occurred, the fee is fixed or determinable, and
collection is probable. If any of these criteria are not met, revenue
recognition is deferred until such time as all criteria are met. The Company
considers all arrangements with payment terms extending beyond twelve months and
other arrangements with payment terms longer than normal not to be fixed or
determinable. If collectibility is not considered probable, revenue is
recognized when the fee is collected. No customer has the right of return.
Arrangements consisting of license and maintenance. For those contracts that
consist solely of license and maintenance, the Company recognizes license
revenues based upon the residual method after all elements other than
maintenance have been delivered as prescribed by SOP 98-9. The Company
recognizes maintenance revenues over the term of the maintenance contract as
vendor specific objective evidence of fair value for maintenance exists. In
accordance with paragraph ten of SOP 97-2, vendor specific objective evidence of
fair value of maintenance is determined by reference to the price the customer
will be required to pay when it is sold separately (that is, the renewal rate).
Each license agreement offers additional maintenance renewal periods at a stated
price. Maintenance contracts are typically one year in duration. Revenue is
recognized on a per copy basis for licensed software when each copy of the
license requested by the customer is delivered.
6
VIRAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 2001
(UNAUDITED)
Revenue is recognized on licensed software on a per user or per server basis
for a fixed fee when the product master is delivered to the customer. There is
no right of return or price protection for sales to domestic and international
distributors, system integrators, or value added resellers (collectively,
"resellers"). In situations where the reseller has a purchase order or other
contractual agreement from the end user that is immediately deliverable, the
Company recognizes revenue on shipment to the reseller, if other criteria in SOP
97-2 are met, since the Company has no risk of concessions. The Company defers
revenue on shipments to resellers if the reseller does not have a purchase order
or other contractual agreement from an end user that is immediately deliverable
or other criteria in SOP 97-2 are not met. The Company recognizes royalty
revenues upon receipt of the quarterly reports from the vendors.
When licenses and maintenance are sold together with professional services
such as consulting and implementation, license fees are recognized upon
shipment, provided that (1) the criteria in the previous paragraph have been
met, (2) payment of the license fee is not dependent upon the performance of the
professional services, and (3) the services do not include significant
alterations to the features and functionality of the software.
Should professional services be essential to the functionality of the
licenses in a license arrangement which contains professional services or should
an arrangement not meet the criteria mentioned previously in this paragraph,
both the license revenues and professional service revenues are recognized in
accordance with the provisions of the AICPA's Statement of Position No. 81-1,
"Accounting for Performance of Construction Type and Certain Production Type
Contracts" ("SOP 81-1"). When reliable estimates are available for the costs and
efforts necessary to complete the implementation services and the implementation
services do not include contractual milestones or other acceptance criteria, the
Company accounts for the arrangements under the percentage of completion
contract method pursuant to SOP 81-1 based upon input measures such as hours or
days. When such estimates are not available, the completed contract method is
utilized. When an arrangement includes contractual milestones, the Company
recognizes revenues as such milestones are achieved provided the milestones are
not subject to any additional acceptance criteria.
Application services. Application services revenues consist primarily of web
design and integration fees, video processing fees and application hosting fees.
Web design and integration fees are recognized ratably over the contract term,
which is generally six to twelve months. The Company generates video processing
fees for each hour of video that a customer deploys. Processing fees are
recognized as encoding, indexing and editorial services are performed and are
based upon hourly rates per hour of video content. Application hosting fees are
generated based on the number of video queries processed, subject in some cases
to monthly minimums and maximums. The Company recognizes revenues on transaction
fees that are subject to monthly minimums based on the greater of actual
transaction fees or the monthly minimum, and monthly maximums based on the
lesser of actual transaction fees or the monthly maximum, since the Company has
no further obligations, the payment terms are normal and each month is a
separate measurement period.
Professional Services. The Company provides professional services such as
consulting, implementation and training services to its customers. Revenues from
such services, when not sold in conjunction with product licenses, are generally
recognized as the services are performed.
Other revenues. Other revenues consist primarily of U.S. government agency
research grants that are best effort arrangements. The software-development
arrangements are within the scope of the Financial Accounting Standards Board's
Statement of Financial Accounting Standards No. 68, "Research and Development
Arrangements." As the financial risks associated with the software-development
arrangement rests solely with the U.S. government agency, the Company is
recognizing revenues as the services are performed. The cost of these services
are included in cost of other revenues. The Company's contractual obligation is
to provide the required level of effort (hours), technical reports, and funds
and man-hour expenditure reports.
7
VIRAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 2001
(UNAUDITED)
Use of Estimates
The preparation of the accompanying unaudited condensed consolidated
financial statements requires management to make estimates and assumptions that
effect the amounts reported in these financial statements. Actual results could
differ from those estimates.
Cash Equivalents and Short-Term Investments
The Company invests its excess cash in money market accounts and debt
instruments and considers all highly liquid debt instruments purchased with an
original maturity of three months or less to be cash equivalents. Investments
with an original maturity at the time of purchase of over three months are
classified as short-term investments regardless of maturity date, as all such
instruments are classified as available-for-sale and can be readily liquidated
to meet current operational needs. At September 30, 2001, all of the Company's
total cash equivalents and short-term investments were classified as
available-for-sale and consisted of obligations issued by U.S. government
agencies and multinational corporations, maturing within one year.
Comprehensive Net Loss
The Company has adopted the Financial Accounting Standards Board's ("FASB")
Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive
Income" ("FAS 130"). FAS 130 establishes standards for the reporting and display
of comprehensive income (loss) and its components in a full set of general
purpose financial statements. To date, unrealized gains and losses have been
insignificant and the Company has had no other comprehensive income (loss), and
consequently, net loss equals total comprehensive net loss.
Net Loss per Share
Basic and diluted net loss per share are computed in conformity with the
FASB's Statement of Financial Accounting Standards No. 128, "Earnings Per Share"
("FAS 128"), for all periods presented, using the weighted average number of
common shares outstanding less shares subject to repurchase.
Pro forma basic and diluted net loss per share have been computed as
described above and also give effect, even if antidilutive, to common equivalent
shares from preferred stock as if such conversion had occurred on April 1, 2000,
or at the date of original issuance, if later.
8
VIRAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 2001
(UNAUDITED)
The following table presents the computation of basic and diluted net loss
per share and pro forma basic and diluted net loss per share (in thousands,
except per share data):
THREE MONTHS ENDED SIX MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------- ----------------------
2001 2000 2001 2000
-------- -------- -------- --------
Net loss ................................. $ (6,369) $ (7,107) $(13,580) $(14,842)
======== ======== ======== ========
Weighted-average shares of common
stock outstanding ...................... 20,383 19,070 20,363 11,387
Less weighted-average shares of
common stock subject to repurchase ..... (136) (408) (173) (449)
-------- -------- -------- --------
Weighted-average shares used in
computation of basic and diluted net
loss per share ......................... 20,247 18,662 20,190 10,938
======== ======== ======== ========
Basic and diluted net loss per share ..... $ (0.31) $ (0.38) $ (0.67) $ (1.36)
======== ======== ======== ========
Shares used in computation of basic and
diluted net loss per share ............. 20,247 18,662 20,190 10,938
Pro forma adjustment to reflect
weighted-average effect of the
assumed conversion of
convertible preferred stock ............ -- 564 -- 5,443
-------- -------- -------- --------
Shares used in computing pro
forma basic and diluted net
loss per share ......................... 20,247 19,226 20,190 16,381
======== ======== ======== ========
Pro forma basic and diluted net
loss per share ......................... $ (0.31) $ (0.37) $ (0.67) $ (0.91)
======== ======== ======== ========
Impact of Recently Issued Accounting Standards
In June 2001, the FASB issued Statement of Financial Accounting Standards
No. 141, "Business Combinations ("FAS 141")." FAS 141 requires use of the
purchase method for all business combinations initiated after June 30, 2001,
thereby eliminating use of the pooling method. FAS 141 also provides new
criteria to determine whether an acquired intangible asset should be recognized
separately from goodwill. Under the new criteria, an acquired intangible asset
would not be recognized separately from goodwill unless either control over the
future economic benefits results from contractual or legal rights or the asset
is capable of being separated or divided and sold, transferred, licensed,
rented, or exchanged. The Company currently believes that FAS 141 will not have
a material impact on its financial position or its results of operations or cash
flows as the Company has not participated in any business combinations through
September 30, 2001.
9
VIRAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 2001
(UNAUDITED)
In June 2001, the FASB issued Statement of Financial Accounting Standards No.
142, "Goodwill and Intangible Assets ("FAS 142")." FAS 142 states that
amortization of goodwill will no longer be required. Instead, impairment to
goodwill is to be tested at least annually at the reporting unit level using a
two-step impairment test whereby the first step determines if goodwill is
impaired and the second step measures the amount of the impairment loss. While
goodwill is to be tested for impairment annually, companies may need to test for
goodwill impairment on an interim basis if an event or circumstance occurs that
might significantly reduce the fair value of a reporting unit below its carrying
amount. Regarding amortization of intangible assets with finite lives, the FASB
requires intangible assets to be amortized over their useful economic lives and
reviewed for impairment under Statement 121. Intangible assets that have
economic lives that are indefinite would not be subject to amortization until
there is evidence that their lives no longer are indefinite, and would be tested
for impairment annually using a lower of cost or fair value approach. The
provisions of FAS 142 will be effective for fiscal years beginning after
December 15, 2001. The Company currently believes that FAS 142 will not have a
material impact on its financial position or its results of operations or cash
flows as the Company has no goodwill or intangible assets subject to the
requirements of FAS 142.
2. COMMITMENTS AND CONTINGENCIES
During the three months ended September 30, 2001, the Company's service
revenues decreased to $1,663,000 from $2,047,000 for the three months ended June
30, 2001. Although the Company's mix of license and service revenues generally
will tend to vary from quarter to quarter based upon the timing of license
shipments and other factors, the Company's service revenues decrease during the
three months ended September 30, 2001 is primarily attributable to significantly
reduced revenues from Major League Baseball Advanced Media L.P. ("MLBAM"), which
accounted for approximately 16% of the Company's total revenues in the quarter
ended June 30, 2001 and less than 5% of the Company's total revenues in the
quarter ended September 30, 2001 (less than 10% of total revenues during the six
months ended September 30, 2001). The Company did not receive certain payments
from MLBAM that were due to the Company during the three months ended September
30, 2001 and therefore the Company determined that it was unable to recognize
the related revenues for these outstanding payments until the period in which
the payments were received. The Company received a significant payment from
MLBAM for certain invoices subsequent to September 30, 2001. However, even after
considering this payment, the Company still has a significant amount of unpaid
invoices with MLBAM (none of which relate to any revenues recognized through
September 30, 2001). The Company will recognize these unpaid invoices as
revenues in the period in which the Company receives payment from MLBAM, if
ever.
The Company's application services use significant capital equipment
resources that have been purchased to support its current customer requirements.
The Company's application services are new and unproven and revenues and related
expenses are difficult to forecast. Customers typically engage in contracts for
the Company's application services for a period of six to twelve months and no
customer has any obligation to renew. For example, MLBAM is a large customer
that accounted for greater than 5% of the Company's revenues for the six months
ended September 30, 2001 and has a contract that expires within the Company's
current fiscal year ending March 31, 2002 with no obligation to renew. Should
the Company lose this customer or other customers for its application services,
the Company may have excess capacity and be required to record a charge for
excess capital equipment and/or other infrastructure costs. The Company's
management reviews its capacity requirements and assesses whether any excess
capacity exists as part of its on-going financial processes.
10
VIRAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 2001
(UNAUDITED)
The Company's principal administrative, research and development, sales,
services and marketing activities are conducted on two leased properties in San
Mateo, California: the first property consists of 21,000 square feet and expires
in May 2002 and the second property consists of 48,000 square feet and expires
in September 2006. In addition, the Company leases 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 June 2003 and a property near London, England where the
Company performs sales, services, marketing and administrative activities and
that expires in February 2002. During the six months ended September 30, 2001,
the Company was able to sublease its excess capacity at its facilities and
received rental payments from its tenants. These sublease agreements will expire
during the Company's current fiscal year ended March 31, 2002, and the Company
may not be successful in renewing its arrangements with its current sublease
tenants or finding new sublease tenants. If this should occur and the Company
deems that the formerly sublet space cannot be used, the Company would be
required to record a charge at the end of the sublease agreement for a portion
of the rental payments that the Company owes to its landlord relating to any
excess capacity that exists at its facilities. The Company's management reviews
its facility requirements and assesses whether any excess capacity exists as
part of its on-going financial processes.
On August 22, 2001 and September 18, 2001, we and certain of our officers
were named as defendants in purported securities class-action lawsuits filed in
the United States District Court for the Southern District of New York (the
"Actions"). The first of the Actions is captioned Chin vs. Virage, Inc., et. al.
and the second is captioned Bartula vs. Virage, Inc., et. al. The Court has
since consolidated the Actions, appointed a lead plaintiff and approved lead
plaintiffs' selection of lead counsel. Lead plaintiff has filed a consolidated
complaint ("Complaint") with the Court. The Complaint alleges claims against us,
certain of our officers, and/or Credit Suisse First Boston ("CSFB"), as lead
underwriter and certain other underwriters (collectively, the "underwriters")
associated with our July 5, 2000 initial public offering, under Sections 11 and
15 of the Securities Act of 1933, as amended. The Complaint also alleges claims
solely against the underwriters under Section 12(2) of the Securities Act of
1933 and Section 10(b) of the Securities Exchange Act of 1934, as amended. We
believe that the claims against us and certain of our officers are without legal
merit and intend to defend them vigorously. Subsequently, all pending cases
against all underwriters and issuers were reassigned to Honorable Judge Shira
Scheindlin, U.S. District Court Judge, United States District Court for the
Southern District of New York. The time for defendants to move to dismiss the
Complaint is presently adjourned pending further instruction from Judge
Scheindlin.
From time to time, we 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.
3. STOCKHOLDERS' EQUITY
In December 2000, the Company entered into a services agreement with MLBAM
and issued an immediately exercisable, non-forfeitable warrant to purchase
200,000 shares of common stock at $5.50 per share. The warrant expires in
December 2003. The value of the warrant was estimated to be $648,000 and was
based upon a Black-Scholes valuation model with the following assumptions: risk
free interest rate of 7.0%, no dividend yield, volatility of 90%, expected life
of three years, exercise price of $5.50 and fair value of $5.38. The non-cash
amortization of the warrant's value is being recorded against service revenues
as revenues from services are recognized over the one-year services agreement.
During the three and six months ended September 30, 2001, the Company recorded
$216,000 and $432,000, respectively, as contra-service revenues representing the
pro-rata amortization of the warrant's value for the aforementioned periods.
11
VIRAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 2001
(UNAUDITED)
4. SEGMENT REPORTING
The Company has two reportable segments: the sale of software and related
software support services including revenues from U.S. government agencies
("software") and the sale of its application and professional services which
includes set-up fees, professional services fees, video processing fees, and
application hosting fees ("application services"). The Company's Chief Operating
Decision Maker ("CODM") is the Company's Chief Executive Officer who evaluates
performance and allocates resources based upon total revenues and gross profit
(loss). Discreet financial information for each segment's profit and loss and
each segment's total assets is not provided to the Company's CODM, nor is it
tracked by the Company.
Information on the Company's reportable segments for the three and six
months ended September 30, 2001 and 2000 are as follows (in thousands):
THREE MONTHS ENDED SIX MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------- ---------------------
2001 2000 2001 2000
------- ------- ------- -------
SOFTWARE:
Total revenues ............. $ 3,792 $ 1,741 $ 6,378 $ 3,121
Total cost of revenues ..... 402 313 760 610
------- ------- ------- -------
Gross profit ............... $ 3,390 $ 1,428 $ 5,618 $ 2,511
======= ======= ======= =======
APPLICATION SERVICES:
Total revenues ............. $ 954 $ 838 $ 2,358 $ 1,389
Total cost of revenues ..... 2,272 1,656 4,657 3,043
------- ------- ------- -------
Gross loss ................. $(1,318) $ (818) $(2,299) $(1,654)
======= ======= ======= =======
5. INCOME TAXES
The Company has not recorded a provision for federal and state or foreign
income taxes for the three and six months ended September 30, 2001 or 2000
because the Company has experienced net losses since inception, which have
resulted in deferred tax assets. The Company has recorded a valuation allowance
against all deferred tax assets as a result of uncertainties regarding the
realization of the balances through future taxable profits.
12
Item 2. 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 condensed consolidated
financial statements and related notes contained herein and the information
contained in our Annual Report on Form 10-K as filed with the United States
Securities and Exchange Commission on June 20, 2001. 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 and in our Annual Report
on Form 10-K. These forward-looking statements speak only as of the date of this
quarterly 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 quarterly report and in our
Annual Report on Form 10-K.
OVERVIEW
Virage is a leading provider of video content management and publishing
solutions. Depending on their particular needs and resources, our customers may
elect to license our software products or employ our application or professional
services to outsource their needs. Our customers include media and entertainment
companies, other corporations, government agencies and educational institutions.
Revenue Recognition
The Company enters into arrangements for the sale of licenses of software
products and related maintenance contracts, application services and
professional services offerings; and also receives revenues under U.S.
government agency research grants. Service revenues include revenues from
maintenance contracts, application services, and professional services. Other
revenues are primarily U.S. government agency research grants.
The Company's revenue recognition policy is in accordance with the American
Institute of Certified Public Accountants' ("AICPA") Statement of Position No.
97-2 ("SOP 97-2"), "Software Revenue Recognition", as amended by Statement of
Position No. 98-4, "Deferral of the Effective Date of SOP 97-2, "Software
Revenue Recognition" ("SOP 98-4"), and Statement of Position No. 98-9,
"Modification of SOP No. 97-2 with Respect to Certain Transactions" ("SOP
98-9"). For each arrangement, the Company determines whether evidence of an
arrangement exists, delivery has occurred, the fee is fixed or determinable, and
collection is probable. If any of these criteria are not met, revenue
recognition is deferred until such time as all criteria are met. The Company
considers all arrangements with payment terms extending beyond twelve months and
other arrangements with payment terms longer than normal not to be fixed or
determinable. If collectibility is not considered probable, revenue is
recognized when the fee is collected. No customer has the right of return.
Arrangements consisting of license and maintenance. For those contracts that
consist solely of license and maintenance, the Company recognizes license
revenues based upon the residual method after all elements other than
maintenance have been delivered as prescribed by SOP 98-9. The Company
recognizes maintenance revenues over the term of the maintenance contract as
vendor specific objective evidence of fair value for maintenance exists. In
accordance with paragraph ten of SOP 97-2, vendor specific objective evidence of
fair value of maintenance is determined by reference to the price the customer
will be required to pay when it is sold separately (that is, the renewal rate).
Each license agreement offers additional maintenance renewal periods at a stated
price. Maintenance contracts are typically one year in duration. Revenue is
recognized on a per copy basis for licensed software when each copy of the
license requested by the customer is delivered.
13
Revenue is recognized on licensed software on a per user or per server basis
for a fixed fee when the product master is delivered to the customer. There is
no right of return or price protection for sales to domestic and international
distributors, system integrators, or value added resellers (collectively,
"resellers"). In situations where the reseller has a purchase order or other
contractual agreement from the end user that is immediately deliverable, the
Company recognizes revenue on shipment to the reseller, if other criteria in SOP
97-2 are met, since the Company has no risk of concessions. The Company defers
revenue on shipments to resellers if the reseller does not have a purchase order
or other contractual agreement from an end user that is immediately deliverable
or other criteria in SOP 97-2 are not met. The Company recognizes royalty
revenues upon receipt of the quarterly reports from the vendors.
When licenses and maintenance are sold together with professional services
such as consulting and implementation, license fees are recognized upon
shipment, provided that (1) the criteria in the previous paragraph have been
met, (2) payment of the license fee is not dependent upon the performance of the
professional services, and (3) the services do not include significant
alterations to the features and functionality of the software.
Should professional services be essential to the functionality of the
licenses in a license arrangement which contains professional services or should
an arrangement not meet the criteria mentioned previously in this paragraph,
both the license revenues and professional service revenues are recognized in
accordance with the provisions of the AICPA's Statement of Position No. 81-1,
"Accounting for Performance of Construction Type and Certain Production Type
Contracts" ("SOP 81-1"). When reliable estimates are available for the costs and
efforts necessary to complete the implementation services and the implementation
services do not include contractual milestones or other acceptance criteria, the
Company accounts for the arrangements under the percentage of completion
contract method pursuant to SOP 81-1 based upon input measures such as hours or
days. When such estimates are not available, the completed contract method is
utilized. When an arrangement includes contractual milestones, the company
recognizes revenues as such milestones are achieved provided the milestones are
not subject to any additional acceptance criteria.
Application services. Application services revenues consist primarily of web
design and integration fees, video processing fees and application hosting fees.
Web design and integration fees are recognized ratably over the contract term,
which is generally six to twelve months. The Company generates video processing
fees for each hour of video that a customer deploys. Processing fees are
recognized as encoding, indexing and editorial services are performed and are
based upon hourly rates per hour of video content. Application hosting fees are
generated based on the number of video queries processed, subject in some cases
to monthly minimums and maximums. The Company recognizes revenues on transaction
fees that are subject to monthly minimums based on the greater of actual
transaction fees or the monthly minimum, and monthly maximums based on the
lesser of actual transaction fees or the monthly maximum, since the Company has
no further obligations, the payment terms are normal and each month is a
separate measurement period.
Professional Services. The Company provides professional services such as
consulting, implementation and training services to its customers. Revenues from
such services, when not sold in conjunction with product licenses, are generally
recognized as the services are performed.
Other revenues. Other revenues consist primarily of U.S. government agency
research grants that are best effort arrangements. The software-development
arrangements are within the scope of the Financial Accounting Standards Board's
Statement of Financial Accounting Standards No. 68, "Research and Development
Arrangements." As the financial risks associated with the software-development
arrangement rests solely with the U.S. government agency, the Company is
recognizing revenues as the services are performed. The cost of these services
are included in cost of other revenues. The Company's contractual obligation is
to provide the required level of effort (hours), technical reports, and funds
and man-hour expenditure reports.
14
RESULTS OF OPERATIONS
The following table sets forth consolidated financial data for the periods
indicated, expressed as a percentage of total revenues.
THREE MONTHS ENDED SIX MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------- ----------------
2001 2000 2001 2000
---- ---- ---- ----
Revenues:
License revenues ..................... 62% 53% 55% 54%
Service revenues ..................... 35 46 43 45
Other revenues ....................... 3 1 2 1
---- ---- ---- ----
Total revenues ..................... 100 100 100 100
Cost of revenues:
License revenues ..................... 4 6 4 7
Service revenues ..................... 50 69 56 72
Other revenues ....................... 2 1 2 2
---- ---- ---- ----
Total cost of revenues ............. 56 76 62 81
---- ---- ---- ----
Gross profit ........................... 44 24 38 19
Operating expenses:
Research and development ............. 50 87 55 95
Sales and marketing .................. 93 165 101 183
General and administrative ........... 28 51 31 56
Stock-based compensation ............. 16 33 18 37
---- ---- ---- ----
Total operating expenses ........... 187 336 205 371
---- ---- ---- ----
Loss from operations ................... (143) (312) (167) (352)
Interest and other income, net ......... 9 36 12 23
---- ---- ---- ----
Net loss ............................... (134)% (276)% (155)% (329)%
==== ==== ==== ====
THREE AND SIX MONTHS ENDED SEPTEMBER 30, 2001 AND 2000
Total Revenues. Total revenues increased 84% to $4,746,000 for the three
months ended September 30, 2001 from $2,579,000 for the three months ended
September 30, 2000. Total revenues increased 94% to $8,736,000 for the six
months ended September 30, 2001 from $4,510,000 for the six months ended
September 30, 2000. These increases were due to increases in license, service
and other revenues. International revenues increased to $1,450,000, or 31% of
total revenues, for the three months ended September 30, 2001 from $642,000, or
25% of total revenues, for the three months ended September 30, 2000.
International revenues increased to $2,614,000, or 30% of total revenues, for
the six months ended September 30, 2001 from $1,035,000, or 23% of total
revenues, for the six months ended September 30, 2000. Sales to one customer
(who is a reseller of our products) accounted for 10% of total revenues for the
three months ended September 30, 2001 and 13% of total revenues for the six
months ended September 30, 2001. No customer constituted more than 10% of total
revenues for the three or six months ended September 30, 2000.
License revenues increased to $2,932,000 for the three months ended September
30, 2001 from $1,373,000 for the three months ended September 30, 2000, an
increase of $1,559,000. License revenues increased to $4,814,000 for the six
months ended September 30, 2001 from $2,466,000 for the six months ended
September 30, 2000, an increase of $2,348,000. These increases were primarily
due to the introduction of new products and greater product deployments by our
new and existing customers driven by the efforts of our domestic and
international sales and marketing operations.
15
Service revenues increased to $1,663,000 for the three months ended September
30, 2001 from $1,202,000 for the three months ended September 30, 2000, an
increase of $461,000. Service revenues increased to $3,710,000 for the six
months ended September 30, 2001 from $2,021,000 for the six months ended
September 30, 2000, an increase of $1,689,000. Service revenues for the three
and six months ended September 30, 2001 include $216,000 and $432,000,
respectively, representing warrant amortization recorded as contra-service
revenues resulting from a warrant issued to Major League Baseball Advanced Media
L.P. ("MLBAM"). Approximately 75% and 43% of service revenues growth for the
three and six months ended September 30, 2001, respectively, was due to an
increase in revenues from customers purchasing maintenance contracts, while the
remainder was due to the revenue growth of our application and professional
services offerings. The smaller percentage of our service revenues growth from
our application and professional services during the three months ended
September 30, 2001 in comparison to the six months ended September 30, 2001 is
primarily attributable to significantly reduced revenues from MLBAM, which
accounted for approximately 16% of our total revenues in the quarter ended June
30, 2001 and less than 5% of our total revenues in the quarter ended September
30, 2001. We did not receive certain payments from MLBAM that were due to us
during the three months ended September 30, 2001 and therefore we determined
that we were unable to recognize the related revenues for these outstanding
payments until the payments were received. We did receive a significant payment
from MLBAM for certain invoices subsequent to September 30, 2001. However, even
after considering this payment, we still have a significant amount of unpaid
invoices with MLBAM (none of which relate to any revenues recognized through
September 30, 2001). We will recognize these unpaid invoices as revenues in the
period in which we receive payment from MLBAM, if ever.
Other revenues increased to $151,000 and $212,000 for the three and six
months ended September 30, 2001, respectively, from $4,000 and $23,000 for the
three and six months ended September 30, 2000, increases of $147,000 and
$189,000, respectively. These increases were attributable to the level of
engineering services performed pursuant to federal government research
contracts.
Total Cost of Revenues. Total cost of revenues increased to $2,674,000, or
56% of total revenues, for the three months ended September 30, 2001 from
$1,969,000, or 76% of total revenues, for the three months ended September 30,
2000. Total cost of revenues increased to $5,417,000, or 62% of total revenues,
for the six months ended September 30, 2001 from $3,653,000, or 81% of total
revenues, for the six months ended September 30, 2000. These increases in
absolute dollars were primarily a result of increases in the cost of service
revenues, particularly the cost of our application services in order to support
the expansion of our application services.
Cost of license revenues increased to $178,000, or 6% of license revenues,
for the three months ended September 30, 2001 from $164,000, or 12% of license
revenues, for the three months ended September 30, 2000. For the six months
ended September 30, 2001, cost of license revenues increased to $332,000, or 7%
of license revenues, from $312,000, or 13% of license revenues, during the same
period in the prior year. These increases in absolute dollars were due to an
increase in revenues from the volume of our products that are subject to
unit-based, rather than fixed, license royalty obligations during the three and
six months ended September 30, 2001. However, the decrease in cost of license
revenues as a percentage of license revenues during the three and six month
periods ended September 30, 2001 is attributable to certain non-unit-based
technology license royalty obligations that remained constant during the three
and six month periods ended September 30, 2001 and 2000, thereby creating
greater economies of scale as our license revenues increased in comparison to
these fixed royalty costs.
Cost of service revenues increased to $2,405,000, or 145% of service
revenues, for the three months ended September 30, 2001 from $1,781,000, or 148%
of service revenues, for the three months ended September 30, 2000. For the six
months ended September 30, 2001, cost of service revenues were $4,937,000, or
133% of service revenues, versus $3,262,000, or 161% of service revenues, for
the six months ended September 30, 2000. The majority of these increases in
absolute dollars were due to expenditures for the expansion of our application
services, in particular to support our largest application services customer
MLBAM during the six months ended September 30, 2001. We expect the cost of
service revenues to increase moderately and margins on our service revenues
could remain negative for the foreseeable future as we attempt to expand our
application services and worldwide support revenues.
16
Cost of other revenues increased to $91,000 and $148,000, or 60% and 70% of
other revenues, for the three and six months ended September 30, 2001 from
$24,000 and $79,000, or 600% and 343% of other revenues, for the three and six
months ended September 30, 2000. These increases in absolute dollars were
primarily due to a greater number of man-hours spent on engineering services for
a government agency. The decreases in cost of other revenues as a percentage of
other revenues are a result of economies of scale as greater revenues in the
three months and six months ended September 30, 2001 were spread over certain
fixed costs that remained constant during the three and six months ended
September 30, 2001 and 2000.
Research and Development Expenses. Research and development expenses consist
primarily of personnel and related costs for our development efforts. Research
and development expenses increased in absolute dollars to $2,344,000, or 50% of
total revenues, for the three months ended September 30, 2001 from $2,231,000,
or 87% of total revenues, for the three months ended September 30, 2000. For the
six months ended September 30, 2001, research and development expenses were
$4,817,000, or 55% of total revenues, versus $4,264,000, or 95% of total
revenues, for the six months ended September 30, 2000. These increases in
absolute dollars were a result of higher development costs as additional
products and product versions were introduced. We expect research and
development expenses to increase moderately in absolute dollars for the
foreseeable future as we believe that significant product development
expenditures are essential for us to maintain and enhance our market position.
To date, we have not capitalized any software development costs as they have
been insignificant.
Sales and Marketing Expenses. Sales and marketing expenses consist of
personnel and related costs for our direct sales force, pre-sales support and
marketing staff, and marketing programs including trade shows and advertising.
Sales and marketing expenses increased in absolute dollars to $4,423,000, or 93%
of total revenues, for the three months ended September 30, 2001 from
$4,255,000, or 165% of total revenues, for the three months ended September 30,
2000. For the six months ended September 30, 2001, sales and marketing expenses
increased in absolute dollars to $8,862,000, or 101% of total revenues, from
$8,238,000, or 183% of total revenues, for the six months ended September 30,
2000. These increases were due to growth in our sales and marketing personnel
and increased expenses incurred in connection with trade shows and additional
marketing programs. We expect sales and marketing expenses to increase
moderately for the foreseeable future as we hire additional sales and marketing
personnel, increase spending on marketing programs, and expand our operations in
North America and internationally.
General and Administrative Expenses. General and administrative expenses
consist primarily of personnel and related costs for general corporate
functions, including finance, accounting, legal, human resources, and costs of
our external audit firm and our outside legal counsel. General and
administrative expenses increased in absolute dollars to $1,330,000, or 28% of
total revenues, for the three months ended September 30, 2001 from $1,302,000,
or 51% of total revenues, for the three months ended September 30, 2000. General
and administrative expenses increased in absolute dollars to $2,662,000, or 31%
of total revenues, for the six months ended September 30, 2001 from $2,544,000,
or 56% of total revenues, for the six months ended September 30, 2000. These
increases were due to increased personnel costs and higher external legal and
audit costs. We expect general and administrative expenses to increase
moderately for the foreseeable future as we incur additional professional
services costs, such as legal and audit costs, to support our growth as a public
company.
Stock-Based Compensation Expense. Stock based compensation expense represents
the amortization of deferred compensation (calculated as the difference between
the exercise price of stock options granted to our employees and the then deemed
fair value of our common stock) for stock options granted to our employees. We
recognized stock-based compensation expense of $756,000 and $856,000 for the
three months ended September 30, 2001 and 2000, respectively. For the six months
ended September 30, 2001, we recognized stock-based compensation expense of
$1,538,000 as compared to $1,692,000 for the six months ended September 30,
2000.
Interest and Other Income, Net. Interest and other income, net, includes
interest income from cash, cash equivalents and short-term investments, offset
primarily by interest on capital leases and bank debt. Interest and other
income, net, decreased to $412,000 and $980,000 for the three and six months
ended September 30, 2001, respectively, from $927,000 and $1,039,000 for the
three and six months ended September 30, 2000. These decreases were a result of
lower interest rates and lower average cash balances.
17
Provision for Income Taxes. We have not recorded a provision for federal and
state or foreign income taxes for the three and six months ended September 30,
2001 or 2000 because we have experienced net losses since inception, which have
resulted in deferred tax assets. We have recorded a valuation allowance against
all deferred tax assets as a result of uncertainties regarding the realization
of the balances through future taxable profits.
LIQUIDITY AND CAPITAL RESOURCES
As of September 30, 2001, we had cash, cash equivalents and short-term
investments of $37,109,000, a decrease of $11,022,000 from March 31, 2001 and
our working capital, defined as current assets less current liabilities, was
$31,156,000, a decrease of $9,432,000 in working capital from March 31, 2001.
The decrease in our working capital is primarily attributable to cash used in
operating activities.
Our operating activities resulted in net cash outflows of $11,195,000 and
$7,965,000 for the six months ended September 30, 2001 and 2000, respectively.
The cash used in these periods was primarily attributable to net losses of
$13,580,000 and $14,842,000 in the six months ended September 30, 2001 and 2000,
respectively.
Investing activities resulted in net cash outflows of $4,267,000 and
$8,046,000 for the six months ended September 30, 2001 and 2000, respectively.
These outflows were primarily for the purchase of short-term investments during
the six months ended September 30, 2001 and for the purchases of computer
hardware and software and furniture and fixtures and short-term investments for
the six months ended September 30, 2000. We expect that we will continue to use
cash resources for capital expenditure purposes for the foreseeable future as we
expand our operations and replace older equipment with newer models.
Financing activities provided net cash inflows of $482,000 and $60,703,000
during the six months ended September 30, 2001 and 2000, respectively. These
inflows were primarily from the proceeds from our employee stock purchase plan
during the six months ended September 30, 2001 and from sales of our preferred
and common stock (including our initial public offering in fiscal 2001) for six
months ended September 30, 2000.
We anticipate that our current cash, cash equivalents and short-term
investments will be sufficient to meet our anticipated cash needs for working
capital and capital expenditures for at least the next 12 months. However, we
may need to raise additional funds in future periods through public or private
financings, or other sources, to fund our operations and potential acquisitions,
if any, until we achieve profitability, if ever. We may not be able to obtain
adequate or favorable financing when necessary to fund our business. Failure to
raise capital when needed could harm our business. If we raise additional funds
through the issuance of equity securities, the percentage of ownership of our
stockholders would be reduced. Furthermore, these equity securities might have
rights, preferences or privileges senior to our common stock.
18
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
OUR REVENUE, COST OF SALES, AND EXPENSE FORECASTS WERE ONLY RECENTLY INTRODUCED
TO THE PUBLIC AND THERE ARE A NUMBER OF RISKS THAT MAKE IT DIFFICULT FOR US TO
FORESEE OR ACCURATELY EVALUATE FACTORS THAT MAY IMPACT SUCH FORECASTS.
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. Visibility over potential sales is typically
limited to the current quarter. In order to provide a revenue forecast for the
current quarter, we must make assumptions about conversion of these potential
sales into current quarter revenues. Such assumptions may be materially
incorrect due to competition for the customer order including 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 hire and retain qualified personnel, our inability to
develop new markets in Europe or Asia, and other factors that may be beyond our
control. In addition, 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 such 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.
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, 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.
BECAUSE WE HAVE ONLY RECENTLY INTRODUCED OUR VIDEO SOFTWARE PRODUCTS,
APPLICATION SERVICES AND PROFESSIONAL SERVICES WE FACE A NUMBER OF RISKS WHICH
MAY SERIOUSLY HARM OUR BUSINESS.
We incorporated in April 1994 and to date we have generated only limited
revenues. We introduced our first video software products in December 1997, our
application services in May 1999 and our professional services in March 2001.
Because we have a limited operating history with our video software products,
application services and professional services and because our revenue sources
may continue to shift as our business develops, you must consider the risks and
difficulties that we may encounter when making your investment decision. These
risks include our ability to:
o expand our customer base;
o increase penetration into key customer accounts;
o maintain our pricing structure;
o develop new products and services; and
o adapt our products and services to meet changes in the Internet video
infrastructure marketplace.
If we do not successfully address these risks, our business will be seriously
harmed.
19
OUR BUSINESS MODEL IS UNPROVEN AND MAY FAIL.
We do not know whether our business model and strategy will be successful.
Our business model is based on the premise that content providers will use our
licensed products and application and professional services to catalog, manage,
and distribute their video content over the Internet and intranets. Our
potential customers may elect to rely on their internal resources or on lower
priced products and services that do not offer the full range of functionality
offered by our products and services. If the assumptions underlying our business
model are not valid or if we are unable to implement our business plan, our
business will suffer.
WE HAVE NOT BEEN PROFITABLE AND IF WE DO NOT ACHIEVE PROFITABILITY, OUR
BUSINESS MAY FAIL.
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 September 30, 2001, we had an accumulated deficit of $74,754,000. We expect
to continue to incur increasing research and development, sales and marketing
and general and administrative expenses. Accordingly, our failure to increase
our revenues significantly or improve our gross margins will harm our business.
In addition, our cash, cash equivalent and short-term investment resources
(collectively, "cash resources") totaled $37,109,000 as of September 30, 2001
and we used $11,195,000 in our operating activities during the six months ended
September 30, 2001. We anticipate that our operating activities will use
additional cash resources for at least the next 12 months. This may leave us
with a deteriorated cash position in comparison to our cash position as of
September 30, 2001 and this may affect our ability to transact future strategic
operating and investing activities in a timely manner, which may harm our
business and cause our stock price to fall. Even if we should achieve
profitability, we may not be able to sustain or increase profitability on a
quarterly or annual basis in the future. If our revenues grow more slowly than
we anticipate, if our gross margins do not improve, or if our operating expenses
exceed our expectations, our operating results will suffer and our stock price
may fall.
OUR QUARTERLY OPERATING RESULTS ARE VOLATILE AND DIFFICULT TO PREDICT. IF WE
FAIL TO MEET THE EXPECTATIONS OF PUBLIC MARKET ANALYSTS OR INVESTORS, THE MARKET
PRICE OF OUR COMMON STOCK MAY DECREASE SIGNIFICANTLY.
Our quarterly 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. If securities analysts follow
our stock, our operating results will likely fall below their expectations in
some future quarter or quarters. Our failure to meet these expectations would
likely cause the market price of our common stock to decline.
Our quarterly revenues depend on a number of factors, many of which are
beyond our control and which makes it difficult for us to predict our revenues
going forward. Our operating expenses may increase and if our revenues and gross
margins do not increase, our business could be seriously harmed. Our operating
expenses may increase from expanding our sales and marketing operations, funding
greater levels of research and development, expanding our application and
professional services and developing our internal organization. Many of these
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 margins would likely
hurt our quarterly operating results.
OUR REVENUES MAY BE HARMED IF GENERAL ECONOMIC CONDITIONS CONTINUE TO WORSEN.
Our revenues are dependent on the health of the economy and the growth of our
customers and potential future customers. If the economy remains stagnant, our
customers may continue to delay or reduce their spending on our software and
service solutions. When economic conditions weaken, sales cycles for sales of
software products and related services tend to lengthen and companies'
information technology budgets tend to be reduced. If that continues to happen,
our revenues could suffer and our stock price may decline. Further, if U.S. or
global economic conditions worsen, we may experience a material adverse impact
on our business, operating results, and financial condition.
20
OUR SERVICE REVENUES HAVE A SUBSTANTIALLY LOWER MARGIN THAN OUR LICENSE
REVENUES, AND AN INCREASE IN SERVICE REVENUES RELATIVE TO LICENSE REVENUES COULD
HARM OUR GROSS MARGINS.
Our service revenues, which includes fees for our application services as
well as professional services such as consulting, implementation, maintenance
and training, were 43% of our total revenues for the six months ended September
30, 2001 and 45% of our total revenues for the six months ended September 30,
2000. Our service revenues have substantially lower gross margins than our
license revenues. Our cost of service revenues for the six months ended
September 30, 2001 and 2000 were 133% and 161%, respectively, of our service
revenues. An increase in the percentage of total revenues represented by service
revenues could adversely affect our overall gross 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.
Historically, the relative amount of service revenues as compared to license
revenues has varied based on customer demand for our application services
revenues. However, we anticipate an increase in the percentage of license
customers requesting professional services as a result of our introduction of
professional services in the fourth quarter of fiscal 2001, which will also
impact the relative amount of service revenues as compared to license revenues.
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.
IF OUR INTERNAL PROFESSIONAL SERVICES ORGANIZATION DOES NOT PROVIDE
IMPLEMENTATION SERVICES EFFECTIVELY AND ACCORDING TO SCHEDULE, OUR REVENUES AND
PROFITABILITY WOULD BE HARMED.
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 these
services, we may be required to recognize revenue from the licensing of our
software products as the implementation services are performed. If our internal
professional services organization does not effectively implement and support
our products or if we are unable to expand our internal professional services
organization as needed to meet our customers' needs, our ability to sell
software, and accordingly our revenues, will be harmed.
THE FAILURE OF ANY SIGNIFICANT FUTURE 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, consulting 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 delay payments to us, which may require us
to account for those customers' revenues on a cash basis, rather than accrual
basis, of accounting. 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, which may hurt our reported operating results
and cause our stock price to fall.
21
For example, although the Company's mix of license and service revenues
generally varies from quarter to quarter based upon the timing of license
shipments and other factors, our service revenues decrease during the three
months ended September 30, 2001 is primarily attributable to significantly
reduced revenues from Major League Baseball Advanced Media L.P. ("MLBAM"), which
accounted for approximately 16% of our total revenues in the quarter ended June
30, 2001 and less than 5% of our total revenues in the quarter ended September
30, 2001 (less than 10% of our total revenues during the six months ended
September 30, 2001). We did not receive certain payments from MLBAM that were
due to us during the three months ended September 30, 2001 and we determined
that we were unable to recognize the related revenues for these outstanding
payments until the period in which the payments were received. We received a
significant payment from MLBAM for certain invoices subsequent to September 30,
2001. However, even after considering this payment, we still have a significant
amount of unpaid invoices with MLBAM (none of which relate to any revenues
recognized through September 30, 2001). We will recognize these unpaid invoices
as revenues in the period in which we receive payment from MLBAM, if ever.
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.
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.
IF OUR CUSTOMERS FAIL TO GENERATE TRAFFIC ON THE VIDEO-RELATED SECTIONS OF THEIR
INTERNET SITES, OUR RECURRING REVENUES MAY DECREASE, WHICH MAY ADVERSELY AFFECT
OUR BUSINESS AND FINANCIAL RESULTS.
Our ability to achieve recurring revenues from our application services is
largely dependent upon the success of our customers in generating traffic on the
video-related sections of their Internet sites. Generally, we generate recurring
revenue from our application services whenever our customers add more hours of
video to an existing project. If our customers do not attract and maintain
traffic on video-related sections of their sites, video queries may decrease and
customers may decide not to add more hours of video to existing projects. This
result would cause revenues from our application services to decrease, which
will prevent us from growing our business.
IF WE FAIL TO INCREASE THE SIZE OF OUR CUSTOMER BASE OR INCREASE OUR REVENUES
WITH OUR EXISTING CUSTOMERS, OUR BUSINESS WILL SUFFER.
Increasing the size of our customer base and increasing the revenues we
generate from our customer base are critical to the success of our business. To
expand our customer base and the revenues we generate from our customers, we
must:
o generate additional revenues from different organizations within our
customers;
o conduct effective marketing and sales programs to acquire new
customers; and
o establish and maintain distribution relationships with value added
resellers and system integrators.
Our failure to achieve one or more of these objectives will hurt our
business.
22
THE PRICES WE CHARGE FOR OUR PRODUCTS AND SERVICES MAY DECREASE, WHICH WOULD
REDUCE OUR REVENUES AND HARM OUR 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, 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.
If we are unable to sell our products or services at acceptable prices
relative to our costs, or if we fail to develop and introduce on a timely basis
new products and services from which we can derive additional revenues, our
financial results will suffer.
WE RELY ON, AND EXPECT TO CONTINUE TO RELY ON, A LIMITED NUMBER OF CUSTOMERS FOR
A SIGNIFICANT PORTION OF OUR REVENUES AND IF ANY OF THESE CUSTOMERS STOPS
LICENSING OUR SOFTWARE OR PURCHASING OUR SERVICES, OUR OPERATING RESULTS WILL
SUFFER.
Historically, a limited number of customers has accounted for a significant
portion of our revenues. For example, our two largest customers (one is a
reseller of our software products) accounted for 20% of our total revenues for
the six months ended September 30, 2001. One of these large customers has an
application services contract that expires within our current fiscal year ending
March 31, 2002 with no obligation to renew. If we were to lose this customer or
one of our other large customers or if this customer or any other large customer
were to delay or default on obligations under their contracts with us, our
operating results could be significantly harmed.
We anticipate that our operating results in any given period will continue to
depend to a significant extent upon revenues from a small number of customers.
We cannot be certain that we will retain our current customers or that we will
be able to recruit additional or replacement customers. If we were to lose one
or more customers, our operating results could be significantly harmed.
ANY FAILURE OF OUR NETWORK COULD LEAD TO SIGNIFICANT DISRUPTIONS IN OUR
APPLICATION SERVICES BUSINESS THAT COULD DAMAGE OUR REPUTATION, REDUCE OUR
REVENUES OR OTHERWISE HARM OUR BUSINESS.
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, 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.
Our failure to protect our network against damage from any of these events
will hurt our business.
23
WE DEPEND ON OUTSIDE THIRD PARTIES TO MAINTAIN OUR COMMUNICATIONS HARDWARE AND
PERFORM MOST OF OUR COMPUTER HARDWARE OPERATIONS AND IF THESE THIRD PARTIES'
HARDWARE AND OPERATIONS FAIL, OUR REPUTATION AND BUSINESS WILL SUFFER.
We have communications hardware and computer hardware operations located at
Exodus Communications' facility in Santa Clara, California, at AboveNet
Communications' facility in New York City, and at Phoenix Communications in New
Jersey. 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. Other outages or
system failures may occur. 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.
POWER OUTAGES IN CALIFORNIA COULD ADVERSELY AFFECT US.
We have significant operations in the state of California and are dependent
on a continuous power supply. California's energy crisis could substantially
disrupt our operations and increase our expenses. California has in the past
implemented, and may in the future continue to implement, rolling blackouts
throughout the state. Although state lawmakers are working to minimize the
impact, if blackouts interrupt our power supply, we may be temporarily unable to
continue operations at our California facilities. Any such interruption in our
ability to continue operation at our facilities could delay the development of
our products and services and disrupt communications with our customers or other
third parties on which we rely, such as web hosting service providers. Future
interruptions could damage our reputation and could result in lost revenue,
either of which could substantially harm our business and results of operations.
Furthermore, there have been shortages in wholesale electricity supplies and
this has in the past caused power prices to increase. If energy prices should
increase again in the future, our operating expenses will likely increase which
could have a negative effect on our operating results, which in turn may cause
our stock price to fall.
IF WE ARE UNABLE TO PERFORM OR SCALE OUR CAPACITY SUFFICIENTLY AS DEMAND FOR OUR
SERVICES INCREASES, WE MAY LOSE CUSTOMERS WHICH WOULD BE DETRIMENTAL TO OUR
BUSINESS.
We cannot be certain that if we increase our customers we will be able to
correspondingly increase our personnel and to perform our application services
at satisfactory levels. Certain customer contracts contain cash penalty
provisions in the event that we do not perform our application services at
satisfactory levels and such penalty provisions will reduce our revenues and
harm our business. In addition, our application services may need to accommodate
an increasing volume of traffic. If we are not able to expand our internal
operations to accommodate such an increase in traffic, our customers' Internet
sites may in the future experience slower response times or outages. If we
cannot adequately handle a significant increase in customers or customers'
traffic, we may lose customers or fail to gain new ones, which may reduce our
revenues and harm our business.
IF WE DO NOT SUCCESSFULLY DEVELOP NEW PRODUCTS AND SERVICES TO RESPOND TO RAPID
MARKET CHANGES DUE TO CHANGING TECHNOLOGY AND EVOLVING INDUSTRY STANDARDS, OUR
BUSINESS WILL BE HARMED.
The market for our products and services is characterized by rapidly changing
technology, evolving industry standards, frequent new product and service
introductions and changes in customer demands. The recent growth of video on the
Internet and intense competition in our industry exacerbate these market
characteristics. Our future success will depend to a substantial degree on our
ability to offer products and services that incorporate leading technology, and
respond to technological advances and emerging industry standards and practices
on a timely and cost-effective basis. To succeed, we must anticipate and adapt
to customer requirements in an effective and timely manner, and offer products
and services that meet customer demands. 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 costs, which will hurt our
business.
24
The development of new or enhanced products and services is a complex and
uncertain process that requires the accurate anticipation of technological and
market trends. We may experience design, manufacturing, marketing and other
technological difficulties that could delay our ability to respond to
technological changes, evolving industry standards, competitive developments or
customer requirements. You should additionally be aware that:
o our technology or systems may become obsolete upon the introduction of
alternative technologies, such as products that better manage and
search video content;
o we could incur substantial costs if we need to modify our products and
services to respond to these alternative technologies;
o we may not have sufficient resources to develop or acquire new
technologies or to introduce new products or services capable of
competing with future technologies; and
o when introducing new or enhanced products or services, we may be
unable to manage effectively the transition from older products and
services and ensure that we can deliver products and services to meet
anticipated customer demand.
WE DEPEND ON TECHNOLOGY LICENSED TO US BY THIRD PARTIES, AND THE LOSS OF OR OUR
INABILITY TO MAINTAIN THESE LICENSES COULD RESULT IN INCREASED COSTS OR DELAY
SALES OF OUR PRODUCTS.
We license technology from third parties, including software that is
integrated with internally developed software and used in our products to
perform key functions. We anticipate that we will continue to license technology
from third parties in the future. This software 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 technology licenses could result in delays in the licensing of our
products until equivalent technology, if available, is developed or identified,
licensed and integrated. 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.
IF WE ARE UNABLE TO RETAIN OUR KEY PERSONNEL, OUR BUSINESS MAY BE HARMED.
Our future success depends to a significant extent on the continued services
of our senior management and other key personnel, and particularly Paul Lego,
our Chief Executive Officer. The loss of either this individual or other 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.
THE CURRENT WORLDWIDE SOCIO-POLITICAL ENVIRONMENT IS UNSTABLE AND SHOULD A MAJOR
CATASTROPHE OCCUR, OUR BUSINESS MAY BE HARMED.
The worldwide socio-political environment has changed dramatically since
September 11, 2001. Our customers, potential customers and vendors are located
worldwide and generally within major international metropolitan areas. For
example, we have a number of customers located in and around New York City and
their operations have been disrupted in many cases by the events of September
11. Should a major catastrophe occur within the vicinity of any of our
customers' and/or potential customers' and/or vendors' operations, our
operations may be adversely impacted and our business may be harmed.
25
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, London and Munich. We conduct our business in
leased space that is shared with other tenants and that contain ventilation
systems and postal operations. Our business also requires that certain
personnel, including our officers, travel in order to perform their jobs
appropriately. Should a major catastrophe occur nationally, internationally or
in specific cities where we conduct our operations our business could be harmed.
In addition, should a catastrophe occur related to any of our employees, our
business may be harmed.
OUR COMMON STOCK PRICE HAS DECLINED IN VALUE BELOW THE EXERCISE PRICE OF MANY
EMPLOYEE STOCK OPTIONS AND, AS A RESULT, WE MAY EXPERIENCE DIFFICULTIES
RETAINING EMPLOYEES.
Our common stock price has recently declined in value below the exercise
price of many stock options granted to employees pursuant to our stock option
plans. Thus, the intended benefit of the stock option, the creation of
performance and retention incentives, may not be realized. As a result, we may
lose employees whom we would prefer to retain which would harm our business. We
may be required to create additional performance and retention incentives in
order to retain these employees including the granting of additional stock
options to these employees at 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.
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.
We expect that we will need to hire additional personnel in all functional
areas in the foreseeable future. Competition for personnel throughout our
industry is intense. We may be unable to attract or assimilate other highly
qualified employees in the future. 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. Some
members of our existing management team have been employed at Virage for less
than one year. We may fail to attract and retain qualified personnel, which
could have a negative impact on our business.
FAILURE TO PROPERLY MANAGE OUR POTENTIAL GROWTH WOULD BE DETRIMENTAL TO OUR
BUSINESS.
Any growth in our operations will place a significant strain on our
resources. As part of this growth, we will have to implement new operational and
financial systems, procedures and controls to expand, train and manage our
employee base and to maintain close coordination among our technical,
accounting, finance, marketing, sales and editorial staffs. We will also need to
continue to attract, retain and integrate personnel in all aspects of our
operations. To the extent we acquire other businesses, we will also need to
integrate and assimilate new operations, technologies and personnel. Failure to
manage our growth effectively could hurt our business.
WE HAVE LEASES FOR OUR FACILITIES THAT EXPIRE ON VARIOUS DATES THROUGH 2006 THAT
WE MAY NOT BE ABLE TO FULLY UTILIZE AND THIS MAY CAUSE US TO INCUR LARGE,
ONE-TIME CHARGES FOR EXCESS CAPACITY.
Our principal administrative, research and development, sales, services and
marketing activities are conducted on two leased properties in San Mateo,
California: the first property consists of 21,000 square feet and expires in May
2002 and the second property consists of 48,000 square feet and 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 we perform research and development under a lease that
expires in June 2003 and a property near London, England where we perform sales,
services, marketing and administrative activities and that expires in February
2002.
26
During the six months ended September 30, 2001, we were able to sublease our
excess capacity at our facilities and received rental payments from these
tenants. These sublease agreements will expire during our current fiscal year
ended March 31, 2002, and we may not be successful in renewing our arrangements
with our current sublease tenants or finding new sublease tenants. If this
should occur, we would be required to record a one-time charge at the end of the
sublease agreement for a portion of the rental payments that we owe to our
landlord relating to any excess capacity that exists at our facilities. Such a
charge will harm our operating results and may cause our stock price to fall.
IF DEMAND FOR OUR APPLICATION SERVICES DECREASES, WE MAY NOT BE ABLE TO FULLY
UTILIZE OUR CAPACITY AND THIS MAY CAUSE US TO INCUR LARGE, ONE-TIME CHARGES FOR
EXCESS CAPACITY.
Our application services use significant capital equipment resources that
have been purchased to support our current customer requirements. Our
application services are new and unproven and revenues and related expenses are
difficult to forecast. Customers typically engage in contracts for our
application services for a period of six to twelve months and while some
customers renew their contracts, none have any obligation to do so. For example,
MLBAM accounted for greater than 5% of our revenues for the six months ended
September 30, 2001 has a contract that expires within our current fiscal year
ending March 31, 2002 with no obligation to renew. If we were to lose this
customer or other customers for our application services, we may have excess
capacity and be required to record a one-time charge for excess capital
equipment.
DEFECTS IN OUR SOFTWARE PRODUCTS COULD DIMINISH DEMAND FOR OUR PRODUCTS, WHICH
MAY CAUSE OUR STOCK PRICE TO FALL.
Our software products are complex and may contain errors that may be detected
at any point in the life of the product. 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, resulting in loss of revenues, delay
in market acceptance and sales, diversion of development resources, injury to
our reputation or increased service and warranty costs. If any of these were to
occur, our business would be adversely affected and our stock price could fall.
Because our products are generally used in systems with other vendors'
products, they must integrate successfully with these existing systems. System
errors, whether caused by our products or those of another vendor, could
adversely affect the market acceptance of our products, and any necessary
revisions could cause us to incur significant expenses.
WE COULD BE SUBJECT TO LIABILITY CLAIMS AND NEGATIVE PUBLICITY IF OUR CUSTOMERS'
SYSTEMS, INFORMATION OR VIDEO CONTENT IS DAMAGED THROUGH THE USE OF OUR PRODUCTS
OR OUR APPLICATION SERVICES.
If our customers' systems, information or video content is damaged by
software errors, product design defects or use of our application services, our
business may be harmed. In addition, these errors or defects may cause severe
customer service and public relations problems. Errors, bugs, viruses 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.
27
OTHERS MAY BRING INFRINGEMENT OR OTHER CLAIMS AGAINST US WHICH COULD BE TIME
CONSUMING AND EXPENSIVE FOR US TO DEFEND.
Other companies, including our competitors, may obtain patents or other
proprietary rights that would prevent, limit or interfere with our ability to
conduct our business. These companies could assert, and it may be found, that
our technologies infringe their proprietary rights. We could incur substantial
costs to defend any litigation, and intellectual property litigation could force
us to do one or more of the following:
o cease using key aspects of our technology that incorporate the
challenged intellectual property;
o obtain a license from the holder of the infringed intellectual
property right; and
o redesign some or all of our products.
From time to time, we have received notices claiming that our technology
infringes patents held by third parties. In the event any such a claim is
successful and we are unable to license the infringed technology on commercially
reasonable terms, our business and operating results would be significantly
harmed.
In addition, from time to time, we 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, we could incur
substantial costs to defend any litigation, which could harm our operations.
IF THE PROTECTION OF OUR INTELLECTUAL PROPERTY IS INADEQUATE, OUR COMPETITORS
MAY GAIN ACCESS TO OUR TECHNOLOGY, AND WE MAY LOSE CUSTOMERS.
We depend on our ability to develop and maintain the proprietary aspects of
our technology. We seek to protect our software, documentation and other written
materials under trade secret and copyright laws, which afford only limited
protection. Our proprietary rights may not prove viable or of value in the
future since the validity, enforceability and type of protection of proprietary
rights in Internet related industries are uncertain and still evolving.
Unauthorized parties may attempt to copy aspects of our products or to obtain
and use information that we regard as proprietary. Policing unauthorized use of
our products is difficult, and while we are unable to determine the extent to
which piracy of our software or code exists, software piracy can be expected to
be a persistent problem. We license our proprietary rights to third parties, and
these licensees may not abide by our compliance and quality control guidelines
or they may take actions that would materially adversely affect us. In addition,
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, and effective patent,
copyright, trademark and trade secret protection may not be available in these
foreign jurisdictions. To date, we have not sought patent protection of our
proprietary rights in any foreign jurisdiction. Our efforts to protect our
intellectual property rights through patent, copyright, trademark and trade
secret laws may not be effective to prevent misappropriation of our technology,
or may not prevent the development and design by others of products or
technologies similar to or competitive with those developed by us. Our failure
or inability to protect our proprietary rights could harm our business.
28
AS WE EXPAND OUR OPERATIONS INTERNATIONALLY, WE WILL FACE SIGNIFICANT RISKS IN
DOING BUSINESS IN FOREIGN COUNTRIES.
As we expand our operations internationally, we will be 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 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.
FAILURE TO INCREASE OUR BRAND AWARENESS AMONG CONTENT OWNERS COULD LIMIT OUR
ABILITY TO COMPETE EFFECTIVELY.
We believe that establishing and maintaining a strong brand name is important
to the success of our business. Competitive pressures may require us to increase
our expenses to promote our brand name, and the benefits associated with brand
creation may not outweigh the risks and costs associated with brand name
establishment. Our failure to develop a strong brand name or the incurrence of
excessive costs associated with establishing our brand name, may harm our
business.
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.
WE HAVE ADOPTED CERTAIN ANTI-TAKEOVER MEASURES THAT MAY MAKE IT MORE DIFFICULT
FOR A THIRD PARTY TO ACQUIRE US.
Our board of directors has the authority to issue up to 2,000,000 shares of
preferred stock and to determine the price, rights, preferences and privileges
of those shares without any further vote or action by the stockholders. The
rights of the holders of common stock will be subject to, and may be adversely
affected by, the rights of the holders of any preferred stock that may be issued
in the future. The issuance of shares of preferred stock, while potentially
providing desirable flexibility in connection with possible acquisitions and for
other corporate purposes, could have the effect of making it more difficult for
a third party to acquire a majority of our outstanding voting stock. We have no
present intention to issue shares of preferred stock. Further, on November 8,
2000, our board of directors adopted a preferred stock purchase rights plan
intended to guard against certain takeover tactics. The adoption of this plan
was not in response to any proposal to acquire us, and the board is not aware of
any such effort. The existence of this plan could also have the effect of making
it more difficult for a third party to acquire a majority of our outstanding
voting stock. In addition, certain provisions of our certificate of
incorporation may have the effect of delaying or preventing a change of control,
which could adversely affect the market price of our common stock.
29
RISKS RELATING TO THE INTERNET VIDEO INFRASTRUCTURE MARKETPLACE
COMPETITION AMONG INTERNET VIDEO INFRASTRUCTURE COMPANIES IS INTENSE. IF WE ARE
UNABLE TO COMPETE SUCCESSFULLY, OUR BUSINESS WILL FAIL.
Competition among Internet video infrastructure companies seeking to attract
new customers is intense and we expect this intensity of competition to increase
in the future. Our competitors vary in size and in the scope and breadth of the
products and services they offer and may have significantly greater financial,
technical and marketing resources. Our direct competition in the marketplace
comes primarily from Convera Corporation. We may also compete indirectly with
system integrators to the extent they may embed or integrate competing
technologies into their product offerings, and in the future we may compete with
video service providers and searchable video portals. In addition, we may
compete with our current and potential customers who may contemplate developing
software or performing application services internally. Increased competition
could result in price reductions, reduced margins or loss of market share, any
of which will cause our business to suffer.
IF BROADBAND TECHNOLOGY IS NOT ADOPTED OR DEPLOYED AS QUICKLY AS WE EXPECT,
DEMAND FOR OUR PRODUCTS AND SERVICES MAY NOT GROW AS QUICKLY AS ANTICIPATED.
Broadband technology such as digital subscriber lines, commonly referred to
as DSL, and cable modems, which allows video content to be transmitted over the
Internet more quickly than current technologies, has only recently been
developed and is just beginning to be deployed. The growth of our business
depends in part on the broad market acceptance of broadband technology. If the
market does not adopt broadband technology, or adopts it more slowly than we
anticipate, demand for our products and services may not grow as quickly as we
anticipate, which will harm our business.
We depend on the efforts of third parties to develop and provide the
technology for broadband transmission. Even if broadband access becomes widely
available, heavy use of the Internet may negatively impact the quality of media
delivered through broadband connections. If these third parties experience
delays or difficulties establishing the technology to support widespread
broadband transmission, or if heavy usage limits the broadband experience, the
market may not accept our products and services.
Because the anticipated growth of our business depends in part on broadband
transmission infrastructure, we are subject to a number of risks, including:
o changes in content delivery methods and protocols;
o the need for continued development by our customers of compelling
content that takes advantage of broadband access and helps drive
market acceptance of our products and services;
o the emergence of new competitors, including traditional broadcast and
cable television companies, which have significant control over access
to content, substantial resources and established relationships with
media providers;
o the development of relationships by our competitors with companies
that have significant access to or control over the broadband
transmission technology or content; and
o the need to establish new relationships with non-PC based providers of
broadband access, such as providers of television set-top boxes and
cable television.
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GOVERNMENT REGULATION OF THE INTERNET COULD LIMIT OUR GROWTH.
We are not currently subject to direct regulation by any government agency,
other than laws and regulations generally applicable to businesses, although
certain U.S. export controls and import controls of other countries may apply to
our products. While there are currently few laws or regulations that
specifically regulate communications or commerce on the Internet, due to the
increasing popularity and use of the Internet, it is possible that a number of
laws and regulations may be adopted in the U.S. and abroad in the near future
with particular applicability to the Internet. It is possible that governments
will enact legislation that may be applicable to us in areas such as content,
network security, access charges and retransmission activities. Moreover, the
applicability to the Internet of existing laws governing issues such as property
ownership, content, taxation, defamation and personal privacy is uncertain. The
adoption of new laws or the adaptation of existing laws to the Internet may
decrease the growth in the use of the Internet, which could in turn decrease the
demand for our services, increase the cost of doing business or otherwise hurt
our business.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Our market risk disclosures as set forth in our Annual Report on Form 10-K as
filed with the United States Securities and Exchange Commission have not changed
significantly.
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PART II: OTHER INFORMATION
Item 1. Legal Proceedings.
On August 22, 2001 and September 18, 2001, we and certain of our officers
were named as defendants in purported securities class-action lawsuits filed
in the United States District Court for the Southern District of New York
(the "Actions"). The first of the Actions is captioned Chin vs. Virage, Inc.,
et. al. and the second is captioned Bartula vs. Virage, Inc., et. al. The
Court has since consolidated the Actions, appointed a lead plaintiff and
approved lead plaintiffs' selection of lead counsel. Lead plaintiff has filed
a consolidated complaint ("Complaint") with the Court. The Complaint alleges
claims against us, certain of our officers, and/or Credit Suisse First Boston
("CSFB"), as lead underwriter and certain other underwriters (collectively,
"the underwriters") associated with our July 5, 2000 initial public offering,
under Sections 11 and 15 of the Securities Act of 1933, as amended. The
Complaint also alleges claims solely against the underwriters under Section
12(2) of the Securities Act of 1933 and Section 10(b) of the Securities
Exchange Act of 1934, as amended. We believe that the claims against us and
certain of our officers are without legal merit and intend to defend them
vigorously. Subsequently, all pending cases against all underwriters and
issuers were reassigned to Honorable Judge Shira Scheindlin, U.S. District
Court Judge, United States District Court for the Southern District of New
York. The time for defendants to move to dismiss the Complaint is presently
adjourned pending further instruction from Judge Scheindlin.
From time to time, we 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.
Item 2. Changes in Securities and Use of Proceeds
(d) Use of Proceeds.
On July 5, 2000, we completed a firm commitment underwritten initial
public offering of 3,500,000 shares of our common stock, at a price of
$11.00 per share. Concurrently with our initial public offering, we also
sold 1,696,391 shares of common stock in a private placement at a price
of $11.00 per share. On July 17, 2000, our underwriters exercised their
over-allotment option for 525,000 shares of our common stock at a price
of $11.00 per share. The shares of the common stock sold in the offering
and exercised via our underwriters' over-allotment option were
registered under the Securities Act of 1933, as amended, on a
Registration Statement on Form S-1 (File No. 333-96315). The Securities
and Exchange Commission declared the Registration Statement effective on
June 28, 2000. The public offering was underwritten by a syndicate of
underwriters led by Credit Suisse First Boston, FleetBoston Robertson
Stephens Inc. and Wit SoundView Corporation, as their representatives.
The initial public offering and private placement resulted in net
proceeds of $57,476,000, after deducting $3,099,000 in underwriting
discounts and commissions and $1,800,000 in costs and expenses related
to the offering. None of the costs and expenses related to the offering
or the private placement were paid directly or indirectly to any
director, officer, general partner of Virage or their associates,
persons owning 10 percent or more of any class of equity securities of
Virage or an affiliate of Virage. Proceeds from the offering and private
placement have been used for general corporate purposes, including
working capital and capital expenditures. The remaining net proceeds
have been invested in cash, cash equivalents and short-term investments.
The use of the proceeds from the offering and private placement does not
represent a material change in the use of proceeds described in our
prospectus.
Item 3. Defaults Upon Senior Securities
None.
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Item 4. Submission of Matters to a Vote of Security Holders
We held our Annual Meeting of Stockholders on September 5, 2001. The
following is a brief description of each matter voted upon at the
meeting and the number of votes cast for, withheld, or against and the
number of abstentions with respect to each matter. Each director
proposed by us was elected and the stockholders also approved the
management proposal we proposed.
(a) The stockholders reelected the nominees for our Board of Directors:
Director Shares voted for Shares withheld
-------- ---------------- ---------------
Paul G. Lego 12,356,019 405,302
Alar E. Arras 12,732,623 28,698
Ronald E.F. Codd 12,732,623 28,698
(b) The stockholders approved the appointment of Ernst & Young LLP as
our independent auditors for the fiscal year ending March 31, 2002:
Shares voted for: 12,730,640
Shares voted against: 16,664
Shares abstaining: 14,017
Item 5. Other Information
None.
Item 6. Exhibits and Report on Form 8-K.
(b) Reports on Form 8-K
None.
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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
VIRAGE, INC.
Date: November 9, 2001 By: /s/ Alfred J. Castino
------------------------------
Alfred J. Castino
Vice President, Finance and
Chief Financial Officer
(Duly Authorized Officer and
Principal Financial Officer)
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