UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
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[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
FOR THE FISCAL YEAR ENDED MARCH 31, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
COMMISSION FILE NUMBER: 0-30903
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VIRAGE, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 38-3171505
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
411 BOREL AVENUE, 100 SOUTH
SAN MATEO, CALIFORNIA 94402-3116
(650) 573-3210
(Address, including zip code, and telephone number, including area code, of the
registrant's principal executive offices)
------------------------
Securities Registered Pursuant to Section 12(b) of the Act: None
Securities Registered Pursuant to Section 12(g) of the Act:
Common Stock, $0.001 par value
(Title of Class)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. [ X ] Yes [ ] No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
As of June 12, 2002, there were approximately 20,754,000 shares of the
registrant's Common Stock outstanding. The aggregate market value of the voting
stock held by non-affiliates of the registrant, based on the closing sale price
of the Common Stock on June 12, 2002 as reported on the Nasdaq National Market
was approximately $13,369,000. Shares of Common Stock held by each current
executive officer and director have been excluded from this computation in that
such persons may be deemed to be affiliates of the Company. This determination
of affiliate status is not a conclusive determination for other purposes.
Documents Incorporated by Reference
Portions of the registrant's Proxy Statement for the registrant's 2002 Annual
Meeting of Stockholders are incorporated by reference into Part III of this Form
10-K to the extent stated herein. The Proxy Statement will be filed within 120
days of registrant's fiscal year ended March 31, 2002.
VIRAGE, INC.
INDEX
PAGE
PART I
Item 1. Business.............................................................................................3
Item 2. Properties..........................................................................................25
Item 3. Legal Proceedings...................................................................................26
Item 4. Submission of Matters to a Vote of Security Holders.................................................27
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters...............................29
Item 6. Selected Consolidated Financial Data................................................................30
Item 7. Management's Discussion and Analysis of Financial Condition and Results of
Operations.....................................................................................31
Item 7A. Quantitative and Qualitative Disclosures About Market Risk..........................................42
Item 8. Financial Statements and Supplementary Data.........................................................43
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial
Disclosure.....................................................................................69
PART III
Item 10. Directors and Executive Officers of the Registrant..................................................69
Item 11. Executive Compensation..............................................................................69
Item 12. Security Ownership of Certain Beneficial Owners and Management......................................69
Item 13. Certain Relationships and Related Transactions......................................................69
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.....................................70
Signatures..........................................................................................71
2
PART I
This annual report on Form 10-K contains forward-looking statements within
the meaning of Section 27A of the Securities Act of 1933 (the "Securities Act"),
as amended, and Section 21E of the Securities Exchange Act of 1934, as amended
(the "Exchange Act"), including statements using terminology such as "can,"
"may," "believe," "designed to," "will," "expect," "plan," "anticipate,"
"estimate," "potential," or "continue," or the negative thereof or other
comparable terminology regarding beliefs, plans, expectations or intentions
regarding the future. Forward-looking statements involve risks and uncertainties
and actual results could differ materially from those discussed in the
forward-looking statements. All forward-looking statements and risk factors
included in this document are made as of the date hereof, based on information
available to the Company as of the date thereof, and the Company assumes no
obligation to update any forward-looking statement or risk factors.
Item 1. Business
Overview
Virage, Inc. is a provider of software products, professional services and
application services that enable owners of rich-media and video assets to more
effectively communicate, manage, retrieve and distribute these rich-media assets
for improved productivity and communication.
Our primary software products are a part of our Video Application Platform
that provides the necessary infrastructure for seamlessly integrating
Internet-ready video into an internal or external website. The Virage Video
Application Platform includes our SmartEncode(TM) products, which encode and
index video within a single automated process, and our server products, which
enable the publishing and distribution of streaming video.
During our fiscal year ended March 31, 2002, we also introduced the
following new software products designed to further our presence in the media
and entertainment, corporate, educational and government marketplaces: VS
Webcasting(TM), which allows corporations to schedule and manage live webcast
events and then easily turn each into a searchable on-demand event; VS
Production(TM), an integrated software solution that automates a customer's
video production process from acquisition to distribution; VS Publishing(TM), a
complete workflow solution that allows media and entertainment companies to turn
their content into compelling rich media programming for the Internet; and VS
Learning(TM) which allows global corporations to use video and other rich media
to build and deliver personalized, on-demand e-learning courses for use in sales
training, product launches, human resources and other professional development.
Owners of rich-media content can leverage our technology and know-how
either by licensing our products and engaging our professional services or by
employing our application services to outsource their needs.
We are based in San Mateo, California. We were founded in April 1994 and
incorporated in Delaware in March 1995. In this report, "Virage," "the Company,"
"our," "us," "we" and similar expressions refer to Virage, Inc. Our principal
executive offices are located at 411 Borel Avenue, 100 South, San Mateo,
California 94402 and our telephone number is (650) 573-3210.
3
Business Background and Strategy
The majority of our revenues are derived from our Video Application
Platform, which is designed to meet the needs of users who have video and
rich-media assets and need to publish, manage and distribute these assets over
the Internet and/or their intranets. These users typically have some in-house
video expertise or are willing to invest in consulting or other resources in
order to use our platform as part of a video and rich-media solution. Revenues
from media and entertainment companies have comprised a substantial portion of
our total revenues followed by revenues from corporate enterprises, government
agencies and educational institutions. We expect that a significant portion of
our revenues will continue to be derived from our SmartEncode and server
products. However, in order to expand the market for our technology and
expertise beyond that for our SmartEncode and server products, we recently have
developed products that work "out-of-the-box" for a specific video or rich-media
application, such as training, communications, video production, or internet
publishing. Our development efforts for these applications focus on functions,
features, and intuitive user interfaces that allow those with little or no video
expertise to implement the intended application quickly and easily. We believe
that successful development and marketing of such application products is
critical to our ability to grow our future sales to a level required for
profitability. There is no guarantee that such new product areas will succeed in
the marketplace. If these new application products do not succeed, we may not be
able to develop a profitable and sustainable business.
We introduced these new application products during the year ended March
31, 2002 which together are designed to further our enterprise strategy and to
provide enhanced solutions to our media and entertainment customers and
corporate enterprise customers. These products include VS Webcasting, VS
Production, VS Publishing and VS Learning. With the exception of VS Production,
we offer our customers the option of running any of these solutions by
leveraging our application services. We believe these offerings are an
important, lower-cost, easily deployable alternative to demonstrate the
functionality and value that our technology and services brings to the customer.
We also believe that these service offerings will help us engage our customers
in longer-term application services contracts for these solutions or in a
comprehensive end-to-end software solution sale.
Our new application products are marketed directly to users such as
executives and managers in sales, marketing, and training positions, in addition
to information technology executives. For example, we can market our VS
Webcasting product to sales executives to assist with new product introductions
and sales force training. The VS Webcasting product can be used for a live event
transmission to a widely distributed field sales force, and also provides an
on-demand playback capability for later viewing or review. An investment in VS
Webcasting can thus save travel time and costs, and allow a sales representative
to review materials or topics of interest whenever he or she needs more
information. We market and sell this product by demonstrating both cost savings
and productivity increases for the users, thus establishing a quantifiable
return on investment.
We are actively marketing our recently introduced application products and
services to new enterprise accounts as well as to our installed base of
enterprise customers that have licensed products from our Video Application
Platform. We have focused our sales force on establishing new relationships and
developing existing relationships by offering entry-level pilots in order to
demonstrate the value proposition that our application products offer. In
addition, we are working with strategic channel partners such as Sony, IBM, and
Sumitomo to extend our sales reach beyond our own sales force.
Products and Services
We are a provider of software products, professional services and
application services that enable owners of rich-media and video assets to more
effectively communicate manage, retrieve and distribute these rich-media assets
for improved productivity and communication.
4
SMARTENCODE AND INDEXING PRODUCTS
VideoLogger(R) and Media Analysis Plug-ins
With a single real-time anlaysis of the video content, our VideoLogger
application generates a rich information index and simultaneously encodes the
video into the selected digital formats. The video index and digital video files
are time synchronized, allowing the index data to reference particular moments
in the video. The indexing process converts video into data that computers can
recognize. The index, or video database, acts like an index found at the back of
a book, allowing pinpoint access into video content. Indexing information can be
derived from automated analysis of the video stream, from external sources of
time-coded data, or from information entered by a user. Our customers can elect
to leverage our media analysis plug-ins in order to automatically extract
information such as a visual storyboard of scene changes, a transcription of
spoken words (via speech recognition), audio classification, closed captioning
or teletext, names of recognized faces and speakers, on-screen text, and time
code. External sources of data could include an "edit decision list" from
non-linear video editing software, a transcript of words spoken, or a real-time
statistics feed from a sports stadium. User entered information can include clip
titles, clip descriptions, categories, clip in and out points, event dates, and
other custom descriptions. The VideoLogger interface allows a customer to
monitor video capture and indexing, control multiple encoders, and create clips
on the fly. Once the index is produced, it can be integrated with a number of
different back-end solutions, including the Virage Solution Server. The Virage
SmartEncode process is available either through the latest release of the Virage
VideoLogger product or in an outsourced fashion through our application
services.
Customers or third-party developers can enhance the SmartEncode process
through the VideoLogger Software Developer Kit (SDK). The VideoLogger SDK
provides developers and systems integrators access to the full range of
VideoLogger functions through a programming interface. This enables reliable
integration into a wide variety of automated workflows and allows developers to
add additional indexing and encoding functionality to VideoLogger as necessary.
Virage ControlCenter(TM)
The Virage ControlCenter product is a powerful workflow application that
remotely schedules, controls, and manages the SmartEncode process for multiple
VideoLoggers from a central console. Capture of the source video signal is the
starting point. Virage software can accept video from a multitude of analog or
digital sources: camera, satellite feed, television, videotape, or digital file.
Capture of multiple video feeds can be automated and managed centrally via
ControlCenter for greater efficiency. For outsourcing needs, Virage production
facilities in the United States and Europe can capture content from a range of
professional and consumer satellites and fiber networks, and from all major tape
formats.
MediaSync(TM)
Our MediaSync product provides a fully integrated, end-to-end solution for
rapidly assembling, synchronizing and publishing streaming video with PowerPoint
slides to a website.
Database Plug-Ins
Virage Database Plug-Ins for Oracle(R) and Informix(R) products help system
integrators build sophisticated video management solutions with the Virage
VideoLogger and relational databases.
5
SERVER PRODUCTS
Virage Solution Server(TM)
The powerful XML-based Virage Solution Server provides a comprehensive
platform for publishing, managing and distributing Virage-enabled content on the
web. The Virage Solution Server hosts the video index generated by the
SmartEncode process. It is designed for high performance and can scale to
enterprise-wide and Internet-wide deployments. The Virage Solution Server
content management capabilities include account setup, deleting or inserting
video assets from the databases, editing existing video assets, and managing
multiple video collections.
The Virage Solution Server is used to publish and distribute content to
video-rich websites. With the Virage Solution Server, a customer can efficiently
publish on-demand video throughout a website, seamlessly integrated with the
existing website look and feel. Sample web templates provide an easy
"out-of-the-box" experience, or customers can develop their own HTML templates
to create search and results pages and player windows tailored to their specific
needs. The Virage Solution Server supports all common streaming formats
including RealVideo, Windows Media, QuickTime, and MPEG. It can also extend the
viewing experience beyond the PC-based Internet to set top boxes, game consoles
and handheld and wireless devices.
Key features of the Virage Solution Server include:
o Search: with Virage Solution Server, content owners can deliver video
content to end-users through well-understood navigation paradigms.
This allows users to quickly find the content of interest;
o Dynamic Publishing: Virage Solution Server can automate the process of
delivering video clips throughout a web site. Content can be
automatically published based on its category or keywords.
o Reporting: daily, weekly and monthly traffic reports provide content
owners with Nielsen-type ratings for published content, with
information on most popular search terms, most accessed clips and best
traffic drivers;
o Content Distribution Network Management: because many content owners
use multiple content distribution networks (CDNs), the Virage Solution
Server provides an abstraction layer to simplify content distribution;
o Personalization: Virage Solution Server provides a range of
capabilities that allow content owners to deploy personalized viewing
experiences;
o Syndication: Because Virage Solution Server separates the content
database from the HTML templates, it allows a single content
collection to be syndicated to multiple sites, each with a unique look
& feel.
Virage Solution Server SDK
The Virage Solution Server Software Developer Kit (SDK) allows developers
and systems integrators to build custom applications on the Virage Solution
Server to suit any publishing environment.
APPLICATION PRODUCTS
VS Webcasting
VS Webcasting allows corporations to schedule and manage live webcast
events--and then turn each quickly and easily into a searchable on-demand event.
VS Webcasting enriches the live experience by integrating streaming video with
slides, documents, surveys and other pertinent online media. At the same time,
it automatically creates a searchable, on-demand presentation that can be
available for review within minutes after an event's conclusion.
6
VS Production
VS Production is an integrated software solution that automates the
professional video production process from acquisition to distribution. By
transforming video into a digital asset that is easy to manage, access, share
and distribute, VS Production helps content owners streamline the process of
producing high-quality video content for on-air, tape or digital distribution.
Built on our award-winning, open platform, VS Production is scalable, reliable
and can integrate into any IT infrastructure.
VS Publishing
VS Publishing is a complete workflow solution that allows media and
entertainment companies to turn their content into compelling rich media
programming for the Internet. With VS Publishing, video can be processed,
assembled, reviewed and published minutes after its creation. Whether content
comes from an archive or direct from on-air production, VS Publishing
streamlines the workflow to the Internet and lets content owners deliver video
where and when it is most valuable to their viewers.
VS Learning
VS Learning provides rich media training and e-learning solutions that
bring subject matter experts face to face with learners anywhere and anytime.
Content authors can assemble video-based training courses quickly and easily
from anywhere in the world. Using VS Learning, global corporations can use video
and other rich media to build and deliver personalized, on-demand e-learning
courses for use in sales training, product launches, human resources and other
professional development. Learners can get pinpoint access to mission-critical
training material--either online or on a CD.
SERVICE OFFERINGS
Software installation and training
License software customers have the option to contract with Virage for
software installation and training support. These services ensure that customers
can get up and running successfully with Virage software as quickly as possible.
These services are typically billed on an hourly or daily basis.
Development and implementation services
Virage offers a variety of professional services aimed at helping customers
to implement, integrate or customize our commercial software. The services
typically consist of implementing our SmartEncode products in a unique
production environment or building specialized plug-ins to our products. We can
also build custom web templates for Virage Solution Server installations and
help with website integration. We offer these services to customers regardless
of whether they license software products, or opt for our application services.
These services are typically billed on an hourly or daily basis, though in some
cases we offer a fixed fee project based upon the size of the project.
SmartEncode services
Instead of purchasing our SmartEncode products, customers can instead
outsource their video processing needs to us. Using our own SmartEncode
products, we process content from a variety of analog or digital sources and
produce multiple formats and bit rates of high quality encoded video along with
a rich video database. Our editorial services include custom headlines,
descriptions, keywords, and other useful information added by our expert content
editors to suit a customer's requirements. We also can transcribe content to
produce an exact text of the speech. We typically bill for such services as a
charge per hour or charge per minute of video processed depending upon the level
of services required. These services are provided out of our production
facilities in the United States and Europe.
7
Application hosting services
Instead of purchasing our server products, customers can instead choose to
have us host the Virage Solution Server and related applications on their
behalf. We host the video information, also known as metadata, and surrounding
application logic while one of our content distribution partners typically hosts
the streaming video files. We provide daily, weekly, and monthly traffic reports
to the content owner. We also provide a secure administration and publishing
interface that provides our customers complete control of how and where their
content gets published. We typically charge a fixed monthly minimum charge for
our application hosting services that increases based upon accesses to our video
database. Our data center provides fault-tolerant servers and 24-by-7 monitoring
to ensure reliable and scalable hosting.
Sales and Marketing
Sales and distribution strategy
We sell our products and application services through a direct sales force
and through indirect distribution channels. We currently target customers in
several markets including media and entertainment companies, corporate
enterprises, government entities and universities. Our sales strategy is to
pursue multiple opportunities for large-scale deployments within each customer
account. We also recently broadened our sales strategies to address common
business user problems in multiple areas of an enterprise. We want to provide
business users with a quick, reliable and scalable solution to their problems
and afford them a definitive return on their investment.
Through our direct sales force in Boston, Chicago, London, Los Angeles,
Miami, New York, San Francisco, Singapore, Atlanta, Houston, and Washington
D.C., we focus on larger customers in North America, Europe, Latin America, and
Asia. Our field representatives sell our products and services to customers who
have been qualified by our telesales personnel. In addition, our direct sales
force manages local relationships with key resellers. Our indirect distribution
channels include major high-technology industry vendors, domestic and
international distributors, system integrators and value-added resellers.
Together, these distributors and value-added resellers accounted for
approximately 31% of total revenues for the year ended March 31, 2002.
Our historically largest reseller recently announced that it is divesting
its business segment in which our products are most complementary. As a result,
we encountered very little channel sales activity from this reseller during the
final fiscal quarter of our fiscal year ended March 31, 2002, particularly in
Europe and Latin America. We believe this factor contributed to our quarterly
decline in total revenues during the fourth fiscal quarter of our fiscal year
ended March 31, 2002. As a result of this channel partner loss, or if we were to
lose one of our channel partners or any of our large channel partners were to
delay or default on obligations under their contracts with us, our future
operating results could be significantly harmed.
Marketing activities
Since our inception, we have invested a substantial percentage of our
revenues in a broad range of marketing activities to generate demand, gain
corporate brand identity and educate the market about our products and services.
These activities have focused primarily on direct marketing, direct mail and
email, seminars, public relations, co-marketing and branding with our major
customer accounts and strategic partners, targeted trade shows, conferences,
speaking engagements, and product information through print collateral and our
Internet site. In addition, we have an established developer relationship
function to encourage independent software developers to develop products and
solutions that are compatible with our products and technologies. Recently, we
have decided to focus a large percentage of our marketing program spending on
webinars, seminars presented over the Internet utilizing our own VS Webcasting
and VS Learning products. We have significantly reduced our spending budgets for
trade shows and public relations in order to fund an increased investment in
these webinars. Should our new focus on webinars fail to attract new customers,
our revenues may be impacted.
8
Customers
Our customers represent large media and entertainment corporations, other
global corporations, educational institutions and government entities. For the
year ended March 31, 2002, one customer accounted for 14% of our total revenues.
No customer accounted for more than 10% of our total revenues for the year ended
March 31, 2001. For the year ended March 31, 2000, two customers accounted for
13% and 10% of our total revenues, respectively.
During the fourth fiscal quarter of our fiscal year ended March 31, 2002,
we completed our application services contract with our largest customer for the
fiscal year ended March 31, 2002. We were unable to reach mutually agreeable
terms for a renewal with this customer and this customer had no obligation to
renew its contract with us. In addition, our historically largest reseller
announced that it is divesting its business segment in which our products are
most complementary. As a result, we encountered very little channel sales
activity from this reseller during the fourth fiscal quarter of our fiscal year
ended March 31, 2002. We believe these two factors contributed to our quarterly
decline in total revenues during the final fiscal quarter of our fiscal year
ended March 31, 2002. As a result of this significant customer loss and channel
partner loss, our future operating results could be significantly harmed. In
addition, if we were to lose one of our other large customers or any of our
large customers were to delay or default on obligations under their contracts
with us, our future operating results could be significantly harmed.
Research and Development
We believe that our future success will depend in part on our ability to
continue to develop new and to enhance existing products and services.
Accordingly, we invest a significant amount of our resources in research and
product development activities. Our research and development expenses totaled
$9,172,000, $9,101,000 and $4,182,000 for the years ended March 31, 2002, 2001
and 2000 respectively. Our recent focus on application product development has
increased the complexity and difficulty of our product development efforts. In
particular, we now have several small application product development teams who
must coordinate their efforts with each other and with the base Video
Application Platform development teams. We have recently hired an R&D executive
and development managers who we believe have stronger experience in managing
such parallel team efforts. Our ability to successfully manage product
development in a more complex environment will be critical to our ability to
execute our product plans and grow our revenues.
Competition
The Internet video and rich-media marketplace is new, rapidly evolving and
intensely competitive. As more companies begin to deploy searchable and
interactive video on the Internet, we expect competition to intensify. We
currently compete directly with other providers in the Internet video
infrastructure and services marketplace including Convera Corporation, Inktomi
Corporation, Sonic Foundry, Inc. and Yahoo! Broadcast Solutions. We may also
compete indirectly with larger system integrators who embed or integrate these
directly competing technologies into their product offerings. It is possible
that we may work with these same larger companies on one customer bid and
compete with them on another. In the future, we may compete with other video
services vendors and searchable video portals. In addition, we may compete with
our current and potential customers who may develop software or perform
application services internally.
9
We believe that the principal competitive factors in our market are:
o video indexing management functionality;
o services experience and expertise;
o demonstrated video technology expertise;
o customer references;
o company reputation;
o ease of installation and use;
o real-time processing capability;
o software reliability and stability;
o scalability;
o pricing;
o customer support; and
o adoption by other customers
We believe we compete favorably with our competitors based on these
factors. However, the market for our products is relatively small today, and
therefore continued success against competitors does not guarantee that we can
grow our business to profitable levels. Our ability to become a profitable and
sustainable business is very dependent on the growth of the Internet and
intranet streaming video business.
Intellectual Property
We depend on our ability to develop and maintain the proprietary aspects of
our technology. To protect our proprietary technology, we rely primarily on a
combination of patent, trademark and copyright laws, as well as confidentiality
and license agreements with our employees and others. We actively seek patent
protection for our intellectual property. We have filed 20 U.S. patent
applications on our proprietary technology. Seven patents have been issued by
the Patent and Trademark Office. Our remaining thirteen patent applications are
currently pending. In 1997, we entered into a five-year patent cross-licensing
agreement with IBM, which we renewed in 2002. The terms of this agreement
include our nonexclusive license of IBM's multimedia software patents in return
for an annual fee and a license to IBM of all of our current patents as
described above and any patents that may be issued to us in the future.
We have twenty trademarks, four of which are registered. We seek to avoid
disclosure of our trade secrets by limiting access to our proprietary technology
and restricting access to our source code. Despite these precautions, it may be
possible for unauthorized third parties to copy particular portions of our
technology or reverse engineer or obtain and use information that we regard as
proprietary. In addition, the laws of some foreign countries do not protect
proprietary rights to the same extent as the laws of the United States. Our
means of protecting our proprietary rights in the United States or abroad may
not be adequate and competing companies may independently develop similar
technology.
Employees
As of March 31, 2002, we had 157 employees and 3 full-time contractors. Of
our 160 total staff, 28 were employed in services, 45 were employed in
engineering, 57 were employed in sales and marketing, and 30 were employed in
general and administrative positions. None of our employees is subject to a
collective bargaining agreement, and we have never experienced a work stoppage.
We consider our relations with our employees to be good.
10
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 are based upon the best
information we have available, but 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 and our visibility for even the current quarter
is rather limited. In order to provide a revenue forecast for the current
quarter, we must make assumptions about conversion of 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 such
as the strength of information technology investment. 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 example, during our fiscal fourth quarter ended March 31,
2002, our total revenues were significantly lower than the total revenues that
we forecast and publicly provided to investors and all other parties in January
2002.
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, severance for
involuntary reductions in headcount should we determine cost cutting measures
are necessary subsequent to our publicly provided guidance, write-downs of
equipment and/or facilities in the event of unforeseen excess capacity, legal
claims, employee turnover, additional royalty expenses should we lose a source
of current technology, losses of key management personnel, unknown defects in
our products, and other factors we cannot foresee.
We have allocated significant product development, sales and marketing resources
toward the deployment of our new application products and we face a number of
risks that may impede market acceptance of these products and therefore hurt our
financial results.
We have invested significant resources into developing and marketing our
recently introduced application products. We believe that these application
products broaden the value proposition to that of the day-to-day business
software application user and expect to derive future revenues as a result of
these product introductions. The market for these products is in a relatively
early stage. We cannot predict how the market for our applications will develop,
and part of our strategic challenge will be to convince enterprise customers of
the productivity, communications, cost and other benefits of our application
products. Our future revenues and revenue growth rates will depend in large part
on our success in creating market acceptance for these products. If we fail to
do so, our products and services will not achieve widespread market acceptance,
and we may not generate significant revenues to offset our development, sales
and marketing costs, which will hurt our business.
11
In addition, resources may be required to fund development of our
application products' feature-sets beyond what we have planned due to
unanticipated marketplace demands. We may determine that we are unable to fund
these additional feature-sets due to financial constraints and may halt the
development of a product at a stage that the marketplace perceives as immature.
We may also encounter that the marketplace for an application product is not as
robust as we had expected and we may react to this by leaving the development of
a product at an early stage. Either of these product development scenarios may
impede market acceptance of any of our new application products and therefore
hurt our financial results.
Because we have only recently introduced our video software products,
application services and professional services, and because we have just
introduced our new application products, we face a number of risks that 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, our professional services in March 2001 and
our application products during the second half of our fiscal year ended March
31, 2002. Because we have a limited operating history with our video software
products, application services, professional services and application products
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 video products and application 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.
Our business model is unproven and may fail, which may significantly decrease
the market price of our common stock.
We do not know whether our business model and strategy will be successful.
Our business model is based on the premise that content providers and other
entities will use our licensed products, professional services and application
services to catalog, manage, and distribute 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. In addition, we recently
introduced our application products and believe these solutions products broaden
the value proposition of our technology to business software application users
within media and entertainment enterprises, global corporations, educational
institutions and government entities. If the assumptions underlying our business
model are not valid or if we are unable to implement our business plan, our
business will suffer.
The average size of our customer orders has been between $40,000 and $60,000
over the past several quarters. Our sales and marketing costs are a high
percentage of the revenues from our orders, due partly to the expense of
developing leads and relatively long sales cycles involved in selling products
that are not yet considered "mainstream" technology investments. For the year
ended March 31, 2002, our sales and marketing expenses totaled 103% of our total
revenues. We also have recently introduced our new applications products in
hopes of increasing both our revenues and average size of our customers' orders
and these products have pricing models based upon a number of assumptions about
the market for our products. If our assumptions are incorrect or our pricing
does not work as intended, we may not be able to increase the average size of
our customer orders or reduce the costs of selling and marketing for our
products and, therefore, we may not be able to develop a profitable and
sustainable business.
12
We have not been profitable and if we do not achieve profitability, our business
may fail. If we need additional financing we may not obtain the required
financing on favorable terms and conditions.
We have experienced operating losses in each quarterly and annual period
since we were formed and we expect to incur significant losses in the future. As
of March 31, 2002, we had an accumulated deficit of $88,924,000. We may 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 $30,694,000 as of March 31, 2002 and we used
$17,871,000 in our operating activities during the year ended March 31, 2002. We
anticipate that our operating activities will use additional cash resources for
at least the next 12 months. This almost certainly will leave us with a
deteriorated cash position in comparison to our cash position as of March 31,
2002 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. The current business environment is not conducive to
raising additional financing. If we require additional financing, the terms of
such financing may heavily dilute the ownership interests of current investors,
and cause our stock price to fall significantly or we may not be able to secure
financing upon acceptable terms at all. Accordingly, our stock price is heavily
dependent upon our ability to grow our revenues and manage our costs in order to
preserve cash resources.
Our restructuring efforts may not result in the intended benefits.
During our year ended March 31, 2002, we took steps to better align the
resources required to operate efficiently in the prevailing market. Through
these steps, we reduced our headcount and are attempting to sublease our excess
facility capacity. While we believe that these steps help us achieve greater
operating efficiency, we have no prior history with such measures and the
results of these measures are less than predictable. These measures could
adversely affect our employees that we wish to retain, customers and/or vendors,
which could harm our ability to operate as intended and which would harm our
business.
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. Our operating results have in
past quarters fallen below securities analyst expectations and will likely fall
below their expectations in some future quarter or quarters. 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, 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 competitive threats in our markets which we may need
to address with additional sales and marketing expenses, severance for
involuntary reductions in headcount should we determine cost cutting measures
are necessary subsequent to our publicly provided guidance, write-downs of
equipment and/or facilities in the event of unforeseen excess capacity, legal
claims, employee turnover, additional royalty expenses should we lose a source
of current technology, losses of key management personnel, unknown defects in
our products, and other factors we cannot foresee. In addition, many
expenditures are planned or committed in advance in anticipation of future
revenues, and if our revenues in a particular quarter are lower than we
anticipate, we may be unable to reduce spending in that quarter. As a result,
any shortfall in revenues or a failure to improve gross profit margin would
likely hurt our quarterly operating results.
For our upcoming fiscal year, we plan to invest significantly in developing,
marketing, and selling our new application products. If we are not able to
achieve significant revenue growth from these products, we may not be able to
meet analyst expectations and our stock price may drop significantly.
13
Future sales of stock could affect our stock price.
If our stockholders sell substantial amounts of our common stock, including
shares issued upon the exercise of outstanding options and in connection with
acquisitions, the market price of our common stock could fall. These sales also
might make it more difficult for us to sell equity or equity-related securities
in the future at a time and price that we deem appropriate.
Failure to comply with NASDAQ's listing standards could result in our delisting
by NASDAQ from the NASDAQ national market and severely limit the ability to sell
any of our common stock.
Our stock is currently traded on the NASDAQ National Market. Under NASDAQ's
listing maintenance standards, if the closing bid price of our common stock is
under $1.00 per share for 30 consecutive trading days, NASDAQ may choose to
notify us that it may delist our common stock from the NASDAQ National Market.
If the closing bid price of our common stock does not thereafter regain
compliance for a minimum of 10 consecutive trading days during the 90 days
following notification by NASDAQ, NASDAQ may delist our common stock from
trading on the NASDAQ National Market. There can be no assurance that our common
stock will remain eligible for trading on the NASDAQ National Market. If our
stock were delisted, the ability of our stockholders to sell any of our common
stock at all would be severely, if not completely, limited.
Our revenues may be harmed if general economic conditions do not improve.
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 and business unit 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.
Our service revenues and recently introduced VS Production solution product have
substantially lower gross profit margins than our license revenues, and an
increase in service revenues or the VS Production solution products 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 54%, 45% and 20% of our total revenues for the years ended
March 31, 2002, 2001 and 2000, respectively. In addition, our recently
introduced VS Production solution may contain a hardware element that is
developed, manufactured and marketed by a third-party partner and bundled with
our software and resold by us. Our service revenues have substantially lower
gross profit margins than our license revenues and we expect that our VS
Production solution may also have substantially lower gross profit margins than
our license revenues. Our cost of service revenues for the years ended March 31,
2002, 2001 and 2000 were 95%, 144% and 218%, respectively, of our service
revenues. An increase in the percentage of total revenues represented by service
revenues and/or our VS Production solution could adversely affect our overall
gross profit margins.
14
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. Our application services require a relatively fixed level of
investment in staff, facilities and equipment. We typically have operated our
application service business at a loss due to fixed investments that exceeded
actual levels of revenues realized. We have reduced the application service
fixed investments over the past year. However, there is no assurance that the
level of application service revenues in the new fiscal year will allow us to
recover our fixed costs and make a positive gross profit margin. In addition, we
have experienced 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 revenues from the licensing of our
software products as the implementation services are performed or based upon the
completed contract method. 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.
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 decreased during the three
months ended September 30, 2001 in comparison to the three months ended June 30,
2001 as a result of reduced revenues from a large application services customer.
This application services customer accounted for approximately 14% of our total
revenues during the year ended March 31, 2002. However, our revenue recognition
policies precluded us from recognizing revenues from this customer in certain
quarters as we did not receive certain payments from this customer that were due
to us. As a result, this customer accounted for 16% of our total revenues during
the three months ended June 30, 2001, less than 5% of our total revenues in the
three months ended September 30, 2001, and 30% of our total revenues in the
three months ended December 31, 2001 (the fiscal quarter in which we received
significant payments from the customer for past services performed in the June
2001 and September 2001 quarters).
15
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.
In addition, we recently introduced our new application products that are
aimed toward a broadened business user base within our key markets. We are
inexperienced with our sales cycle for these new application products to these
users and we cannot predict how the market for our application products will
develop, and part of our strategic challenge will be to convince these users of
the productivity, communications, cost and other benefits of our application
products. Accordingly, it is likely that delays in our sales cycles with these
application products will occur and this could cause significant variations in
our operating results.
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.
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.
16
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.
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 some of our application
services is partly 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 consumer-oriented
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.
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 and revenues from media and entertainment companies have
comprised a substantial portion of our total revenues followed by revenues from
corporate enterprises, government agencies and educational institutions. During
the fourth fiscal quarter of our fiscal year ended March 31, 2002, we completed
our application services contract with our largest customer (a media and
entertainment customer) for the fiscal year ended March 31, 2002. We were unable
to reach mutually agreeable terms for a renewal with this former customer. In
addition, our historically largest reseller (that generally re-sold our products
to media and entertainment enterprises) announced that it is divesting its
business segment in which our products are most complementary. As a result, we
encountered very little channel sales activity from this reseller during the
fourth fiscal quarter of our fiscal year ended March 31, 2002. We believe these
two factors contributed to our quarterly decline in total revenues during the
fourth fiscal quarter of our fiscal year ended March 31, 2002. As a result of
this significant customer loss and channel partner loss, our future operating
results could be significantly harmed. In addition, if we were to lose one of
our other large customers or any of our large customers were to delay or default
on obligations under their contracts with us, our future 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.
17
Our failure to protect our network against damage from any of these events
will hurt our business.
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 and at Palo Alto
Internet Exchange in Palo Alto, CA. 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.
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. Intense competition in
our industry may 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.
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.
18
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 has had energy crises in the past that
resulted in rolling blackouts throughout the state. These rolling blackouts
could have substantially disrupted our operations and have increased our
expenses. California may implement future rolling blackouts should the state
find itself in a similar future energy predicament. 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, in the past, shortages in wholesale electricity supplies and this has
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.
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 such as senior development
staff, product marketing staff and sales personnel. The loss of key employees
would likely have an adverse effect on our business. We do not have employment
agreements with most of our senior management team. If one or more of our senior
management team were to resign, the loss could result in loss of sales, delays
in new product development and diversion of management resources.
19
The threat of terrorism and/or other major militaristic related responses
creates a greater amount of instability for global business operations 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, 2001. 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.
In addition, the significant majority of our operations are conducted at
offices within a 60-mile radius of the major metropolitan cities of San
Francisco, New York City, Boston and London. 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 workforce reductions and financial performance may adversely affect the
morale and performance of our personnel we wish to retain and may adversely
affect our ability to hire new personnel.
Our restructuring efforts included reductions in our workforce in order to
reduce costs and bring staffing in line with our anticipated requirements. There
were costs associated with the workforce reductions related to severance and
other employee-related costs, and our realignment plan may yield unanticipated
costs and consequences, such as attrition beyond our planned reduction in staff.
In addition, our common stock has declined in value below the exercise price of
many options granted to employees pursuant to our stock option plans. Thus, the
intended benefits of the stock options granted to our employees, the creation of
performance and retention incentives, may not be realized. In addition,
workforce reductions and management changes create anxiety and uncertainty and
may adversely affect employee morale. As a result, we may lose employees whom we
would prefer to retain. As a result of these factors, our remaining personnel
may seek employment with larger, more established companies or companies they
perceive as having less volatile stock prices. In addition, 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. For example, in
February 2002, we introduced a Voluntary Stock Option Cancellation and Re-grant
Program in which a number of our employees cancelled stock options that had
significantly higher exercise prices in comparison to where our common stock
price currently trades. These employees will receive new options in August 2002
at exercise prices equivalent to our common stock price at that date. This may
cause dilution to our existing stockholder base, which may cause our stock price
to fall. Additionally, the exercise price of the new option could potentially be
higher than the price of the cancelled options, which would render the options
less effective as an incentive for our employees.
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 sales, development, marketing and
administrative personnel 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 particularly given our continued
operating losses and weakening cash position. We have in the past experienced,
and we expect to continue to experience, difficulty in hiring highly skilled
employees with appropriate qualifications. In addition, new hires frequently
require extensive training before they achieve desired levels of productivity.
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.
20
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, especially in light of the significant headcount reductions we have
made to our business during the year ended March 31, 2002 and may be required to
make in the future. To the extent we acquire other businesses, we would also
need to integrate and assimilate new operations, technologies and personnel.
Failure to manage any 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
write-offs 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 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 2004. During the years ended March 31, 2002 and 2001, the
Company was able to sublease its excess capacity at its facilities and received
rental payments from its tenants. Two of the Company's sublease tenants who
accounted for the significant majority of the Company's sublease receipts did
not renew their sublease agreements during the year ended March 31, 2002. The
Company has not been successful in finding any new sublease tenants and,
accordingly, recorded expense of $396,000 during the three months ended March
31, 2002 to account for its on-going, excess operating facilities. Should the
Company continue to have excess operating lease capacity and the Company is
unable to find a sub lessee at a rate equivalent to its operating lease rate,
the Company would be required to record a charge for the rental payments that
the Company owes to its landlord relating to this excess facility capacity. The
Company's management reviews its facility requirements and assesses whether any
excess capacity exists as part of its on-going financial processes.
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 charges for excess
capacity.
Our application services use significant capital equipment and other
infrastructure resources that have been purchased and engaged to support its
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 no customer has any obligation to renew. During the year ended March
31, 2002, the Company incurred equipment write-downs of $455,000 as a direct
result of a decline in demand for its application services. Should the Company
lose other customers for its application services, the Company may have excess
capacity and be required to record additional charges 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.
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.
21
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.
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.
22
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.
As we operate internationally, we face significant risks in doing business in
foreign countries.
We are subject to a number of risks associated with international business
activities, including:
o costs of customizing our products and services for foreign countries,
including localization, translation and conversion to international
and other foreign technology standards;
o compliance with multiple, conflicting and changing governmental laws
and regulations, including changes in regulatory requirements that may
limit our ability to 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.
23
In addition to the above-stated risks, under the Financial Accounting
Standards Board's Statement of Financial Accounting Standards No. 142, "Goodwill
and Other Intangible Assets" ("FAS 142"), any future goodwill resulting from any
future acquisitions we may undertake will not be amortized but instead reviewed
at least annually for impairment. We will be required to test goodwill for
impairment using the two-step process prescribed in FAS 142. The first step is a
screen for potential impairment, while the second step measures the amount of
impairment, if any. Should we enter into any future acquisition transactions and
general macroeconomic deteriorate subsequent to the acquisition, which affects
our business and operating results over the long-term, and/or should the future
acquisition target not provide the results that are anticipated when the merger
is consummated, we could be required to record accelerated impairment charges
related to goodwill, which could adversely affect our financial results.
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.
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. Furthermore, we may
compete with new or different competitors who sell similar or competing
solutions in the vertical markets applicable to our various solution
applications. 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.
24
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.
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 2. Properties
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 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 2004.
25
Item 3. Legal Proceedings
Beginning on August 22, 2001, purported securities fraud class action
complaints were filed in the United States District Court for the Southern
District of New York. The cases were consolidated and the litigation is now
captioned as In re Virage, Inc. Initial Public Offering Securities Litigation,
Civ. No. 01-7866 (SAS) (S.D.N.Y.), related to In re Initial Public Offering
Securities Litigation, 21 MC 92 (SAS) (S.D.N.Y.). On or about April 19, 2002,
the plaintiffs electronically served an amended complaint. The amended complaint
is brought purportedly on behalf of all persons who purchased the Company's
common stock from June 28, 2000 through December 6, 2000. It names as defendants
the Company, two of our officers, and several investment banking firms that
served as underwriters of our initial public offering. The complaint alleges
liability under Sections 11 and 15 of the Securities Act of 1933 and Sections
10(b) and 20(a) of the Securities Exchange Act of 1934, on the grounds that the
registration statement for the offering did not disclose that: (1) the
underwriters had agreed to allow certain customers to purchase shares in the
offerings in exchange for excess commissions paid to the underwriters; and (2)
the underwriters had arranged for certain customers to purchase additional
shares in the aftermarket at predetermined prices. The amended complaint also
alleges that false analyst reports were issued. No specific damages are claimed.
The Company is aware that similar allegations have been made in other
lawsuits filed in the Southern District of New York challenging over 300 other
initial public offerings and secondary offerings conducted in 1999 and 2000.
Those cases have been consolidated for pretrial purposes before the Honorable
Judge Shira A. Scheindlin. Defendants' time to respond to the complaints has
been stayed pending a plan for further coordination. We believe that the
allegations against our officers and us are without merit, and we intend to
contest them vigorously.
From time to time, the Company may become involved in litigation claims
arising from its ordinary course of business. The Company believes that there
are no claims or actions pending or threatened against it, the ultimate
disposition of which would have a material adverse effect on the Company.
26
Item 4. Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of security holders during the fourth
quarter of our fiscal year ended March 31, 2002.
Executive Officers of the Registrant
The following table sets forth certain information regarding our executive
officers as of June 12, 2002:
Name Age Position
---- --- --------
Paul G. Lego............................. 43 President, Chief Executive Officer and Chairman
of the Board of Directors
Alfred J. Castino........................ 50 Chief Financial Officer
Stanford S. Au........................... 39 Vice President, Engineering
David J. Girouard........................ 36 Senior Vice President, Marketing and Corporate
Strategy
Michael H. Lock.......................... 39 Senior Vice President, Worldwide Sales
Frank H. Pao............................. 33 Vice President, Business Affairs
Paul G. Lego, chairman of the board of directors, president and chief
executive officer, joined Virage in January 1996. From January 1995 to January
1996, Mr. Lego was an associate at Sutter Hill Ventures, a venture capital firm.
From June 1988 to December 1994, Mr. Lego was the chief operating officer at
Digidesign, a manufacturer of digital audio recording and editing systems, which
was acquired by Avid Technology in January 1995. Mr. Lego has also held various
marketing, manufacturing and engineering positions with Pyramid Technology
Corporation, the General Electric Company and Digital Equipment Corporation. Mr.
Lego holds a B.S. in electrical engineering from Cornell University and an
M.B.A. from Harvard Business School.
Alfred J. Castino, chief financial officer, joined Virage in January 2000.
From September 1999 to January 2000, Mr. Castino was the chief financial officer
of RightPoint, a marketing software firm that was acquired by E.piphany. From
September 1997 to August 1999, Mr. Castino was employed at PeopleSoft as vice
president of finance and chief accounting officer, as senior vice president of
finance and administration, and chief financial officer. From April 1996 to
September 1997, Mr. Castino was vice president and corporate controller at
Chiron Corporation, a biotechnology company. From August 1989 to March 1996, Mr.
Castino held finance positions at Sun Microsystems including finance director of
United States operations, director of finance and planning for European
operations, and assistant corporate controller. Mr. Castino's prior experience
also includes seven years at Hewlett-Packard Company in various financial
management positions. Mr. Castino is a certified public accountant. Mr. Castino
holds a B.A. in economics from Holy Cross College and an M.B.A. from Stanford
University.
Stanford S. Au, vice president, engineering, joined Virage in January 2002.
Mr. Au came to Virage from AOL-Time Warner's Netscape Communications, where he
held various positions from 1998 to 2002, most recently as vice president and
general manager of AOL's IBPP business unit. Prior to Netscape, he was an
original member of KIVA software's executive staff, which was acquired by
Netscape. Mr. Au has also held various engineering and senior management
positions at Apple Computer, Sun Microsystems, and Hewlett-Packard. Mr. Au holds
a B.S. in electrical engineering and computer science from the University of
California, Berkeley.
David J. Girouard, senior vice president, marketing and corporate strategy,
joined Virage in May 1997. Prior to becoming our senior vice president,
marketing and corporate strategy, Mr. Girouard was our vice president and
general manager, Virage Interactive, and was as a director of product marketing.
From December 1994 to April 1997, Mr. Girouard was a product manager in the
worldwide product marketing group at Apple Computer. Mr. Girouard holds a B.A.
in engineering sciences and a B.E. from Dartmouth College. He also holds an
M.B.A. from the University of Michigan.
27
Michael H. Lock, senior vice president, worldwide sales, joined Virage in
January 2001. Prior to joining Virage, Mr. Lock held various sales and marketing
positions at Oracle Corporation, most recently as Vice President, Sales and
Marketing, from 1996 to 2000. Mr. Lock also has served in a variety of sales,
marketing and general management positions with IBM, Dun and Bradstreet Software
and Drake International. Mr. Lock received a B.S. in Business Administration
from Wilfrid Laurier University in Ontario, Canada.
Frank H. Pao, vice president, business affairs, joined Virage in April
1997. From September 1994 to March 1997, Mr. Pao specialized in intellectual
property and licensing transactions at the law firm of Gray Cary Ware &
Freidenrich. He has also held various engineering positions at Advanced
Cardiovascular Systems and Lawrence Berkeley Laboratories. Mr. Pao holds a B.S.
in bioengineering from the University of California at Berkeley and a J.D. from
Boalt Hall School of Law at the University of California at Berkeley.
28
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
(a) Our common stock is listed on the Nasdaq National Market under the
symbol "VRGE".
Following our initial public offering on June 29, 2000, the following high
and low closing sales prices were reported by Nasdaq in each period indicated:
High Low
---- ---
Year Ended March 31, 2002
-------------------------
Fourth quarter $ 3.56 $ 2.00
Third quarter $ 3.47 $ 1.61
Second quarter $ 4.15 $ 1.65
First quarter $ 5.90 $ 1.81
Year Ended March 31, 2001
-------------------------
Fourth quarter $ 7.50 $ 2.00
Third quarter $18.38 $ 4.63
Second quarter $30.63 $10.00
First quarter (from June 29, 2000) $22.00 $14.47
The reported last sale price of our common stock on the Nasdaq National
Market on June 12, 2002 was $1.02. The approximate number of holders of record
of the shares of our common stock was 255 as of June 12, 2002. This number does
not include stockholders whose shares are held in trust by other entities.
Because many of our shares of common stock are held by brokers and other
institutions on behalf of stockholders, we are unable to estimate the total
number of stockholders represented by these record holders.
We have not paid any cash dividends on our capital stock. We currently
intend to retain future earnings, if any, to fund the development and growth of
our business and, therefore, do not anticipate paying any cash dividends in the
foreseeable future. See Item 7, "Management's Discussion and Analysis of
Financial Condition and Results of Operations-Liquidity and Capital Resources."
(b) There has been no change to the disclosure contained in our report on
Form 10-Q for the nine months ended December 31, 2001 regarding the use of
proceeds generated by our initial public offering.
29
Item 6. Selected Consolidated Financial Data
SELECTED CONSOLIDATED FINANCIAL DATA
You should read the selected consolidated financial data set forth below in
conjunction with Item 7, "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and our Consolidated Financial Statements
and the Notes thereto included elsewhere in this annual report. Historical
results are not necessarily indicative of results that may be expected for any
future period.
Fiscal Years Ended
March 31,
--------------------------------------------------------------------
2002 2001 2000 1999 1998
-------- -------- -------- -------- --------
(in thousands, except per share data)
Consolidated Statements of Operations Data:
Revenues:
License revenues ...................................... $ 7,414 $ 6,161 $ 4,188 $ 1,956 $ 1,438
Service revenues ...................................... 9,099 5,136 1,102 253 130
Other revenues ........................................ 232 104 271 1,141 1,134
-------- -------- -------- -------- --------
Total revenues ................................. 16,745 11,401 5,561 3,350 2,702
Cost of revenues:
License revenues ...................................... 705 723 870 397 454
Service revenues ...................................... 8,607 7,381 2,400 426 62
Other revenues ........................................ 153 149 260 859 809
-------- -------- -------- -------- --------
Total cost of revenues ......................... 9,465 8,253 3,530 1,682 1,325
-------- -------- -------- -------- --------
Gross profit ............................................ 7,280 3,148 2,031 1,668 1,377
Operating expenses:
Research and development .............................. 9,172 9,101 4,182 2,325 1,751
Sales and marketing ................................... 17,301 17,129 8,349 4,362 2,810
General and administrative ............................ 4,985 5,298 2,653 1,273 935
Stock-based compensation .............................. 5,113 3,294 1,070 -- --
-------- -------- -------- -------- --------
Total operating expenses ....................... 36,571 34,822 16,254 7,960 5,496
-------- -------- -------- -------- --------
Loss from operations .................................... (29,291) (31,674) (14,223) (6,292) (4,119)
Interest and other income, net .......................... 1,541 2,800 384 123 19
-------- -------- -------- -------- --------
Loss before income taxes ................................ (27,750) (28,874) (13,839) (6,169) (4,100)
Provision for income taxes .............................. -- -- (36) -- --
-------- -------- -------- -------- --------
Net loss ................................................ (27,750) (28,874) (13,875) (6,169) (4,100)
Series E convertible preferred stock
dividend .............................................. -- -- (4,544) -- --
-------- -------- -------- -------- --------
Net loss applicable to common
stockholders .......................................... $(27,750) $(28,874) $(18,419) $ (6,169) $ (4,100)
======== ======== ======== ======== ========
Basic and diluted net loss per share
applicable to common stockholders ..................... $ (1.37) $ (1.88) $ (8.06) $ (3.67) $ (2.84)
======== ======== ======== ======== ========
Shares used in computation of basic and
diluted net loss per share applicable
to common stockholders ................................ 20,327 15,397 2,286 1,679 1,443
March 31,
----------------------------------------------------------------
2002 2001 2000 1999 1998
-------- -------- -------- -------- --------
(in thousands)
Consolidated Balance Sheets Data:
Cash, cash equivalents and short-term investments ............ $ 30,694 $ 48,131 $ 10,107 $ 4,357 $ 5,780
Working capital .............................................. 24,077 40,588 8,101 3,879 4,723
Total assets ................................................. 39,552 60,206 18,872 6,605 7,289
Long-term obligations, net of current portion ................ -- -- 83 241 311
Redeemable convertible preferred stock ....................... -- -- 36,995 17,936 12,472
Accumulated deficit .......................................... (88,924) (61,174) (32,300) (13,881) (7,712)
Total stockholders' equity (net capital deficiency) .......... $ 30,059 $ 49,706 $(23,221) $(13,326) $ (7,257)
30
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following discussion and analysis of our financial condition and results
of operations should be read in conjunction with the "Selected Consolidated
Financial Data", the condensed consolidated financial statements and related
notes contained herein. This discussion contains forward-looking statements
within the meaning of Section 27A of the Securities Act and Section 21E of the
Exchange Act. We may identify these statements by the use of words such as
"believe", "expect", "anticipate", "intend", "plan" and similar expressions.
These forward-looking statements involve several risks and uncertainties. Our
actual results may differ materially from those set forth in these
forward-looking statements as a result of a number of factors, including those
described under the caption "Risk Factors" herein. These forward-looking
statements speak only as of the date of this report, and we caution you not to
rely on these statements without also considering the risks and uncertainties
associated with these statements and our business as addressed elsewhere in this
report.
Fiscal Year 2002 Overview
Virage, Inc. is a provider of software products, professional services and
application services that enable owners of rich-media and video assets to more
effectively communicate, manage, retrieve and distribute these rich-media assets
for improved productivity and communications. Depending on their particular
needs and resources, our customers may elect to license our software products or
employ our application or professional services. Our customers include media and
entertainment companies, other corporations, government agencies and educational
institutions.
Application Products Launches
Our traditional video software offerings, including our SmartEncode and
server suite of products, have historically met the needs of users who have
video and rich-media assets and need to publish, manage, and distribute these
assets over the Internet and/or their intranets. In order to expand the market
for our technology beyond these products, we have recently refocused our product
development, sales, and marketing strategies in an effort to address common
business user problems in multiple areas of an enterprise. We want to provide
these users with a quick, reliable, and scalable solution to their problems
while affording them a definitive return on their investment.
Pursuant to this goal, in December 2001, we announced our first two
rich-media application products: VS Publishing and VS Webcasting. VS Publishing
offers media and entertainment customers a streamlined workflow for rich-media
web publishing, including a simple editorial control and greater website
programming capabilities. The new product allows content owners to publish more
content with fewer resources. VS Publishing is available as either in-house
software or as a hosted service. VS Webcasting allows corporations to
self-produce live and on-demand webcasting events such as executive
communications, human resource broadcasts and webinars. Webcasts can include
audio and video synchronized with slide presentations and documents as well as
audience polls and questions. At the same time, VS Webcasting creates a
searchable, on-demand version of the event that is available after the live
broadcast is completed. VS Webcasting is available as either in-house software
or as a hosted service.
In February and April 2002, respectively, we announced our third and fourth
software application products, VS Learning and VS Production. VS Learning is a
new enterprise software application for rich media training and e-learning that
enables companies to create, manage, publish and view on-demand training courses
and presentations containing video and other rich media information. The
solution is available both as a licensed software product and as a hosted
service. VS Production is an integrated software solution for media and
entertainment enterprises that automates the professional video production
process from acquisition to distribution.
31
We believe that the success of our application products is critical to our
future and have heavily invested our resources in the development, marketing,
and sale of them. The market for our application products is in a relatively
early stage. We cannot predict how much the market for our application products
will develop, and part of our strategic challenge will be to convince enterprise
customers of the productivity, communications, cost, and other benefits of our
solutions. Our future revenues and revenue growth rates will depend in large
part on our success in creating market acceptance for our application products.
Business Restructuring Charges
During the year ended March 31, 2002, we continually evaluated our cost
structure, reviewed the relative success of our various service offerings, and
analyzed our geographical office needs based on historical and expected future
market demands. As part of these reviews, we reduced headcount and
infrastructure, particularly in our application services business, and
consolidated operations throughout the world, resulting in headcount reductions
of approximately 60 employees and the recording of $2,038,000 in business
restructuring charges during the year. A breakdown of our business restructuring
charges and the remaining restructuring accrual as of March 31, 2002 is as
follows:
Expenditures Balance at
Category Additions Cash Non-cash March 31, 2002
-------- --------- ---- -------- --------------
Excess facilities and other exit costs ......... $ 655 $ 151 $ -- $ 504
Employee separation and other costs ............ 928 669 -- 259
Equipment write-downs .......................... 455 -- 455 --
------ ------ ------ ------
Total ........................................ $2,038 $ 820 $ 455 $ 763
====== ====== ====== ======
Excess Facilities and Other Exit Costs: Excess facilities and other exit
costs relate to lease obligation and closure costs associated with offices we
have vacated as a result of our cost reduction initiatives. The office locations
affected by our cost restructuring efforts include our San Mateo, California,
and Munich, Germany offices. In our San Mateo headquarters location, we have an
operating lease commitment for approximately 48,000 square feet of office space,
an amount higher than our current needs. As a result, we have vacated a portion
of this facility and recorded $396,000 in expense. It is management's best
estimate that this space will continue to be vacant for the next 12 months and
that we will not be able to recoup the losses from our rental payments for the
period from April 1, 2002 to March 31, 2003 by earning a profit from a sub
lessee at some point over the course of our obligation period, which continues
through September 2006. The current commercial real estate market in Northern
California is poor for sub lessors looking for tenants, and while we will make
every attempt to secure a sublease, we believe that we will be unable to
sublease this additional space at a reasonable rate for the next 12 months. We
also recorded other excess facilities costs of $215,000 primarily related to our
21,000 square foot facility in San Mateo. Should we continue to have excess
operating lease capacity and be unable to find a sub lessee at a rate equivalent
to our operating lease rate, we would be required to record additional charges
for the rental payments that we owe to our landlord relating to this excess
facility. Our management reviews its facility requirements and assesses whether
any excess capacity exists as part of our on-going financial processes.
Due to an unfavorable market environment in Germany and most of Central
Europe, we decided to close our satellite sales office in Munich, Germany, in
March 2002. Pursuant to this closure, we recorded approximately $44,000 in exit
costs, primarily attributable to equipment lease commitments and legal fees. We
do not have any outstanding operating lease commitments in Germany for office
space after the closure of the office in March 2002.
Employee Severance: Employee separation and other costs, which include
severance, related taxes, outplacement and other benefits, totaled approximately
$928,000 during the year ended March 31, 2002 (representing approximately 60
terminated employees), of which $669,000 had been paid in cash as of March 31,
2002. Personnel affected by the cost reduction initiatives include employees in
positions throughout the company in sales, marketing, services, engineering, and
general and administrative functions in all geographies, with a particular
emphasis on our application services employees as we further downsized this
business.
32
Equipment Write-Downs: As part of our cost restructuring efforts, we decided
to substantially downsize our application services offering, both in response to
weak market conditions and to the termination of our contract with our largest
customer during the year ended March 31, 2002. Pursuant to these efforts, we
reduced our application services infrastructure by taking a portion of our
production equipment out of service and subsequently writing off approximately
$455,000 in assets at net book value, primarily in our New York office. Should
we lose other application services customers, we may have excess capacity and be
required to record additional charges for excess capital equipment and/or other
infrastructure costs. Our management reviews its capacity requirements and
assesses whether any excess capacity exists as part of our on-going financial
processes.
Voluntary Stock Option Cancellation and Re-grant Program
In February 2002, we canceled 2,678,250 stock options of certain employees
who elected to participate in our voluntary stock option cancellation and
re-grant program. Many of our employees canceled stock options that had
significantly higher exercise prices in comparison to where our common stock
price currently trades. On approximately August 7, 2002, we currently have an
obligation to issue 2,653,250 stock options with a new exercise price equal to
the closing fair market value of our stock on August 7, 2002. As a result of
this program, we were required to accelerate the amortization of the remaining
deferred compensation related to these canceled stock options. This acceleration
of amortization is included in the $6,511,000 of deferred compensation expense
recorded in our statement of operations for the year ended March 31, 2002.
We believe that this program will help to retain our employees and to improve
our workforce morale. However, this program may cause dilution to our existing
stockholder base, which may cause our stock price to fall. Additionally, the
exercise price of the new option could potentially be higher than the price of
the cancelled options, which would render the options less effective as an
incentive for our employees.
Critical Accounting Policies & Estimates
The discussion and analysis of our financial position and results of
operations are based upon our consolidated financial statements, which have been
prepared in accordance with generally accepted accounting principles in the
United States. The preparation of these consolidated financial statements
requires us to make estimates and judgments that affect the reported amounts of
assets, liabilities, revenues, and expenses, and related disclosure of
contingent assets and liabilities. We base our estimates on historical
experience and on various other assumptions that are believed to be reasonable
under the circumstances, the results of which form the basis for making
judgments about the carrying values of assets and liabilities that are not
readily apparent from other sources. Estimates and assumptions are reviewed as
part of our management's on-going financial processes. Actual results may differ
from these estimates under different assumptions and conditions.
We believe our critical accounting policies and estimates include accounting
for revenue recognition and the accounting and related estimates for our
commitments and contingencies.
Revenue Recognition
We enter into arrangements for the sale of licenses of software products and
related maintenance contracts, application services and professional services
offerings; and also receive 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.
33
Our 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") and is also
consistent with the Securities and Exchange Commission's Staff Accounting
Bulletin No. 101, "Revenue Recognition in Financial Statements.". For each
arrangement, we determine 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. We consider 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, we recognize license revenues based
upon the residual method after all elements other than maintenance have been
delivered as prescribed by SOP 98-9. We recognize 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.
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, we
recognize revenue on shipment to the reseller, if other criteria in SOP 97-2 are
met, since we have no risk of concessions. We defer 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. We recognize 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 above, 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, we
account 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, we recognize revenues as such
milestones are achieved provided the milestones are not subject to any
additional acceptance criteria.
34
Application services. Application services revenues consist primarily of
account set-up, web design and integration fees, video processing fees and
application hosting fees. Account set-up, web design and integration fees are
recognized ratably over the contract term, which is generally six to twelve
months. We generate 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 to monthly minimums. We recognize revenues on
transaction fees that are subject to monthly minimums on a monthly basis since
we have no further obligations, the payment terms are normal and each month is a
separate measurement period.
Professional services. We provide professional services such as consulting,
implementation and training services to our 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, we recognize 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.
We follow very specific and detailed guidelines, discussed above, in
determining revenues; however, certain judgments and estimates are made and used
to determine revenue recognized in any accounting period. Material differences
may result in the amount and timing of revenue recognized for any period if
different conditions were to prevail. For example, in determining whether
collection is probable, we assess each customer's ability and intent to pay. Our
actual experience with respect to collections could differ from our initial
assessment if, for instance, unforeseen declines in the overall economy occur
and negatively impact our customers' financial condition. To date, we believe
that our revenue recognition has been proper and our related reserves have been
sufficient.
Commitments and Contingencies
In the normal course of business, we are subject to commitments and
contingencies, including operating leases, restructuring liabilities, and legal
proceedings and claims that cover a wide range of matters, including
securities-related litigation and other claims in the ordinary course of
business. We record accruals for such contingencies based upon our assessment of
the probability of occurrence and, where determinable, an estimate of the
liability. We consider many factors in making these assessments including past
history and the specifics of each matter. We believe that there are no claims or
actions pending or threatened against us that would have a material adverse
effect on our operating results. Further, we review our assessment of the
likelihood of loss on any outstanding contingencies as part of our management's
on-going financial processes. However, actual results may differ from these
estimates under different assumptions and conditions.
35
Results of Operations
The following table sets forth consolidated financial data for the periods
indicated, expressed as a percentage of total revenues.
Fiscal Years Ended
March 31,
------------------------
2002 2001 2000
---- ---- ----
Revenues:
License revenues ............................... 44% 54% 75%
Service revenues ............................... 54 45 20
Other revenues ................................. 2 1 5
---- ---- ----
Total revenues ......................... 100 100 100
---- ---- ----
Cost of revenues:
License revenues ............................... 4 6 16
Service revenues ............................... 52 65 43
Other revenues ................................. 1 1 5
---- ---- ----
Total cost of revenues ................. 57 72 64
---- ---- ----
Gross profit ..................................... 43 28 36
Operating expenses:
Research and development ....................... 55 80 75
Sales and marketing ............................ 103 150 150
General and administrative ..................... 30 47 48
Stock-based compensation ....................... 30 29 19
---- ---- ----
Total operating expenses ............... 218 306 292
---- ---- ----
Loss from operations ............................. (175) (278) (256)
Interest and other income, net ................... 9 25 7
---- ---- ----
Loss before income taxes ......................... (166) (253) (249)
Provision for income taxes ....................... -- -- --
---- ---- ----
Net loss ......................................... (166) (253) (249)
Series E convertible preferred stock dividend .... -- -- (82)
---- ---- ----
Net loss applicable to common stockholders ....... (166)% (253)% (331)%
==== ==== ====
We incurred net losses applicable to common stockholders of $27,750,000,
$28,874,000, and $18,419,000 during the three years ended March 31, 2002, 2001
and 2000, respectively. As of March 31, 2002, we had an accumulated deficit of
$88,924,000. We expect to continue to incur operating losses for the foreseeable
future. In view of the rapidly changing nature of our market and our limited
operating history, we believe that period-to-period comparisons of our revenues
and other operating results are not necessarily meaningful and should not be
relied upon as indications of future performance. Our historic revenue growth
rates are not necessarily sustainable or indicative of our future growth.
Fiscal Years Ended March 31, 2002 and 2001
Revenues. Total revenues increased to $16,745,000 in fiscal 2002 from
$11,401,000 in fiscal 2001, an increase of $5,344,000. This increase was due to
increases in license, service and other revenues. International revenues
increased in absolute dollars to $3,997,000, or 24% of total revenues, in fiscal
2002 from $3,341,000, or 29% of total revenues, in fiscal 2001. One customer
accounted for 14% of total revenues in fiscal 2002. There were no customers who
accounted for more than 10% of total revenues in fiscal 2001.
License revenues increased to $7,414,000 in fiscal 2002 from $6,161,000 in
fiscal 2001. This increase was a result of both higher unit sales of our
VideoLogger and Virage Solution Server products and the introduction of new
product lines. Recently, our largest reseller announced that it will divest its
business segment in which our products are most complementary. As a result, we
encountered very little channel sales activity from this reseller during the
final fiscal quarter of our fiscal year ended March 31, 2002. We believe this
factor contributed to our quarterly decline in total revenues during the final
fiscal quarter of our fiscal year ended March 31, 2002. As a result of the loss
of this channel partner, or if we were to lose 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 future operating results could be
significantly harmed.
36
Service revenues increased to $9,099,000 in fiscal 2002 from $5,136,000 in
fiscal 2001, an increase of $3,963,000. Approximately 56% of this increase was
due to revenue growth from our application services offering while 22% of this
increase was due to higher revenues from our professional services and training
offerings. The remainder was due to an increase in the number of customers
purchasing maintenance contracts. Service revenues in fiscal 2002 include
$648,000 of warrant amortization recorded as contra-service revenues resulting
from a warrant issued to MLBAM. The growth in application services revenues was
primarily attributable to higher revenues from MLBAM, which accounted for 14% of
total revenues during the year ended March 31, 2002. We do not expect any
revenues from MLBAM in the current fiscal year since we could not mutually agree
on terms for a renewal of this contract. We believe this factor contributed to
our quarterly decline in total revenues during the final fiscal quarter of our
fiscal year ended March 31, 2002.
Other revenues increased to $232,000 in fiscal 2002 from $104,000 in fiscal
2001, an increase of $128,000. This increase was attributable to the level of
engineering services performed pursuant to federal government research
contracts.
Cost of Revenues. Cost of license revenues consists primarily of royalty
fees for third-party software products integrated into our products. Our cost of
service revenues includes personnel expenses, related overhead, communication
expenses and capital depreciation costs for maintenance and support activities
and application and professional services. Our cost of other revenues primarily
includes engineering personnel expenses and related overhead for engineering
research for government projects. Total cost of revenues increased to
$9,465,000, or 57% of total revenues, in fiscal 2002 from $8,253,000, or 72% of
total revenues, in fiscal 2001. This increase in total cost of revenues was due
to increases in the cost of service and other revenues, slightly offset by a
decrease in the cost of license revenues.
Cost of license revenues decreased to $705,000, or 10% of license revenues,
in fiscal 2002 from $723,000, or 12% of license revenues, in fiscal 2001. This
decrease was due to slightly lower unit sales of our products that are subject
to unit-based (rather than fixed-fee) license royalty payments in fiscal 2002 in
comparison to fiscal 2001.
Cost of service revenues increased to $8,607,000, or 95% of service
revenues, in fiscal 2002 from $7,381,000, or 144% of service revenues in fiscal
2001. This increase in absolute dollars was due to expenditures to support the
growth of our application services business, particularly in support of our
contract with MLBAM. As a result of both the termination of our contract with
MLBAM and lower demand for our application services offering, we expect our cost
of service revenues to decline in the foreseeable future as we continue our
efforts to control costs and improve gross profit margins in this area.
Cost of other revenues increased to $153,000, or 66% of other revenues, in
fiscal 2002 from $149,000, or 143% of other revenues, in fiscal 2001. This
absolute dollar increase was attributable to the level of engineering services
performed pursuant to federal government research contracts.
Research and Development Expenses. Research and development expenses consist
primarily of personnel and related costs for our development efforts. Research
and development expenses increased to $9,172,000, or 55% of total revenues, in
fiscal 2002 from $9,101,000, or 80% of total revenues, in fiscal 2001. The
increase in absolute dollars was primarily due to our business restructuring
charges, particularly in connection with our lease write-downs, and was
partially offset by lower variable headcount costs and reduced localization
expenses. We expect research and development expenses to increase for the
foreseeable future as we believe that significant product development
expenditures are essential for us to maintain and enhance our market position
and expand into new user markets. To date, we have not capitalized any software
development costs as they have been insignificant after establishing
technological feasibility.
37
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 seminars.
Sales and marketing expenses increased to $17,301,000, or 103% of total
revenues, in fiscal 2002 from $17,129,000, or 150% of total revenues, in fiscal
2001. The increase in absolute dollars was primarily due to our business
restructuring charges, particularly in connection with our lease write-downs,
and was partially offset by lower travel costs. We expect sales and marketing
expenses to remain in the range of relatively flat to a modest increase for the
foreseeable future as we attempt to limit our overall expense growth for the
company and to focus our marketing activities in specific areas, particularly
with respect to our new application products.
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, facilities,
costs of our external audit firm and costs of our outside legal counsel. General
and administrative expenses decreased to $4,985,000, or 30% of total revenues,
in fiscal 2002 from $5,298,000 or 47% of total revenues, in fiscal 2001. The
decrease was primarily due to lower variable headcount costs and reduced
professional services fees, and was partially offset by business restructuring
charges, particularly in connection with our lease write-downs. We expect
general and administrative expenses to increase for the foreseeable future as we
incur additional professional services costs, including higher legal fees and
insurance premiums, especially for our director and officer liability insurance
coverage.
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 $5,113,000 and
$3,294,000 in fiscal 2002 and 2001, respectively, in connection with the
granting of stock options to our employees. Our stock-based compensation expense
in fiscal 2002 increased due to the cancellation of stock options resulting from
participation in our voluntary stock option cancellation and re-grant program
for our employees. Effective April 1, 2002, we expect that stock-based
compensation expense will decrease due to the immediate expensing of the
majority of our employee-related deferred compensation in our fourth fiscal
quarter of 2002. We will continue to amortize the remaining deferred
compensation balance as expense for employees who did not participate in our
voluntary stock option cancellation and re-grant program.
Interest and Other Income, Net. Interest and other income, net, includes
interest income from cash and cash equivalents offset (in fiscal 2001) by
interest on capital leases and bank debt. Interest and other income, net,
decreased to $1,541,000 in fiscal 2002 from $2,800,000 in fiscal 2001, a
decrease of $1,259,000. The decrease was a result of lower interest rates and
lower average cash balances during fiscal 2002.
Provision for Income Taxes. We have not recorded a provision for federal and
state or foreign income taxes in either fiscal 2002 or 2001 because we have
experienced net losses since inception, which have resulted in deferred tax
assets. We have recorded a valuation allowance for the entire deferred tax asset
as a result of uncertainties regarding the realization of the asset balance
through future taxable profits.
Fiscal Years Ended March 31, 2001 and 2000
Total Revenues. Total revenues increased to $11,401,000 in fiscal 2001 from
$5,561,000 in fiscal 2000, an increase of $5,840,000. This increase was due to
increases in license and service revenues, partially offset by a decrease in
other revenues. International revenues increased to $3,341,000, or 29% of total
revenues, in fiscal 2001 from $1,241,000, or 22% of total revenues, in fiscal
2000. There were no customers who accounted for more than 10% of total revenues
in fiscal 2001. Sales to our two largest customers accounted for 13% and 10%,
respectively, of total revenues in fiscal 2000. Sales to agencies of the U.S.
government accounted for 10% of total revenues in fiscal 2001 and 12% of total
revenues in fiscal 2000.
38
License revenues increased to $6,161,000 in fiscal 2001 from $4,188,000 in
fiscal 2000, an increase of $1,973,000. The increase was primarily due to the
introduction of new product lines, expansion of our domestic sales and marketing
operations, and the opening of European sales offices.
Service revenues increased to $5,136,000 in fiscal 2001 from $1,102,000 in
fiscal 2000, an increase of $4,034,000. Approximately 73% of this growth was due
to revenue growth from our application services offering which was introduced in
May 1999 and the remainder was due to an increase in the number of customers
purchasing maintenance contracts.
Other revenues decreased to $104,000 in fiscal 2001 from $271,000 in fiscal
2000, a decrease of $167,000. This decrease was attributable to the level of
engineering services performed for the federal government.
Total Cost of Revenues. Total cost of revenues increased to $8,253,000, or
72% of total revenues, in fiscal 2001 from $3,530,000, or 64% of total revenues,
in fiscal 2000. This increase in total cost of revenues was due to increases in
cost of license and service revenues, partially offset by a decrease in cost of
other revenues.
Cost of license revenues decreased to $723,000, or 12% of license revenues,
in fiscal 2001 from $870,000, or 21% of license revenues, in fiscal 2000. This
decrease was due to an increase in the proportion of revenues from our products
that are subject to fixed, rather than unit-based, license royalty payments in
fiscal 2001.
Cost of service revenues increased to $7,381,000, or 144% of service
revenues, in fiscal 2001 from $2,400,000, or 218% of service revenues in fiscal
2000. This increase in absolute dollars was due almost entirely to larger
expenditures to support the growth in our application services.
Cost of other revenues decreased to $149,000, or 143% of other revenues, in
fiscal 2001 from $260,000, or 96% of other revenues, in fiscal 2000. This
absolute dollar decrease was due to a reduction in other revenues.
Research and Development Expenses. Research and development expenses
increased to $9,101,000, or 80% of total revenues, in fiscal 2001 from
$4,182,000, or 75% of total revenues, in fiscal 2000. The increase in absolute
dollars was primarily due to an increase in our research and development staff.
Sales and Marketing Expenses. Sales and marketing expenses increased to
$17,129,000, or 150% of total revenues, in fiscal 2001 from $8,349,000, or 150%
of total revenues, in fiscal 2000. Approximately half of this increase in
absolute dollars was due to growth in our sales and marketing personnel while
the remainder was due to increased expenses incurred in connection with trade
shows and additional marketing programs. The increase in our sales and marketing
staff related to the opening of new sales offices in the United States and
Europe.
General and Administrative Expenses. General and administrative expenses
increased to $5,298,000, or 47% of total revenues, in fiscal 2001 from
$2,653,000 or 48% of total revenues, in fiscal 2000. The significant majority of
this increase was due to an increase in headcount, with the remainder due to
increased external legal and audit costs.
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 $3,294,000 and
$1,070,000 in fiscal 2001 and 2000, respectively, in connection with the
granting of stock options to our employees.
Interest and Other Income, Net. Interest and other income, net, increased to
$2,800,000 in fiscal 2001 from $384,000 in fiscal 2000, an increase of
$2,416,000. The increase was due to interest income from increased cash
balances, primarily due to the proceeds from our initial public offering in June
2000.
39
Provision for Income Taxes. We have not recorded a provision for fiscal 2001
income taxes. We recorded a provision for fiscal 2000 for current foreign and
state income taxes of $36,000. We have experienced net losses since inception,
which have resulted in deferred tax assets. We have recorded a valuation
allowance for the entire deferred tax asset as a result of uncertainties
regarding the realization of the asset balance through future taxable profits.
Liquidity and Capital Resources
As of March 31, 2002, we had cash, cash equivalents and short-term
investments of $30,694,000, a decrease of $17,437,000 from March 31, 2001 and
our working capital, defined as current assets less current liabilities, was
$24,077,000, a decrease of $16,511,000 in working capital from March 31, 2001.
The decrease in our cash, cash equivalents, and short-term investments and our
working capital is primarily attributable to cash used in operating activities.
Our operating activities resulted in net cash outflows of $17,871,000,
$16,863,000, and $12,331,000 for the years ended March 31, 2002, 2001 and 2000,
respectively. The cash used in these periods was primarily attributable to net
losses applicable to common stockholders of $27,750,000, $28,874,000, and
$18,419,000 in the years ended March 31, 2002, 2001 and 2000, respectively,
offset by depreciation, losses on disposals of assets, and non-cash, stock-based
charges.
Investing activities resulted in cash inflows of $1,968,000 for the year
ended March 31, 2002 and cash outflows of $34,770,000 and $2,021,000 for the
years ended March 31, 2001 and 2000, respectively. Our investing inflows were
primarily from the maturity of our short-term investments and our outflows were
primarily for the purchase of short-term investments and capital equipment. We
expect that we will continue to invest in short-term investments and purchase
capital equipment as we replace older equipment with newer models.
Financing activities provided net cash inflows of $809,000, $61,206,000, and
$20,103,000 during the years ended March 31, 2002, 2001 and 2000, respectively.
These inflows were primarily from the proceeds of our employee stock purchase
plan during fiscal 2002 and from sales of our preferred and common stock
(including our IPO in fiscal 2001) during fiscal 2001 and 2000.
At March 31, 2002, we have contractual and commercial commitments not
included on our balance sheet primarily for our San Mateo, California facility
that we have an obligation to lease through September 2006. These commitments
are payable in each of our fiscal years ended March 31 as follows: $3,486,000 in
2003, $3,445,000 in 2004, $3,382,000 in 2005, $3,240,000 in 2006 and $1,844,000
in 2007 ($15,397,000 in total). Additional information regarding our contractual
and commercial commitments is provided in Note 2 of our Consolidated Financial
Statements and Notes thereto included in Part II, Item 8, of this Annual Report.
We anticipate that our current cash, cash equivalents and available credit
facilities 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.
40
Recent Accounting Pronouncements
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 adoption of FAS 141 did 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 March 31, 2002.
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. 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.
In August 2001, the FASB issued Statement of Financial Accounting Standards
No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets (FAS
144)," which addresses financial accounting and reporting for the impairment or
disposal of long-lived assets and supersedes FAS 121 and the accounting and
reporting provisions of Accounting Principles Board Opinion No. 30, "Reporting
the Results of Operations for a Disposal of a Segment of a Business." FAS 144 is
effective for fiscal years beginning after December 15, 2001, with earlier
application encouraged. The Company adopted FAS 144 as of April 1, 2002 and it
does not expect that the adoption of this statement will have a significant
impact on the Company's financial position and results of operations.
In November 2001, the FASB issued a Staff Announcement (the "Announcement"),
Topic D-103, which concluded that the reimbursement of "out-of-pocket" expenses
should be classified as revenue in the statement of operations. This
Announcement is to be applied in financial reporting periods beginning after
December 15, 2001. Upon application of this Announcement, comparative financial
statements for prior periods should be reclassified to comply with the guidance
in this Announcement. The Company adopted the Announcement in its fiscal fourth
quarter of its year ended March 31, 2002 and the Announcement did not have a
material affect on the Company's operations, financial position or cash flows.
41
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Foreign Currency Exchange Rate Risk
We develop products in the United States. We currently license our products
from the United States and from our subsidiary in the United Kingdom.
Substantially all of our sales from the United States operation are denominated
in U.S. dollars. Our subsidiary based in the United Kingdom incurs most of its
expenses in pounds sterling and most of its sales are denominated in US dollars.
We are unaware of any known trends or uncertainties that have had or will have a
material impact on total revenues, expenses or loss from continuing operations
related to the Euro conversion. We expect that future license and service
revenues will continue to be derived from international markets and may be
denominated in the currency of the applicable market. As a result, our financial
results could be affected adversely by various factors, including foreign
currency exchange rates or weak economic conditions in foreign markets. Although
we will continue to monitor our exposure to currency fluctuations and, when
appropriate, may use economic hedging techniques in the future to minimize the
effect of these fluctuations, we cannot assure you that exchange rate
fluctuations will not adversely affect our financial results in the future.
Through March 31, 2002, we have not engaged in any foreign currency hedging
activities.
Interest Rate Risk
Our exposure to financial market risk, including changes in interest rates,
relates primarily to our investment portfolio. We typically do not attempt to
reduce or eliminate our market exposure on our investment securities because a
substantial majority of our investments are in fixed rate securities with
maturities not exceeding 12 months. We do not invest in any derivative
instruments. The fair value of our investment portfolio or related income as of
March 31, 2002, would decrease by approximately $116,000 for a 100 basis point
increase and increase by approximately $117,000 for a 100 basis point decrease
in interest rates. Our investment instruments are mainly fixed-rate and
relatively short-term.
42
Item 8. Financial Statements and Supplementary Data
VIRAGE, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Report of Ernst & Young LLP, Independent Auditors............................44
Consolidated Balance Sheets..................................................45
Consolidated Statements of Operations........................................46
Consolidated Statements of Redeemable Convertible Preferred
Stock and Stockholders' Equity (Net Capital Deficiency)....................47
Consolidated Statements of Cash Flows........................................48
Notes to Consolidated Financial Statements...................................49
43
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
The Board of Directors and Stockholders
Virage, Inc.
We have audited the accompanying consolidated balance sheets of Virage, Inc. as
of March 31, 2002 and 2001, and the related consolidated statements of
operations, redeemable convertible preferred stock and stockholders' equity (net
capital deficiency), and cash flows for each of the three years in the period
ended March 31, 2002. Our audits also included the financial statement schedule
listed in the Index at item 14(a). These financial statements and schedule are
the responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements and schedule based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Virage, Inc. at
March 31, 2002 and 2001, and the consolidated results of its operations and its
cash flows for each of the three years in the period ended March 31, 2002, in
conformity with accounting principles generally accepted in the United States.
Also, in our opinion, the related financial statement schedule, when considered
in relation to the basic financial statements taken as a whole, presents fairly
in all material respects, the information set forth therein.
/s/ Ernst & Young LLP
San Jose, California
April 12, 2002
44
VIRAGE, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
March 31,
------------------------------
2002 2001
--------- ---------
ASSETS
Current assets:
Cash and cash equivalents .............................................................. $ 4,586 $ 19,680
Short-term investments ................................................................. 26,108 28,451
Accounts receivable, net of allowance for doubtful
accounts of $1,153 and $867 at March 31, 2002
and 2001, respectively ............................................................... 2,366 2,331
Prepaid expenses and other current assets .............................................. 220 515
--------- ---------
Total current assets ............................................................... 33,280 50,977
Property and equipment:
Computer equipment and software ........................................................ 6,143 6,819
Furniture .............................................................................. 1,406 963
Leasehold improvements ................................................................. 1,943 2,157
--------- ---------
9,492 9,939
Less: accumulated depreciation ........................................................ 5,791 3,247
--------- ---------
3,701 6,692
Other assets ............................................................................. 2,571 2,537
--------- ---------
Total assets ....................................................................... $ 39,552 $ 60,206
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable ....................................................................... $ 831 $ 1,153
Accrued payroll and related expenses ................................................... 2,376 3,279
Accrued expenses ....................................................................... 2,946 3,003
Deferred revenue ....................................................................... 3,050 2,954
--------- ---------
Total current liabilities .......................................................... 9,203 10,389
Deferred rent ............................................................................ 290 111
Commitments and contingencies
Stockholders' equity:
Preferred stock, $0.001 par value:
Authorized shares-- 2,000,000
Issued and outstanding shares-- none ................................................. -- --
Common stock, $0.001 par value:
Authorized shares-- 100,000,000
Issued and outstanding shares-- 20,621,535 and 20,228,752 at March
31, 2002 and 2001, respectively .................................................... 21 20
Additional paid-in capital ............................................................. 121,387 120,707
Deferred compensation .................................................................. (2,425) (9,847)
Accumulated deficit .................................................................... (88,924) (61,174)
--------- ---------
Total stockholders' equity ......................................................... 30,059 49,706
--------- ---------
Total liabilities and stockholders' equity ......................................... $ 39,552 $ 60,206
========= =========
See accompanying notes
45
VIRAGE, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
Years Ended March 31,
--------------------------------------------------
2002 2001 2000
-------- -------- --------
Revenues:
License revenues .................................................. $ 7,414 $ 6,161 $ 4,188
Service revenues .................................................. 9,099 5,136 1,102
Other revenues .................................................... 232 104 271
-------- -------- --------
Total revenues .................................................. 16,745 11,401 5,561
Cost of revenues:
License revenues .................................................. 705 723 870
Service revenues(1) ............................................... 8,607 7,381 2,400
Other revenues .................................................... 153 149 260
-------- -------- --------
Total cost of revenues .......................................... 9,465 8,253 3,530
-------- -------- --------
Gross profit ........................................................ 7,280 3,148 2,031
Operating expenses:
Research and development(2) ....................................... 9,172 9,101 4,182
Sales and marketing(3) ............................................ 17,301 17,129 8,349
General and administrative(4) ..................................... 4,985 5,298 2,653
Stock-based compensation .......................................... 5,113 3,294 1,070
-------- -------- --------
Total operating expenses ........................................ 36,571 34,822 16,254
-------- -------- --------
Loss from operations ................................................ (29,291) (31,674) (14,223)
Interest and other income ........................................... 1,541 2,822 421
Interest expense .................................................... -- (22) (37)
-------- -------- --------
Loss before income taxes ............................................ (27,750) (28,874) (13,839)
Provision for income taxes .......................................... -- -- (36)
-------- -------- --------
Net loss ............................................................ (27,750) (28,874) (13,875)
Series E convertible preferred stock dividend ....................... -- -- (4,544)
-------- -------- --------
Net loss applicable to common stockholders .......................... $(27,750) $(28,874) $(18,419)
======== ======== ========
Basic and diluted net loss per share
applicable to common stockholders ................................. $ (1.37) $ (1.88) $ (8.06)
======== ======== ========
Shares used in computation of basic and
diluted net loss per share applicable to
common stockholders ............................................... 20,327 15,397 2,286
======== ======== ========
(1) Excluding $443, $301 and $98 in amortization of deferred stock-based
compensation for the years ended March 31, 2002, 2001 and 2000,
respectively.
(2) Excluding $833, $536 and $199 in amortization of deferred stock-based
compensation for the years ended March 31, 2002, 2001 and 2000,
respectively.
(3) Excluding $2,095, $983 and $394 in amortization of deferred stock-based
compensation for the years ended March 31, 2002, 2001 and 2000,
respectively.
(4) Excluding $1,742, $1,474 and $379 in amortization of deferred stock-based
compensation for the years ended March 31, 2002, 2001 and 2000,
respectively.
See accompanying notes.
46
VIRAGE, INC.
CONSOLIDATED STATEMENTS OF REDEEMABLE
CONVERTIBLE PREFERRED STOCK AND
STOCKHOLDERS' EQUITY (NET CAPITAL DEFICIENCY)
(in thousands, except share data)
Stockholders' Equity (Net Capital Deficiency)
---------------------------------------------
Redeemable Convertible
Preferred Stock Common Stock Additional
-------------------------- ------------------------- Paid-In
Shares Amount Shares Amount Capital
----------- ----------- ----------- ----------- -----------
Balance at March 31, 1999 ........... 7,282,499 $ 17,936 2,323,383 $ 2 $ 952
Issuance of Series E preferred
stock, net of issuance costs .... 3,033,700 19,059 -- -- --
Deemed dividend on Series E
preferred stock ................. -- -- -- -- 4,544
Issuance of common stock .......... -- -- 44,583 -- 185
Exercise of stock options for cash,
net of repurchases ............. -- -- 1,330,180 1 1,139
Deferred compensation related
to grant of stock options ....... -- -- -- -- 15,886
Amortization of deferred
compensation .................... -- -- -- -- --
Issuance of warrants in
consideration for advertising ... -- -- -- -- 780
Issuance of warrants in
consideration for technology
right .......................... -- -- -- -- 185
Net loss and comprehensive net
loss ........................... -- -- -- -- --
----------- ----------- ----------- ----------- -----------
Balance at March 31, 2000 ........... 10,316,199 36,995 3,698,146 3 23,671
Exercise of warrants for cash and
net exercise of warrants to
purchase preferred and common
stock .......................... 53,252 125 04,039 -- 2,000
Conversion of preferred stock to
common upon initial public
offering ....................... (10,369,451) (37,120) 10,369,451 11 37,109
Issuance of common stock from
initial public offering and
underwriter overallotment ....... -- -- 4,025,000 4 39,472
Issuance of common stock .......... -- -- 1,636,361 2 17,998
Issuance of common stock from
exercise of options, net of
repurchases and issuance of ESPP
stock ........................... -- -- 295,755 -- 1,034
Amortization of warrant fair values -- -- -- -- 6
Amortization of deferred
compensation .................... -- -- -- -- --
Issuance and remeasurement of
stock options to consultants .... -- -- -- -- 71
Reversal of deferred compensation
upon employee termination ....... -- -- -- -- (654)
Net loss and comprehensive net
loss ............................ -- -- -- -- --
----------- ----------- ----------- ----------- -----------
Balance at March 31, 2001 ........... -- -- 20,228,752 20 120,707
Issuance of common stock from
exercise of options, net of
repurchases and issuance of ESPP
stock ........................... -- -- 392,783 1 808
Amortization of warrant fair values -- -- -- -- 660
Amortization of deferred
compensation .................... -- -- -- -- --
Acceleration of stock option
vesting ........................ -- -- -- -- 123
Reversal of deferred compensation
upon employee termination ....... -- -- -- -- (911)
Net loss and comprehensive net
loss ............................ -- -- -- -- --
----------- ----------- ----------- ----------- -----------
Balance at March 31, 2002 ........... -- $ -- 20,621,535 $ 21 $ 121,387
=========== =========== =========== =========== ===========
Stockholders' Equity (Net Capital Deficiency)
---------------------------------------------
Total
Equity (Net
Deferred Accumulated Capital
Compensation Deficit Deficiency)
----------- ----------- -----------
Balance at March 31, 1999 ........... $ (399) $ (13,881) $ (13,326)
Issuance of Series E preferred
stock, net of issuance costs .... -- -- --
Deemed dividend on Series E
preferred stock ................. -- (4,544) --
Issuance of common stock .......... -- -- 185
Exercise of stock options for cash,
net of repurchases ............. -- -- 1,140
Deferred compensation related
to grant of stock options ....... (15,886) -- --
Amortization of deferred
compensation .................... 1,690 -- 1,690
Issuance of warrants in
consideration for advertising ... -- -- 780
Issuance of warrants in
consideration for technology
right .......................... -- -- 185
Net loss and comprehensive net
loss ........................... -- (13,875) (13,875)
----------- ----------- -----------
Balance at March 31, 2000 ........... (14,595) (32,300) (23,221)
Exercise of warrants for cash and
net exercise of warrants to
purchase preferred and common
stock .......................... -- -- 2,000
Conversion of preferred stock to
common upon initial public
offering ....................... -- -- 37,120
Issuance of common stock from
initial public offering and
underwriter overallotment ....... -- -- 39,476
Issuance of common stock .......... -- -- 18,000
Issuance of common stock from
exercise of options, net of
repurchases and issuance of ESPP
stock ........................... -- -- 1,034
Amortization of warrant fair values -- -- 6
Amortization of deferred
compensation .................... 4,165 -- 4,165
Issuance and remeasurement of
stock options to consultants .... (71) -- --
Reversal of deferred compensation
upon employee termination ....... 654 -- --
Net loss and comprehensive net
loss ............................ -- (28,874) (28,874)
----------- ----------- -----------
Balance at March 31, 2001 ........... (9,847) (61,174) 49,706
Issuance of common stock from
exercise of options, net of
repurchases and issuance of ESPP
stock ........................... -- -- 809
Amortization of warrant fair values -- -- 660
Amortization of deferred
compensation .................... 6,511 -- 6,511
Acceleration of stock option
vesting ........................ -- -- 123
Reversal of deferred compensation
upon employee termination ....... 911 -- --
Net loss and comprehensive net
loss ............................ -- (27,750) (27,750)
----------- ----------- -----------
Balance at March 31, 2002 ........... $ (2,425) $ (88,924) $ 30,059
=========== =========== ===========
See accompanying notes.
47
VIRAGE, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
Years Ended March 31,
------------------------------------------------
2002 2001 2000
-------- -------- --------
Cash flows from operating activities:
Net loss ............................................................... $(27,750) $(28,874) $(13,875)
Adjustments to reconcile net loss to net cash used
in operating activities:
Depreciation and amortization ........................................ 2,911 1,947 444
Loss on disposal of assets ........................................... 455 -- --
Amortization of deferred compensation related to
stock options ...................................................... 6,511 4,165 1,689
Amortization of warrant fair values .................................. 695 627 210
Acceleration of stock option vesting ................................. 123 -- --
Write-off of investment in Scimagix .................................. -- -- 79
Changes in operating assets and liabilities:
Accounts receivable ................................................ (35) (539) (832)
Prepaid expenses and other current assets .......................... 295 116 (314)
Other assets ....................................................... (69) 52 (3,116)
Accounts payable ................................................... (322) 380 589
Accrued payroll and related expenses ............................... (903) 2,620 22
Accrued expenses ................................................... (57) 1,234 1,555
Deferred revenue ................................................... 96 1,298 1,218
Deferred rent ...................................................... 179 111 --
-------- -------- --------
Net cash used in operating activities .................................. (17,871) (16,863) (12,331)
Cash flows from investing activities:
Purchase of property and equipment ..................................... (375) (6,319) (2,021)
Purchases of short-term investments .................................... (59,419) (49,383) --
Sales and maturities of short-term investments ......................... 61,762 20,932 --
-------- -------- --------
Net cash provided by (used in) investing activities .................... 1,968 (34,770) (2,021)
Cash flows from financing activities:
Proceeds from bank line of credit ...................................... -- 806 --
Principal payments on loans and capital leases ......................... -- (1,047) (281)
Proceeds from exercise of stock options, net of
repurchases .......................................................... 42 537 1,140
Proceeds from employee stock purchase plan ............................. 767 497 --
Proceeds from exercise of warrants to purchase
preferred and common stock ........................................... -- 2,125 --
Proceeds from issuance of common stock, net of
offering costs ....................................................... -- 58,288 185
Proceeds from issuance of preferred stock .............................. -- -- 19,059
-------- -------- --------
Net cash provided by financing activities .............................. 809 61,206 20,103
-------- -------- --------
Net increase (decrease) in cash and cash
equivalents .......................................................... (15,094) 9,573 5,751
Cash and cash equivalents at beginning of period ....................... 19,680 10,107 4,356
-------- -------- --------
Cash and cash equivalents at end of period ............................. $ 4,586 $ 19,680 $ 10,107
======== ======== ========
Supplemental disclosures of cash flow information:
Cash paid for interest ................................................. $ -- $ 22 $ 37
Supplemental disclosures of non-cash operating,
investing and financing activities:
Conversion of prepaid offering costs to equity at
IPO .................................................................. $ -- $ 812 $ --
Conversion of redeemable preferred stock to equity
at IPO ............................................................... $ -- $ 37,120 $ --
Deferred compensation related to stock options ......................... $ -- $ 71 $ 15,886
Reversal of deferred compensation upon employee
termination .......................................................... $ 911 $ 654 $ --
Series E convertible preferred stock dividend .......................... $ -- $ -- $ 4,544
Intangible assets resulting from fair value of
warrants ............................................................. $ -- $ -- $ 966
Book value of equipment write-downs .................................... $ 822 $ -- $ --
Accumulated depreciation of equipment write-downs ...................... $ 367 $ -- $ --
See accompanying notes.
48
VIRAGE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Organization and Summary of Significant Accounting Policies
Description of Business
Virage, Inc. ("Virage" or "the Company") is a provider of software products,
professional services and application services that enable owners of rich-media
and video assets to more effectively communicate manage, retrieve and distribute
these assets for improved productivity and communications. The Company sells
worldwide to media and entertainment enterprises, corporations, educational
institutions and government entities. The Company's customers can leverage the
Company's technology and know-how either by licensing the Company's products and
engaging its professional services or by employing the Company's application
services to outsource the customer's needs.
Basis of Presentation
The consolidated financial statements include the accounts of the Company
and its wholly-owned subsidiaries, Virage Europe, Ltd. and Virage GmbH. All
significant intercompany accounts and transactions have been eliminated in
consolidation.
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 March 31, 2002, all of the Company's 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.
Short-term investments at each year-end, including those instruments
classified as cash equivalents and restricted instruments classified as other
assets, were as follows (in thousands):
March 31,
------------------------
2002 2001
-------- --------
Money market funds ............................. $ 2,805 $ 1,877
Commercial paper and corporate
bonds ........................................ 11,818 22,966
US government obligations ...................... 17,379 22,108
-------- --------
Total investments ............................ 32,002 46,951
Amounts classified as cash
equivalents .................................. (3,805) (18,500)
Amounts classified as other assets ............. (2,089) --
-------- --------
$ 26,108 $ 28,451
======== ========
As of March 31, 2002, the Company had collateralized a letter of credit for
its primary operating facility with certain short-term investment instruments
and has classified these collateralized instruments totaling $2,089,000 as other
assets in the Company's balance sheet. As of March 31, 2002 and 2001, the fair
value approximated the amortized cost of available-for-sale securities. Realized
gains and losses from sales of investments were insignificant for all periods
presented.
49
VIRAGE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued)
Property and Equipment
Property and equipment are carried at cost less accumulated depreciation.
Property and equipment are depreciated for financial reporting purposes using
the straight-line method over the estimated useful lives of generally one to
three years or, in the case of property under capital leases and leasehold
improvements, over the lesser of the useful life of the assets or lease term.
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")
and is also consistent with the Securities and Exchange Commission's Staff
Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements." 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.
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.
50
VIRAGE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued)
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 above, 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 time-based rates of video content. Application hosting fees are
generated by and based upon the number of video queries processed, subject in
most cases to monthly minimums. The Company recognizes revenues on transaction
fees that are subject to monthly minimums based upon the monthly minimum rate
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 provided all other revenue recognition
criteria are met.
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
("FASB") 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.
Concentration of Revenues and Credit Risk
The Company performs ongoing credit evaluations of its customers and
maintains reserves for potential credit losses, and such losses have been within
management's expectations. The Company generally requires no collateral from its
customers. If the company determines that payment from the customer is not
probable, the Company defers revenues until payment from the customer is
received and all other criteria for revenue recognition (as described above)
have been met.
51
VIRAGE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued)
Major customers (non-federal government agencies). For the year ended March
31, 2002, the Company had one customer, Major League Baseball Advanced Media
L.P. ("MLBAM"), which accounted for 14% of the Company's total revenues. The
Company and MLBAM's application services contract was successfully completed and
the contract expired in February 2002. The two parties were not able to mutually
agree on terms with each other for a renewal of this contract. For the year
ended March 31, 2001, there were no customers that accounted for 10% or more of
the Company's total revenues. For the year ended March 31, 2000, two customers
each accounted for 13% and 10% of the Company's total revenues.
European customers accounted for approximately 10% and 18% of the Company's
accounts receivable balance as of March 31, 2002 and 2001, respectively.
Federal Government Agencies. For the years ended March 31, 2002, 2001 and
2000 direct and indirect revenues from federal government agencies accounted for
14%, 10%, and 12%, respectively, of total revenues. No single federal government
agency accounted for more than 10% of total revenues for the years ended March
31, 2002, 2001 or 2000.
Advertising Costs
Advertising costs are expensed as incurred. Advertising expense (including
the amortization of the fair value of a warrant during the years ended March 31,
2001 and 2000--see Note 3), totaled $54,000, $697,000 and $256,000 for the years
ended March 31, 2002, 2001and 2000, respectively.
Comprehensive Net Loss Applicable to Common Stockholders
The Company has adopted the FASB's 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, the Company has had no other comprehensive income (loss) of a
significant nature, and consequently, net loss applicable to common stockholders
equals total comprehensive net loss applicable to common stockholders.
Use of Estimates
The preparation of the Company's consolidated financial statements in
conformity with generally accepted accounting principles requires management to
make estimates and assumptions that affect the amounts reported in the Company's
consolidated financial statements and accompanying notes. Actual results could
differ materially from those estimates.
Net Loss per Share Applicable to Common Stockholders
Basic and diluted net loss per share applicable to common stockholders 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.
52
VIRAGE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued)
The following table presents the computation of basic and diluted net loss
per share applicable to common stockholders (in thousands, except per share
data):
Years Ended March 31,
----------------------------------
2002 2001 2000
-------- -------- --------
Net loss applicable to common
stockholders .......................... $(27,750) $(28,874) $(18,419)
======== ======== ========
Weighted-average shares of common
stock outstanding ..................... 20,452 15,781 2,710
Less weighted-average shares of
common stock subject to repurchase .... (125) (384) (424)
-------- -------- --------
Weighted-average shares used in
computation of basic and
diluted net loss per share
applicable to common
stockholders .......................... 20,327 15,397 2,286
======== ======== ========
Basic and diluted net loss per
share applicable to common
stockholders .......................... $ (1.37) $ (1.88) $ (8.06)
======== ======== ========
The Company has excluded all outstanding stock options, warrants and shares
subject to repurchase from the calculation of basic and diluted net loss per
share applicable to common stockholders because these securities are
antidilutive for all periods presented. Options and warrants to purchase
7,630,293, 6,502,656 and 3,779,990 shares of common stock and common stock
equivalents were outstanding at March 31, 2002, 2001 and 2000, respectively.
Such securities, had they been dilutive, would have been included in the
computation of diluted net loss per share applicable to common stockholders
using the treasury stock method.
Fair Value of Financial Instruments
The Company has evaluated the estimated fair value of financial instruments
at March 31, 2002 and 2001. The amounts reported for cash and cash equivalents,
short-term investments, accounts receivable and accounts payable approximate
their carrying values due to the short-term maturities of these instruments.
Segment Information
The Company has adopted the FASB's Statement of Financial Accounting
Standards No. 131, "Disclosures about Segments of an Enterprise and Related
Information," which establishes standards for reporting information about
operating segments. Operating segments are defined as components of an
enterprise about which separate financial information is available that is
evaluated regularly by the chief operating decision maker or group in deciding
how to allocate resources and in assessing performance. The Company's segment
information is presented in Note 7.
Long-Lived Assets
The Company has adopted the FASB's Statement of Financial Accounting
Standards No. 121, "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to be Disposed of," ("FAS 121") which requires impairment
losses to be recorded for long-lived assets used in operations, such as
property, equipment and improvements, and intangible assets, when indicators of
impairment are present and the undiscounted cash flows estimated to be generated
by those assets are less than the carrying amount of the assets. Through March
31, 2002, FAS 121 has had no impact on the Company's financial position or
results of operations other than that disclosed in Note 2.
53
VIRAGE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued)
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 adoption of FAS 141 did 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 March 31, 2002.
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. 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.
In August 2001, the FASB issued Statement of Financial Accounting Standards
No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets (FAS
144)," which addresses financial accounting and reporting for the impairment or
disposal of long-lived assets and supersedes FAS 121 and the accounting and
reporting provisions of Accounting Principles Board Opinion No. 30, "Reporting
the Results of Operations for a Disposal of a Segment of a Business." FAS 144 is
effective for fiscal years beginning after December 15, 2001, with earlier
application encouraged. The Company adopted FAS 144 as of April 1, 2002 and it
does not expect that the adoption of this statement will have a significant
impact on the Company's financial position and results of operations.
54
VIRAGE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued)
In November 2001, the FASB issued a Staff Announcement (the "Announcement"),
Topic D-103, which concluded that the reimbursement of "out-of-pocket" expenses
should be classified as revenue in the statement of operations. This
Announcement is to be applied in financial reporting periods beginning after
December 15, 2001. Upon application of this Announcement, comparative financial
statements for prior periods should be reclassified to comply with the guidance
in this Announcement. The Company adopted the Announcement in its fiscal fourth
quarter of its year ended March 31, 2002 and the Announcement did not have a
material affect on the Company's operations, financial position or cash flows.
2. Commitments and Contingencies
In the normal course of business, the Company is subject to commitments and
contingencies, including operating leases, restructuring liabilities and
litigation including securities-related litigation and other claims in the
ordinary course of business. The Company records accruals for such contingencies
based upon its assessment of the probability of occurrence and, where
determinable, an estimate of the liability. The Company considers many factors
in making these assessments including past history and the specifics of each
matter. The Company reviews its assessment of the likelihood of loss on any
outstanding contingencies as part of its on-going financial processes. However,
actual results may differ from these estimates under different assumptions and
conditions.
Leases
The Company leases certain of its facilities under operating leases, some of
which have options to extend the lease period. Rent expense was $4,678,000,
$2,714,000, and $717,000 for the years ended March 31, 2002, 2001 and 2000,
respectively.
Future minimum lease payments under non-cancelable operating leases at March
31, 2002 are as follows (in thousands):
Operating
Years Ending March 31, Leases
----------------------- ----------
2003............................ $ 3,196
2004............................ 3,105
2005............................ 3,082
2006............................ 2,940
2007............................ 1,494
----------
Total minimum payments....... $ 13,817
==========
During the years ended March 31, 2002 and 2001, the Company was able to
sublease certain of its facilities. Rental payments received that relate to the
subleases were $2,344,000 and $1,185,000 for the years ended March 31, 2002 and
2001, respectively (none for the year ended March 31, 2000). The sublease
agreements remaining provide for payments to be received by the Company of
$88,000, $66,000 and $66,000 during the years ended March 31, 2003, 2004 and
2005, respectively.
55
VIRAGE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued)
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 2004. During the years ended March 31, 2002 and 2001,
the Company was able to sublease its excess capacity at its facilities and
received rental payments from its tenants as described above. Two of the
Company's sublease tenants who accounted for the significant majority of the
Company's sublease receipts described above did not renew their sublease
agreements during the year ended March 31, 2002. The Company has not been
successful in finding any new sublease tenants and, accordingly, recorded
expense of $396,000 in the fiscal fourth quarter of the year ended March 31,
2002 to account for its excess operating capacity at its 48,000 square foot
facility in San Mateo, California. The Company also recorded $215,000 of expense
for excess facility capacity at its 21,000 square foot facility in San Mateo,
California. Should the Company continue to have excess operating lease capacity
and the Company is unable to find a sub lessee at a rate equivalent to its
operating lease rate, the Company would be required to record a charge for the
rental payments that the Company owes to its landlord relating to this excess
facility capacity. The Company's management reviews its facility requirements
and assesses whether any excess capacity exists as part of its on-going
financial processes.
Technology Provider Royalty Commitments
The Company licenses technology from third parties, including software that
is integrated with internally developed software and used in the Company's
products to perform key functions. In consideration for this, the Company is
obligated to provide its third party technology partners with cash royalty
payments generally calculated as a fee per unit of product that the Company
sells that incorporates the third party's technology. In some instances, the
Company is obligated to pay a minimum royalty or fixed-fee to the vendor,
regardless of the quantities of products the Company actually sells. Royalty
expenses are included in the Company's cost of license revenues, which totaled
$705,000, $723,000 and $870,000 for the years ended March 31, 2002, 2001 and
2000, respectively.
Future minimum and fixed fee royalty payments under these agreements at
March 31, 2002 are as follows (in thousands):
Minimum
Years Ending March 31, Commitments
----------------------- -----------
2003............................ $ 290
2004............................ 340
2005............................ 300
2006............................ 300
2007............................ 350
-----------
Total minimum payments....... $ 1,580
===========
It is the Company's best estimate as of March 31, 2002 that the Company will
recoup each period's commitment via future revenue streams generated by its
products, best evidenced by the gross profit generated historically by the
Company's license revenues. The Company believes that it has no loss-type
contracts related to its technology provider royalty commitments as of March 31,
2002.
56
VIRAGE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued)
Currently, the Company anticipates that it 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 the Company
does not believe that it is substantially dependent on any licensed technology,
some of the software the Company licenses from third parties could be difficult
for it to replace. The loss of any of these technology licenses could result in
delays in the licensing of the Company's products until equivalent technology,
if available, is developed or identified, licensed and integrated. The use of
additional third-party software would require the Company 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
the Company's products depends upon the successful operation of third-party
licensed products in conjunction with the Company's products, and therefore any
undetected errors in these licensed products could prevent the implementation or
impair the functionality of the Company's products, delay new product
introductions and/or damage the Company's reputation.
Restructuring
During the year ended March 31, 2002, the Company implemented restructuring
programs to better align operating expenses with anticipated revenues. The
Company recorded a $2,038,000 restructuring charge, which consists of $611,000
in facility exit costs, $928,000 in employee severance costs, $455,000 in
equipment write-downs, and $44,000 in other exit costs across most of the
expense line-items in the Company's consolidated statement of operations for the
year ended March 31, 2002. The restructuring programs resulted in a reduction in
force across all company functions of approximately 60 employees. At March 31,
2002, the Company had $763,000 of accrued restructuring costs related to monthly
rent for excess facility capacity, employee severance payments and other exit
costs. The Company expects to pay these accrued amounts out over the course of
the next 12 months.
The following table depicts the restructuring activity during the year ended
March 31, 2002 (in thousands):
Expenditures
--------------------- Balance at
Category Additions Cash Non-cash March 31, 2002
-------- --------- ---- -------- --------------
Excess facilities ...................... $ 611 $ 151 $ -- $ 460
Employee severance ..................... 928 669 -- 259
Equipment write-downs .................. 455 -- 455 --
Other exit costs ....................... 44 -- -- 44
------ ------ ------ ------
Total .................................. $2,038 $ 820 $ 455 $ 763
====== ====== ====== ======
During the fourth fiscal quarter of the Company's fiscal year ended March
31, 2002, the Company completed its application services contract with its
largest customer, MLBAM. The Company and MLBAM were unable to reach mutually
agreeable terms for a renewal and MLBAM had no obligation to renew its contract.
In addition, the Company's historically largest reseller announced that it is
divesting its business segment in which the Company's products are most
complementary. As a result, the Company encountered very little channel sales
activity from this reseller during the fourth fiscal quarter of its fiscal year
ended March 31, 2002. The Company believes these two factors contributed to its
quarterly decline in total revenues during the fourth fiscal quarter of its
fiscal year ended March 31, 2002. As a result of this significant customer loss
and channel partner loss, our future operating results could be significantly
harmed. In addition, if we were to lose one of our other large customers or any
of our large customers were to delay or default on obligations under their
contracts with us, our future operating results could be significantly harmed.
This could lead to the Company taking additional restructuring actions in order
to reduce costs and bring staffing in line with anticipated requirements.
57
VIRAGE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued)
The Company's application services use significant capital equipment and
other infrastructure resources that have been purchased and engaged 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. During the year ended March 31, 2002, the Company incurred equipment
write-downs of $455,000 (included in cost of service revenues) as a direct
result of a decline in demand for its application services. Should the Company
lose other customers for its application services, the Company may have excess
capacity and be required to record additional charges 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.
The Company has invested significant resources into developing and marketing
its recently introduced applications products. The Company believes that these
solutions products broaden the value proposition to that of the day-to-day
business software application user and expects to derive future revenues as a
result of these product introductions. The market for the Company's application
products is in a relatively early stage. The Company cannot predict how the
market for its application products will develop, and part of its strategic
challenge will be to convince enterprise customers of the productivity,
communications, cost and other benefits of our application products. The
Company's future revenues and revenue growth rates will depend in large part on
its success in creating market acceptance for its application products. If the
Company fails to do so, its products and services will not achieve widespread
market acceptance, and may not generate significant revenues to offset its
development, sales and marketing costs, which will hurt its business. This could
lead to the Company taking additional restructuring actions in order to reduce
costs and bring staffing in line with anticipated requirements.
Litigation
Beginning on August 22, 2001, purported securities fraud class action
complaints were filed in the United States District Court for the Southern
District of New York. The cases were consolidated and the litigation is now
captioned as In re Virage, Inc. Initial Public Offering Securities Litigation,
Civ. No. 01-7866 (SAS) (S.D.N.Y.), related to In re Initial Public Offering
Securities Litigation, 21 MC 92 (SAS) (S.D.N.Y.). On or about April 19, 2002,
plaintiffs electronically served an amended complaint. The amended complaint is
brought purportedly on behalf of all persons who purchased the Company's common
stock from June 28, 2000 through December 6, 2000. It names as defendants the
Company; two of the Company's officers; and several investment banking firms
that served as underwriters of the Company's initial public offering. The
complaint alleges liability under Sections 11 and 15 of the Securities Act of
1933 and Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, on the
grounds that the registration statement for the offering did not disclose that:
(1) the underwriters had agreed to allow certain customers to purchase shares in
the offerings in exchange for excess commissions paid to the underwriters; and
(2) the underwriters had arranged for certain customers to purchase additional
shares in the aftermarket at predetermined prices. The amended complaint also
alleges that false analyst reports were issued. No specific damages are claimed.
The Company is aware that similar allegations have been made in other
lawsuits filed in the Southern District of New York challenging over 300 other
initial public offerings and secondary offerings conducted in 1999 and 2000.
Those cases have been consolidated for pretrial purposes before the Honorable
Judge Shira A. Scheindlin. Defendants' time to respond to the complaints has
been stayed pending a plan for further coordination. The Company believes that
the allegations against it and the individual defendants are without merit, and
intends to contest them vigorously.
58
VIRAGE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued)
From time to time, the Company may become involved in litigation claims
arising from its ordinary course of business. The Company believes that there
are no claims or actions pending or threatened against it, the ultimate
disposition of which would have a material adverse effect on the Company.
3. Stockholders' Equity
Preferred Stock
The Company's Certificate of Incorporation authorizes 2,000,000 shares of
preferred stock and the Board of Directors also adopted a preferred stock
purchase right plan intended to guard the Company against certain takeover
tactics. The Company's Board of Directors has the authority to fix or alter the
designation, powers, preferences and rights of the shares of each preferred
series and qualifications, limitations or restrictions to any unissued series of
preferred stock.
Initial Public Offering
In July 2000, the Company completed its initial public offering and issued
3,500,000 shares of its common stock to the public at a price of $11.00 per
share. The Company received net proceeds of $34,105,000 in cash after deducting
the underwriters' commissions and approximately $1,700,000 of offering costs.
The Company's underwriters also exercised their over-allotment option to
purchase an additional 525,000 shares of the Company's common stock at a price
of $11.00 per share resulting in an additional $5,371,000 of net proceeds to the
Company. All outstanding shares of redeemable convertible preferred stock were
converted into an aggregate of 10,369,451 shares of common stock at the closing
of the Company's public offering.
In addition, the Company's stockholders approved a 1-for-2 reverse stock
split of the Company's preferred and common stock and also authorized an
increase in the authorized number of common shares from 20,000,000 shares to
100,000,000 shares that became effective upon the consummation of the Company's
initial public offering. All share data has been restated to reflect the reverse
stock split.
Common Stock Purchase Agreement
In July 2000, the Company completed an $18,000,000 common stock purchase
agreement with certain private investors issuing 1,636,361 common shares at
$11.00 per share concurrent with its initial public offering.
Series E Preferred Stock Dividend
In December 1999, the Company issued 684,343 additional shares of Series E
redeemable convertible preferred stock at a price of $6.56 per share for a total
purchase price of $4,489,000. The fair value of the shares at the time of
issuance was estimated to be $13.20 per share. The difference between the fair
value of $13.20 per share and issue price of $6.56 per share has been accounted
for as a deemed dividend totaling $4,544,000.
59
VIRAGE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued)
Warrants
In September 1995 and October 1996, in connection with capital lease
agreements, the Company issued warrants to purchase 23,332 shares of common
stock at an exercise price of $0.75 per share, subject to certain adjustments.
Interest expense related to the fair value of the warrants was insignificant.
The fair value of the warrants was calculated using the Black-Scholes option
pricing model assuming a fair value of common stock of $0.75, risk-free interest
rate of 6.5%, volatility factor of 40%, and a life of 10 years. The warrants
were exercised during the year ended March 31, 2001 pursuant to a net exercise
provision in the warrant agreements resulting in the issuance of 22,221 common
shares.
In May 1997, in connection with a credit facility agreement, Virage issued
warrants to purchase 8,654 shares of Series B preferred stock at an exercise
price of $2.60 per share. The warrants expire in May 2002 and as of March 31,
2002 remain outstanding. Interest expense related to the fair value of the
warrants was insignificant. The fair value of the warrants was calculated using
the Black-Scholes option pricing model assuming a fair value of Series B
preferred stock of $2.60, risk-free interest rate of 6.5%, volatility factor of
40%, and a life of 5 years.
In November 1999, the Company entered into a software development and
distribution agreement with SRI, International that provides the Company with a
non-exclusive license from SRI, International to embed and distribute SRI's
optical character recognition technology as a plug-in module to the Company's
VideoLogger product. The Company is required to pay SRI, International cash
royalty payments, subject to a minimum of $100,000 over the term of the
agreement, based upon annual license copy volumes as are defined within the
agreement. The Company also issued an immediately exercisable, nonforfeitable
warrants to purchase 19,055 shares of Series E preferred stock at an exercise
price of $6.56 per share, subject to certain adjustments. During the year ended
March 31, 2001, the warrant was exercised resulting in $125,000 of proceeds to
the Company. The Company determined the fair value of the warrants ($185,000)
using the Black-Scholes valuation model assuming a fair value of the Series E
preferred stock of $13.20, a risk-free interest rate of 5.9%, a volatility
factor of 90%, and a life of 3 years. The fair value of the warrants has been
recorded as a technology right and is being amortized to cost of goods sold over
the life of the agreement, which expires on December 31, 2004. Amortization
expense of $35,000, $35,000 and $15,000 was recorded during the years ended
March 31, 2002, 2001 and 2000, respectively.
In December 1999, the Company issued an immediately exercisable warrant to
purchase 75,435 shares of Series E preferred stock at $6.56 per share in
consideration for advertising provided by an Internet portal company. During the
year ended March 31, 2001, the warrant was net exercised by the holder resulting
in the issuance of 34,197 shares. The Company determined the fair value of the
warrant using the Black-Scholes valuation model assuming a fair value of the
Series E preferred stock of $13.20, risk-free interest rate of 6.1%, volatility
factor of 90%, and a life of 4 years. The fair value of the warrant ($781,000)
was recorded as deferred advertising costs and was amortized into sales and
marketing expense on a straight-line basis over 12 months, the term of the
advertising agreement, which commenced January 2000. Amortization expense of
$586,000 and $195,000 was recorded during the years ended March 31, 2001 and
2000, respectively.
60
VIRAGE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued)
In February 2000, the Company entered into a six-year operating lease
agreement on a new building. As part of the operating lease agreement, the
Company issued a warrant to the landlord in June 2000 to purchase 181,818 shares
of common stock at $11.00 per share which was exercised during the year ended
March 31, 2001 resulting in proceeds of $2,000,000 to the Company. The warrant
was issued concurrent with the pricing of the Company's IPO and if not
exercised, the warrant would have expired at the end of the first day that the
Company's stock began trading on NASDAQ. The Company estimated that the value of
the warrant is $72,000 using a Black-Scholes model with the following
assumptions: price of $11.00 as the deemed fair value, a risk-free interest rate
of 6.1%, a volatility factor of 90%, and an expected life of one day (based upon
the foregoing explanation of the warrant's short contractual life). The value of
the warrant is being amortized as rent expense over the term of the six-year
lease agreement and $12,000 and $6,000 was recorded during the years ended March
31, 2002 and 2001, respectively.
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 was recorded against service revenues as
revenues from services were recognized over the one-year services agreement.
During the year ended March 31, 2002, the Company recorded a charge of $648,000
as contra-service revenues representing the amortization of the warrant's fair
value.
Voluntary Stock Option Cancellation and Re-grant Program
In February 2002, the Company offered a voluntary stock option cancellation
and re-grant program to its employees. The plan allows employees with stock
options at exercise prices of $5.00 per share and greater to cancel a portion or
all of these unexercised stock options effective February 6, 2002, if they so
choose, provided that should an employee participate, any option granted to that
employee within the six months preceding February 6, 2002 is automatically
cancelled. On February 6, 2002, 2,678,250 shares with a weighted-average
exercise price of $9.54 per share were cancelled pursuant to this program. As a
result of this program, the Company was required to accelerate the amortization
of the remaining deferred compensation (see below) related to these cancelled
stock options. This acceleration of amortization is included in the $6,511,000
of deferred compensation expense recorded in the Company's statement of
operations for the year ended March 31, 2002.
On approximately August 7, 2002, each employee participating will be
granted new options equivalent to the number cancelled. The exercise price of
the new options will be the fair market price of the Company's common stock as
listed on the Nasdaq National Market at the close of business six months and one
day after the cancellation of the existing options, anticipated to be on August
7, 2002. The vesting period will remain consistent with the original option
grants. Members of the Company's Board of Directors, including the Company's
Chairman and Chief Executive Officer, and the Company's Chief Financial Officer,
Senior Vice President of Worldwide Sales and employees who are residents of
Germany are not eligible for this program. As of March 31, 2002, the Company had
an obligation to grant 2,653,250 shares pursuant to this program.
61
VIRAGE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued)
Employee Stock Plans
In December 1997, the Company's stockholders agreed to terminate the Virage,
Inc. 1995 Stock Option Plan (the "1995 Plan") and to introduce the Virage, Inc.
1997 Stock Option Plan (the "1997 Plan"). All options issued under the 1995 Plan
remained outstanding under that plan and did not become outstanding under the
1997 Plan. The 1997 Plan provides for the granting of incentive stock options
and nonqualified stock options to employees, directors, and consultants. Under
the 1997 Plan, the Board of Directors (or any properly appointed officer of the
Company) determines the term of each award and the award price. In the case of
incentive stock options, the exercise price may be established at an amount not
less than the fair market value at the date of grant, while nonstatutory options
may have exercise prices not less than 85% of the fair market value as of the
date of grant. Options granted to any person owning stock possessing more than
10% of the total combined voting power must have exercise prices of at least
110% of the fair market value at the date of grant. Options generally vest
ratably over a four-year period commencing with the grant date and expire no
later than ten years from the date of grant. The 1997 Plan provides for the
lesser of 1,000,000 shares or five percent of outstanding shares to increase the
number of shares outstanding on an annual basis effective every April 1.
Options granted under the 1995 Plan are not exercisable until they are fully
vested. Options granted under the 1997 Plan are immediately exercisable, but
shares so purchased that are not yet vested may be repurchased by Virage upon
termination of employment at the exercise price. All shares subject to options
outstanding under the 1995 Plan that expired or were terminated, canceled, or
repurchased were added to the number of shares authorized and reserved for
issuance under the 1997 Plan.
In April 2001, the Company's Board of Directors agreed to establish the
Virage 2001 Nonstatutory Stock Option Plan (the "2001 Plan"). The 2001 Plan
provides for a maximum aggregate number of shares of stock that may be issued
under the Plan of 900,000 and provides for the granting of nonqualified stock
options to employees (excluding officers of the Company and any other person
whose eligibility to receive an option under the 2001 Plan at the time of grant
would require the approval of the Company's stockholders) and consultants. Under
the 2001 Plan, the Board of Directors (or any properly appointed officer of the
Company) determines the term of each award and the award price. Options
generally vest ratably over a four-year period commencing with the grant date
and expire no later than ten years from the date of grant.
The Company has elected to follow Accounting Principles Board Opinion No.
25, "Accounting for Stock Issued to Employees" ("APB Opinion No. 25"), and
related interpretations in accounting for its employee stock options because, as
discussed below, the alternative fair value accounting provided for under the
FASB's Statement of Financial Accounting Standards No. 123, "Accounting for
Stock-Based Compensation" ("FAS 123"), requires use of option valuation models
that were not developed for use in valuing employee stock options.
62
VIRAGE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued)
A summary of all of the Company's stock option plans activity and related
information is set forth below:
Options Outstanding
--------------------------
Shares Weighted
Available Number of Average
For Grant Shares Exercise Price
---------- ---------- --------------
Balance at March 31, 1999......... 1,201,974 1,981,704 $ 0.35
Options authorized.............. 5,000,000 -- --
Options granted................. (3,121,423) 3,121,423 $ 7.26
Options exercised............... -- (1,330,430) $ 0.86
Options canceled................ 119,183 (119,183) $ 0.74
---------- ----------
Balance at March 31, 2000......... 3,199,734 3,653,514 $ 6.00
Options granted................. (3,252,025) 3,252,025 $ 8.55
Options exercised............... -- (266,481) $ 2.20
Options canceled................ 345,056 (345,056) $ 8.69
Options repurchased............. 23,897 -- $ 2.07
---------- ----------
Balance at March 31, 2001......... 316,662 6,294,002 $ 7.34
Options authorized.............. 1,900,000 -- --
Options granted................. (2,422,525) 2,422,525 $ 3.08
Options exercised............... -- (206,787) $ 0.33
Options canceled................ 3,741,351 (3,741,351) $ 9.32
Options repurchased............. 80,050 -- $ 0.34
---------- ----------
Balance at March 31, 2002......... 3,615,538 4,768,389 $ 3.92
========== ==========
As of March 31, 2002, the Company had an obligation to issue 2,653,250
shares to participants in its voluntary cancellation and re-grant program (see
above). In addition, there were 22,561 shares of common stock exercised pursuant
to stock options that were not fully vested. These shares are subject to
repurchase solely at the option of the Company at the original grant price upon
an employee's termination.
The following table summarizes information about stock options outstanding
and exercisable at March 31, 2002:
Options Outstanding Options Exercisable
--------------------------------------------- -----------------------------
Weighted-
Average Weighted-
Remaining Average Weighted-
Range of Number Contractual Exercise Price Number Average
Exercise Prices Outstanding Life (in years) Exercisable Exercise Price
- ----------------- ---------- ----------- -------------- ----------- --------------
$ 0.15-- $ 0.40 215,935 5.93 $ 0.31 211,976 $ 0.31
$ 1.00-- $ 2.50 1,553,900 9.07 $ 2.16 703,150 $ 1.86
$ 2.58-- $ 4.00 1,214,028 8.82 $ 3.33 725,816 $ 3.67
$ 4.15-- $ 6.00 1,262,083 8.59 $ 4.84 1,222,083 $ 4.84
$ 8.00-- $ 12.00 522,443 8.11 $ 9.83 494,633 $ 9.74
---------- ----------
$ 0.15-- $ 12.00 4,768,389 8.63 $ 3.92 3,357,658 $ 4.40
========== ==== ====== ========== ======
63
VIRAGE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued)
In March 2000, the Company's stockholders approved the Virage, Inc. 2000
Employee Stock Purchase Plan (the "ESPP"), which is designed to allow eligible
employees of the Company to purchase shares of the Company's common stock at
semiannual intervals through periodic payroll deductions. An aggregate of
1,500,000 shares of common stock has been reserved for the ESPP, and 319,217
shares have been issued through March 31, 2002. The number of shares reserved is
increased cumulatively by the lesser of 400,000 shares or two percent of the
number of issued and outstanding shares of common stock on the immediately
preceding March 31 on each April 1 through April 1, 2010. The ESPP is
implemented in a series of successive offering periods, each with a maximum
duration of 24 months. Eligible employees can have up to 10% of their base
salary deducted that is to be used to purchase shares of the common stock on
specific dates determined by the board of directors (up to a maximum of $25,000
per year based upon the fair market value of the shares). The price of common
stock purchased under the ESPP will be equal to 85% of the lower of the fair
market value of the common stock on the commencement date of each offering
period or the specified purchase date.
Fair Value Disclosures
As described above, the Company has elected to follow APB Opinion No. 25 and
related interpretations in accounting for its employee stock options. However,
FAS 123 requires pro forma information regarding net loss as if the Company had
accounted for and calculated the related non-cash, stock-based expense for its
employee stock plans under the fair value method prescribed under FAS 123. In
order to determine this pro forma net loss, the fair value for the Company's
options was estimated at the date of grant using the Black-Scholes option
valuation model with the following weighted average assumptions for the years
ended March 31, 2002, 2001 and 2000: risk-free interest rates of 3.0%, 6.5% and
5.8%, respectively, volatility factors of 113%, 90% and 90%, respectively, no
dividend yield and an expected life of the options of four years. The fair value
of shares issued and to be issued pursuant to the Company's employee stock
purchase plan were estimated using the following weighted average assumptions:
risk-free interest rate of 4.4%, no dividend yield, a volatility factor of 113%,
and an expected life of the option of six months. The Black-Scholes option
valuation model used by the Company to determine fair value for purposes of its
pro forma disclosure was developed for use in estimating the fair value of
traded options that have no vesting restrictions and are fully transferable. In
addition, option valuation models require the input of highly subjective
assumptions, including the expected price volatility. Because the Company's
employee stock options and stock purchase plan shares have characteristics
significantly different from those of traded options and because changes in the
subjective input assumptions can materially affect the fair value estimate, in
the Company's opinion, the existing models do not necessarily provide a reliable
single measure of the fair value of its employee stock options. The
weighted-average grant date fair value of options granted during the years ended
March 31, 2002, 2001 and 2000 was $2.35, $5.78 and $4.28, respectively, and the
weighted-average grant date fair value of ESPP shares was $1.04 and $2.07 during
the years ended March 31, 2002 and 2001, respectively. For purposes of pro forma
disclosures, the estimated fair value of the options is amortized to expense
over the options' vesting period. The pro forma net loss applicable to common
stockholders would have been $35,782,000, $35,043,000 and $19,765,000 or
$(1.76), $(2.28) and $(8.65) per share for the years ended March 31, 2002, 2001
and 2000, respectively.
64
VIRAGE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued)
Deferred Compensation & Option Vesting Acceleration
During the years ended March 31, 2001 and 2000, the Company recorded
aggregate deferred compensation of $71,000 and $15,886,000, respectively,
representing the difference between the exercise price of stock options granted
and the then deemed fair value of the Company's common stock (none for the year
ended March 31, 2002). The amortization of deferred compensation is charged to
operations over the vesting period of the options using the straight-line
method, which is typically four years. For the years ended March 31, 2002, 2001
and 2000, the Company amortized $6,511,000, $4,165,000 and $1,689,000,
respectively, of deferred compensation of which $5,113,000, 3,294,000 and
$1,070,000, respectively, related to stock options issued to employees
(presented separately in the Company's statement of operations) and $1,398,000,
$871,000 and $619,000, respectively, related to stock options issued to
consultants.
During the year ended March 31, 2002, the Company accelerated the vesting of
stock options for certain employees upon their termination pursuant to certain
agreements entered into between the former employees and the Company. Pursuant
to FIN 44, the fair value of the options of $123,000 was determined based upon
the intrinsic value of the accelerated shares as of the modification date and
was recorded as expense during the year ended March 31, 2002.
Options Issued to Consultants
As of March 31, 2002, the Company had granted options to purchase 295,523
shares of common stock to consultants at exercise prices ranging from $1.00 to
$12.00 per share. The options were granted in exchange for consulting services
to be rendered and vest over periods ranging from immediately to four years. The
Company valued these options at $2,846,000 being their fair value estimated
using a Black-Scholes valuation model assuming fair values of common stock
ranging from $1.52 to $11.00 per share, risk-free interest rates ranging from
4.75% to 6.13%, a volatility factor of 90% and a life of four years. The options
issued to consultants were marked-to-market using the estimate of fair value at
the end of each accounting period pursuant to the FASB's Emerging Issues Task
Force Issue No. 96-18, "Accounting for Equity Instruments That Are Issued to
Other Than Employees for Acquiring or in Conjunction with Selling, Goods or
Services." During the year ended March 31, 2001, the Company recorded additional
deferred compensation of $71,000 pursuant to this provision which was amortized
over the remaining vesting period. The Company recorded a non-cash, stock-based
charge to operations of $1,398,000, $871,000 and $619,000 for the years ended
March 31, 2002, 2001 and 2000, respectively, representing the amortization of
deferred compensation related to these options. The Company also reversed the
unamortized portion of deferred compensation of $29,000 related to these options
during the year ended March 31, 2002 due to the termination of service by these
consultants prior to the full-vesting of the options granted.
4. Shares Reserved
At March 31, 2002, common stock reserved for future issuance was as follows:
Number of Securities
to be Issued upon
Exercise of Weighted Shares
Outstanding Options, Average Available
Warrants and Rights Exercise Price For Grant
---------------------- --------------- ----------
Equity compensation plans approved
by stockholders................................... 4,094,511 $ 4.11 4,571,073
Equity compensation plans not approved
by stockholders................................... 882,532 $ 3.35 225,248
--------------- -----------
Total.......................................... 4,977,043 $ 3.97 4,796,321
=============== ========== ===========
65
VIRAGE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued)
Included in the 4,571,073 shares available for grant for equity
compensation plans approved by stockholders are 1,180,783 shares reserved
pursuant to the Company's ESPP (see above) and 2,653,250 shares reserved for
future issuance pursuant to the Company's voluntary cancellation and re-grant
program (see above).
5. Savings Plan
The Company maintains a savings plan under Section 401(k) of the Internal
Revenue Code. Under the plan, employees may defer certain amounts of their
pretax salaries but not more than statutory limits. The Company may make
discretionary contributions to the plan as determined by the Board of Directors.
The Company has not contributed to the plan through March 31, 2002.
6. Income Taxes
Due to operating losses and the Company's inability to recognize an
income tax benefit from current losses, there is no provision for income taxes
for the years ended March 31, 2002 or 2001. Provisions for income taxes for the
year ended March 31, 2000 consisted primarily of current foreign taxes and state
income taxes.
The difference between the provision for income taxes and the amount
computed by applying the Federal statutory income tax rate to income before
taxes is explained below (in thousands):
March 31,
-------------------------------------
2002 2001 2000
----------- ----------- ----------
Tax benefit at federal statutory rate (34%)..................... $ (9,435) $ (9,817) $ (4,705)
Loss for which no tax benefit is currently recognizable......... 6,985 8,664 4,066
Nondeductible stock compensation................................ 2,450 1,153 603
State and foreign income taxes.................................. -- -- 36
----------- ----------- ----------
Total provision............................................... $ -- $ -- $ --
=========== =========== ==========
Significant components of the Company's deferred tax assets are as follows
(in thousands):
March 31,
---------------------
2002 2001
---- ----
Deferred tax assets:
Net operating loss carryforwards.................... $ 24,000 $ 16,188
Tax credit carryforwards............................ 870 814
Other individually immaterial items................. 2,170 2,166
--------- ---------
Total deferred tax assets........................ 27,040 19,168
Valuation allowance................................... (27,040) (19,168)
--------- ---------
Net deferred tax assets............................... $ -- $ --
========= =========
FASB Statement No. 109, "Accounting for Income Taxes," provides for the
recognition of deferred tax assets if realization of such assets is more likely
than not. Based upon the weight of available evidence, which includes the
Company's historical operating performance and the reported cumulative net
losses in all prior years, the Company has provided a full valuation allowance
against its net deferred tax assets. The valuation allowance increased by
$7,872,000 and $8,642,000 during the years ended March 31, 2002 and 2001,
respectively.
66
VIRAGE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued)
As of March 31, 2002, the Company had federal and state net operating loss
carryforwards of approximately $66,000,000 and $27,000,000, respectively. As of
March 31, 2002, the Company also had federal and state research and development
tax credit carryforwards of approximately $577,000 and $300,000, respectively.
The net operating loss and tax credit carryforwards will expire at various dates
beginning in 2003, if not utilized.
Utilization of the net operating loss and tax credit carryforwards may be
subject to substantial annual limitations due to the ownership change
limitations provided by the Internal Revenue Code and similar state provisions.
The annual limitation may result in the expiration of net operating losses and
tax credit carryforwards before utilization.
7. Segment Reporting
The Company has two reportable segments: the sale of software and related
software support services including other 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
hosting and distribution fees ("application and professional 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 years ended March
31, 2002 and 2001 are as follows (in thousands):
Years Ended March 31,
-----------------------------------------
2002 2001 2000
------------- ------------- -----------
Software:
Total revenues................ $ 10,301 $ 8,018 $ 5,123
Total cost of revenues........ 1,460 1,347 1,600
----------- ----------- -----------
Gross profit.................. $ 8,841 $ 6,671 $ 3,523
=========== =========== ===========
Application and Professional
Services:
Total revenues................ $ 6,444 $ 3,383 $ 438
Total cost of revenues........ 8,005 6,906 1,930
----------- ----------- -----------
Gross loss.................... $ (1,561) $ (3,523) $ (1,492)
============ ============ ===========
Total revenues to customers located outside the United States were
approximately $3,997,000, $3,341,000 and $1,241,000 for the years ended March
31, 2002, 2001 and 2000, respectively. Virage Europe Ltd. and Virage GmbH, the
Company's European subsidiaries, accounted for approximately $2,114,000,
$2,020,000 and $1,137,000 of the Company's total revenues for the years ended
March 31, 2002, 2001 and 2000, respectively. The total combined assets of Virage
Europe Ltd. and Virage GmbH accounted for less than five percent of the
Company's total assets as of March 31, 2002 and 2001.
67
VIRAGE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued)
8. Quarterly Financial Data (Unaudited)
Three Months Ended
----------------------------------------------------------------------------------------------------
March 31, December 31, September 30, June 30, March 31, December 31, September 30, June 30,
2002 2001 2001 2001 2001 2000 2000 2000
---- ---- ---- ---- ---- ---- ---- ----
(in thousands)
Total revenues...... $ 3,221 $ 4,788 $ 4,746 $ 3,990 $ 3,623 $ 3,268 $ 2,579 $ 1,931
Gross profit........ 1,502 2,459 2,072 1,247 1,258 1,033 610 247
Net loss
applicable
to common
stockholders...... (8,966) (5,204) (6,369) (7,211) (7,028) (7,004) (7,107) (7,735)
Basic and diluted
net loss per
share applicable
to common
stockholders...... $ (0.44) $ (0.26) $ (0.31) $ (0.36) $ (0.35) $ (0.35) $ (0.38) $ (2.41)
9. Subsequent Events (Unaudited)
The Company's 1997 stock option plan provides for the lesser of 1,000,000
shares or five percent of outstanding shares to increase the number of shares
outstanding on an annual basis effective every April 1. Accordingly, 1,000,000
shares were authorized as additional shares to be granted under this plan on
April 1, 2002. In addition, 400,000 shares were authorized as additional shares
to be granted under the Company's ESPP pursuant to the plan's provisions
effective April 1, 2002.
68
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
There were no matters to be reported under this item.
PART III
Item 10. Directors and Executive Officers of the Registrant
(a) Executive Officers
The information with respect to Executive Officers is included in Part
I hereof after Item 4.
(b) Directors
The information required by this item is included in the section
entitled "Election of Directors" in the Proxy Statement for the 2002
Annual Meeting of Stockholders ("Proxy Statement") and is incorporated
by reference herein. The information regarding compliance with section
16(a) of the Exchange Act is included in the Proxy Statement and
incorporated herein by reference.
Item 11. Executive Compensation
The information required by this item is included in the section entitled
"Executive Compensation" in the Proxy Statement and is incorporated herein by
reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management
The information required by this item is included in the section entitled
"Security Ownership of Certain Beneficial Owners and Management" in the Proxy
Statement and is incorporated herein by reference and is also included in Note 4
of the Company's Consolidated Financial Statements and Notes thereto included in
Part II, Item 8, hereof.
Item 13. Certain Relationships and Related Transactions
The information required by this item is included in the section entitled
"Certain Transactions" in the Proxy Statement and is incorporated herein by
reference.
69
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K
(a) (1) Financial Statements
The consolidated financial statements of Virage as set forth under
Item 8 are filed as part of this Annual Report on Form 10-K.
(2) Financial Statement Schedule
Virage, Inc.
Schedule II--Valuation and Qualifying Accounts
(in thousands)
Additions Balance
Balance at charged to at end
beginning costs and of
Description of period expenses Write-offs Period
----------- --------- -------- ---------- ------
Fiscal year ended March 31, 2002
Allowance for doubtful accounts................$ 867 $ 286 $ -- $1,153
Fiscal year ended March 31, 2001
Allowance for doubtful accounts................$ 591 $ 276 $ -- $ 867
Fiscal year ended March 31, 2000
Allowance for doubtful accounts................$ 134 $ 457 $ -- $ 591
All other schedules are omitted because they are not applicable or the amounts
are insignificant or the required information is presented in the Consolidated
Financial Statements and Notes thereto in Item 8 above.
(3) Exhibits
Exhibit
Number Description of Document
- ------ -----------------------
3.1+ Amended and Restated Certificate of Incorporation of the Registrant
3.2+ Amended and Restated Bylaws of the Registrant
4.1+ Second Amended and Restated Rights Agreement, dated September 21, 1999,
between Registrant and certain stockholders
4.2+ Specimen Stock Certificate
4.3+ Amendment No. 1 to Second Amended and Restated Rights Agreement, dated
September 21, 1999, between Registrant and certain stockholders
4.5++ Warrant to Purchase Common Stock between Virage and MLB Advanced Media,
L.P., dated December 31, 2000
10.1+ Form of Indemnification Agreement between Registrant and Registrant's
directors and officers
10.2+ 1995 Stock Option Plan
10.3+ 1997 Stock Option Plan
10.4+ 2000 Employee Stock Purchase Plan
10.5+ Lease Agreement, dated January 17, 1996, as amended, between Casiopea
Venture Corporation and Registrant
10.6+ Lease Agreement, dated January 17, 1996, as amended, between Casiopea
Venture Corporation and Registrant
10.7+ License Agreement, dated September 27, 1999, between Office Dynamics
Limited, Protege Property and Registrant
10.8+ Security and Loan Agreement, dated November 2, 1998, as amended,
between Imperial Bank and Registrant
10.9+ Office Lease, dated February 17, 2000, between Jim Joseph, Trustee, Jim
Joseph Revocable Trust, dated January 19, 2000, and Registrant
10.10+ Agreement, dated February 28, 2000, between Pinewood Studios Limited
and Registrant
10.11 2001 Nonstatutory Stock Option Plan
23.1 Consent of Ernst & Young LLP, Independent Auditors
24.1 Power of Attorney (included on signature page)
+ Incorporated by reference to the Registrant's Registration Statement on Form
S-1 (Registration No. 333-96315).
++ Incorporated by reference to the Registrant's Quarterly Report filed on Form
10-Q on February 6, 2001.
(b) Reports on Form 8-K:
No reports on Form 8-K were filed during the fourth quarter ended March
31, 2002.
(c) See Item 14(a)(3) above.
(d) See Items 8 and 14(a)(2) above.
70
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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, on June 14, 2002.
Virage, Inc.
By: /s/ Paul G. Lego
--------------------------------------
Paul G. Lego
Chairman of the Board of Directors,
President and Chief Executive Officer
POWER OF ATTORNEY
Know all persons by these presents, that each person whose signature
appears below constitutes and appoints Paul G. Lego and Alfred J. Castino,
jointly and severally, his attorneys-in-fact, each with the power of
substitution, for him in any and all capacities, to sign any amendments to this
Report on Form 10-K, and to file the same, with exhibits thereto and other
documents in connection therewith, with the Securities and Exchange Commission,
hereby ratifying and confirming all that each of said attorneys-in-fact, or his
substitute or substitutes, may do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
Signature Title Date
--------- ----- ----
/s/ Paul G. Lego Chairman, Presdient & Chief June 14, 2002
- ------------------------------------------- Executive Officer
Paul G. Lego (Principal Executive Officer)
/s/ Alfred J. Castino Vice President and Chief June 14, 2002
- ------------------------------------------- Financial Officer
Alfred J. Castino (Principal Financial and Accounting
Officer)
/s/ Alar E. Arras Director June 14, 2002
- -------------------------------------------
Alar E. Arras
/s/ Ronald E.F. Codd Director June 14, 2002
- -------------------------------------------
Ronald E.F. Codd
/s/ Philip W. Halperin Director June 14, 2002
- -------------------------------------------
Philip W. Halperin
/s/ Randall S. Livingston Director June 14, 2002
- -------------------------------------------
Randall S. Livingston
/s/ Standish H. O'Grady Director June 14, 2002
- -------------------------------------------
Standish H. O'Grady
/s/ Lawrence K. Orr Director June 14, 2002
- -------------------------------------------
Lawrence K. Orr
/s/ William H. Younger, Jr. Director June 14, 2002
- -------------------------------------------
William H. Younger, Jr.
71
INDEX TO EXHIBITS
Exhibit
Number Description of Document
- ------ -----------------------
3.1+ Amended and Restated Certificate of Incorporation of the Registrant
3.2+ Amended and Restated Bylaws of the Registrant
4.1+ Second Amended and Restated Rights Agreement, dated September 21, 1999,
between Registrant and certain stockholders
4.2+ Specimen Stock Certificate
4.3+ Amendment No. 1 to Second Amended and Restated Rights Agreement, dated
September 21, 1999, between Registrant and certain stockholders
4.5++ Warrant to Purchase Common Stock between Virage and MLB Advanced Media,
L.P., dated December 31, 2000
10.1+ Form of Indemnification Agreement between Registrant and Registrant's
directors and officers
10.2+ 1995 Stock Option Plan
10.3+ 1997 Stock Option Plan
10.4+ 2000 Employee Stock Purchase Plan
10.5+ Lease Agreement, dated January 17, 1996, as amended, between Casiopea
Venture Corporation and Registrant
10.6+ Lease Agreement, dated January 17, 1996, as amended, between Casiopea
Venture Corporation and Registrant
10.7+ License Agreement, dated September 27, 1999, between Office Dynamics
Limited, Protege Property and Registrant
10.8+ Security and Loan Agreement, dated November 2, 1998, as amended,
between Imperial Bank and Registrant
10.9+ Office Lease, dated February 17, 2000, between Jim Joseph, Trustee, Jim
Joseph Revocable Trust, dated January 19, 2000, and Registrant
10.10+ Agreement, dated February 28, 2000, between Pinewood Studios Limited
and Registrant
10.11 2001 Nonstatutory Stock Option Plan
23.1 Consent of Ernst & Young LLP, Independent Auditors
24.1 Power of Attorney (included on signature page)
72