UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
FORM 10-Q
------------------------
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER: 0-30903
------------------------
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 ROAD, 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)
------------------------
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
[X] Yes [ ] No
The number of outstanding shares of the registrant's Common Stock, $0.001
par value, was 20,754,239 as of August 1, 2002.
-----------------------------------------------------------------
-----------------------------------------------------------------
1
VIRAGE, INC.
INDEX
PAGE
PART I: FINANCIAL INFORMATION
Item 1. Financial Statements (unaudited)
Condensed Consolidated Balance Sheets - June 30, 2002 and March 31, 2002.. 3
Condensed Consolidated Statements of Operations -- Three Months Ended
June 30, 2002 and 2001........................................... 4
Condensed Consolidated Statements of Cash Flows -- Three Months Ended
June 30, 2002 and 2001........................................... 5
Notes to Condensed Consolidated Financial Statements...................... 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations........................................ 14
Item 3. Quantitative and Qualitative Disclosures About Market Risk.......... 29
PART II: OTHER INFORMATION
Item 1. Legal Proceedings.................................................... 30
Item 2. Changes in Securities and Use of Proceeds............................ 30
Item 3. Defaults Upon Senior Securities...................................... 31
Item 4. Submission of Matters to a Vote of Security Holders.................. 31
Item 5. Other Information.................................................... 31
Item 6. Exhibits and Reports on Form 8-K..................................... 31
Signature.................................................................... 32
2
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
VIRAGE, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands)
(unaudited)
June 30, March 31,
2002 2002
--------- ---------
ASSETS
Current assets:
Cash and cash equivalents ........................ $ 2,102 $ 4,586
Short-term investments ........................... 23,430 26,108
Accounts receivable, net ......................... 1,885 2,366
Prepaid expenses and other current assets ........ 1,118 220
--------- ---------
Total current assets ......................... 28,535 33,280
Property and equipment, net ........................ 3,028 3,701
Other assets ....................................... 2,588 2,571
--------- ---------
Total assets ................................. $ 34,151 $ 39,552
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable ................................. $ 595 $ 831
Accrued payroll and related expenses ............. 2,463 2,376
Accrued expenses ................................. 2,568 2,946
Deferred revenue ................................. 3,108 3,050
--------- ---------
Total current liabilities .................... 8,734 9,203
Deferred rent ...................................... 324 290
Commitments and contingencies
Stockholders' equity:
Common stock ..................................... 21 21
Additional paid-in capital ....................... 121,553 121,387
Deferred compensation ............................ (2,056) (2,425)
Accumulated deficit .............................. (94,425) (88,924)
--------- ---------
Total stockholders' equity ................... 25,093 30,059
--------- ---------
Total liabilities and stockholders' equity ... $ 34,151 $ 39,552
========= =========
See accompanying notes.
3
VIRAGE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
(unaudited)
Three Months Ended
June 30,
-----------------------
2002 2001
-------- --------
Revenues:
License revenues ................................. $ 1,611 $ 1,882
Service revenues ................................. 1,624 2,047
Other revenues ................................... -- 61
-------- --------
Total revenues ................................. 3,235 3,990
Cost of revenues:
License revenues ................................. 187 154
Service revenues(1) .............................. 1,159 2,532
Other revenues ................................... -- 57
-------- --------
Total cost of revenues ......................... 1,346 2,743
-------- --------
Gross profit ....................................... 1,889 1,247
Operating expenses:
Research and development(2) ...................... 2,382 2,473
Sales and marketing(3) ........................... 3,685 4,439
General and administrative(4) .................... 1,142 1,332
Stock-based compensation ......................... 371 782
-------- --------
Total operating expenses ....................... 7,580 9,026
-------- --------
Loss from operations ............................... (5,691) (7,779)
Interest and other income, net ..................... 190 568
-------- --------
Net loss ........................................... $ (5,501) $ (7,211)
======== ========
Basic and diluted net loss per share ............... $ (0.27) $ (0.36)
======== ========
Shares used in computation of basic and diluted
net loss per share ............................... 20,687 20,133
======== ========
(1) Excluding $5 in amortization of deferred employee stock-based compensation
for the three months ended June 30, 2002 ($74 for the three months ended
June 30, 2001).
(2) Excluding $23 in amortization of deferred employee stock-based compensation
for the three months ended June 30, 2002 ($117 for the three months ended
June 30, 2001).
(3) Excluding $31 in amortization of deferred employee stock-based compensation
for the three months ended June 30, 2002 ($233 for the three months ended
June 30, 2001).
(4) Excluding $312 in amortization of deferred employee stock-based compensation
for the three months ended June 30, 2002 ($358 for the three months ended
June 30, 2001).
See accompanying notes.
4
VIRAGE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
Three Months Ended
June 30,
--------
2002 2001
-------- --------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss .................................................. $ (5,501) $ (7,211)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization ........................... 685 705
Loss on disposal of assets .............................. 106 --
Amortization of deferred compensation related to
stock options ......................................... 371 987
Amortization of technology right ........................ 9 9
Amortization of warrant fair values ..................... 3 219
Changes in operating assets and liabilities:
Accounts receivable ................................... 481 (159)
Prepaid expenses and other current assets ............. (898) (424)
Other assets .......................................... (26) --
Accounts payable ...................................... (236) (139)
Accrued payroll and related expenses .................. 87 (840)
Accrued expenses ...................................... (378) 395
Deferred revenue ...................................... 58 300
Deferred rent ......................................... 34 56
-------- --------
Net cash used in operating activities ..................... (5,205) (6,102)
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment ........................ (118) (85)
Purchase of short-term investments ........................ (22,600) (30,407)
Sales and maturities of short-term investments ............ 25,278 23,328
-------- --------
Net cash provided by (used in) investing activities ....... 2,560 (7,164)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from exercise of stock options, net of repurchases 10 (11)
Proceeds from employee stock purchase plan ................ 151 489
-------- --------
Net cash provided by financing activities ................. 161 478
-------- --------
Net decrease in cash and cash equivalents ................. (2,484) (12,788)
Cash and cash equivalents at beginning of period .......... 4,586 19,680
-------- --------
Cash and cash equivalents at end of period ................ $ 2,102 $ 6,892
======== ========
SUPPLEMENTAL DISCLOSURES OF NONCASH
OPERATING, INVESTING AND FINANCING ACTIVITIES:
Deferred compensation related to stock options ............ $ 36 $ 71
Reversal of deferred compensation upon employee termination $ 34 $ 234
See accompanying notes.
5
VIRAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2002
(unaudited)
1. Summary of Significant Accounting Policies
Basis of Presentation
The accompanying unaudited condensed consolidated financial statements have
been prepared in accordance with generally accepted accounting principles for
interim financial information and in accordance with the instructions to Form
10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of
the information and footnotes required by generally accepted accounting
principles for complete financial statements. In the opinion of management, all
adjustments (consisting of normal recurring accruals) necessary for a fair
presentation of the financial statements at June 30, 2002 and for the three
month periods ended June 30, 2002 and 2001 have been included.
The condensed consolidated financial statements include the accounts of
Virage, Inc. (the "Company") and its majority owned subsidiaries, Virage Europe,
Ltd. and Virage GmbH. All significant intercompany balances and transactions
have been eliminated in consolidation.
Results for the three months ended June 30, 2002 are not necessarily
indicative of results for the entire fiscal year or future periods. These
financial statements should be read in conjunction with the consolidated
financial statements and the accompanying notes included in the Company's Annual
Report on Form 10-K, dated June 14, 2002 as filed with the United States
Securities and Exchange Commission. The accompanying balance sheet at March 31,
2002 is derived from the Company's audited consolidated financial statements at
that date.
Revenue Recognition
The Company enters into arrangements for the sale of licenses of software
products and related maintenance contracts, application services and
professional services offerings; and also receives revenues under U.S.
government agency research grants. Service revenues include revenues from
maintenance contracts, application services, and professional services. Other
revenues are primarily U.S. government agency research grants.
The Company's revenue recognition policy is in accordance with the American
Institute of Certified Public Accountants' ("AICPA") Statement of Position No.
97-2 ("SOP 97-2"), "Software Revenue Recognition", as amended by Statement of
Position No. 98-4, "Deferral of the Effective Date of SOP 97-2, "Software
Revenue Recognition"" ("SOP 98-4"), and Statement of Position No. 98-9,
"Modification of SOP No. 97-2 with Respect to Certain Transactions" ("SOP 98-9")
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.
6
VIRAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
June 30, 2002
(unaudited)
Revenue is recognized on licensed software on a per user or per server basis
for a fixed fee when the product master is delivered to the customer. There is
no right of return or price protection for sales to domestic and international
distributors, system integrators, or value added resellers (collectively,
"resellers"). In situations where the reseller has a purchase order or other
contractual agreement from the end user that is immediately deliverable, the
Company recognizes revenue on shipment to the reseller, if other criteria in SOP
97-2 are met, since the Company has no risk of concessions. The Company defers
revenue on shipments to resellers if the reseller does not have a purchase order
or other contractual agreement from an end user that is immediately deliverable
or other criteria in SOP 97-2 are not met. The Company recognizes royalty
revenues upon receipt of the quarterly reports from the vendors.
When licenses and maintenance are sold together with professional services
such as consulting and implementation, license fees are recognized upon
shipment, provided that (1) the criteria in the previous paragraph have been
met, (2) payment of the license fee is not dependent upon the performance of the
professional services, and (3) the services do not include significant
alterations to the features and functionality of the software.
Should professional services be essential to the functionality of the
licenses in a license arrangement which contains professional services or should
an arrangement not meet the criteria mentioned 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.
7
VIRAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
June 30, 2002
(unaudited)
Use of Estimates
The preparation of the accompanying unaudited condensed consolidated
financial statements requires management to make estimates and assumptions that
effect the amounts reported in these financial statements. Actual results could
differ from those estimates.
Cash Equivalents and Short-Term Investments
The Company invests its excess cash in money market accounts and debt
instruments and considers all highly liquid debt instruments purchased with an
original maturity of three months or less to be cash equivalents. Investments
with an original maturity at the time of purchase of over three months are
classified as short-term investments regardless of maturity date, as all such
instruments are classified as available-for-sale and can be readily liquidated
to meet current operational needs. At June 30, 2002, all of the Company's total
cash equivalents and short-term investments were classified as
available-for-sale and consisted of obligations issued by U.S. government
agencies and multinational corporations, maturing within one year.
Comprehensive Net Loss
The Company has adopted the Financial Accounting Standards Board's ("FASB")
Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive
Income" ("FAS 130"). FAS 130 establishes standards for the reporting and display
of comprehensive income (loss) and its components in a full set of general
purpose financial statements. To date, unrealized gains and losses have been
insignificant and the Company has had no other significant comprehensive income
(loss), and consequently, net loss equals total comprehensive net loss.
Net Loss per Share
Basic and diluted net loss per share are computed in conformity with the
FASB's Statement of Financial Accounting Standards No. 128, "Earnings Per Share"
("FAS 128"), for all periods presented, using the weighted average number of
common shares outstanding less shares subject to repurchase.
The following table presents the computation of basic and diluted net loss
per share and pro forma basic and diluted net loss per share (in thousands,
except per share data):
Three Months Ended
June 30,
-------------------------
2002 2001
-------- --------
Net loss ............................. $ (5,501) $ (7,211)
======== ========
Weighted-average shares of
common stock outstanding ........... 20,706 20,343
Less: Weighted-average shares of
common stock subject to
repurchase ......................... (19) (210)
-------- --------
Weighted-average shares used
in computation of basic and
diluted net loss per share ......... 20,687 20,133
======== ========
Basic and diluted net loss per
share .............................. $ (0.27) $ (0.36)
======== ========
8
VIRAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
June 30, 2002
(unaudited)
Impact of Recently Issued Accounting Standards
In June 2001, the FASB issued Statement of Financial Accounting Standards
No. 141, "Business Cominations ("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 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 June 30, 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 Company has adopted
FAS 142, which has not had 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." The
Company adopted FAS 144 as of April 1, 2002 and the adoption of this statement
has not had 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. 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.
9
VIRAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
June 30, 2002
(unaudited)
Restructuring
During the three months ended June 30, 2002, the Company implemented
additional restructuring programs to better align operating expenses with
anticipated revenues. The Company recorded a $731,000 restructuring charge,
which consisted of $625,000 in employee severance costs and $106,000 in
equipment write-downs across most of the expense line items in the Company's
consolidated statement of operations for the three months ended June 30, 2002.
The restructuring programs resulted in a reduction in force across all company
functions of approximately 30 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 out all restructuring amounts accrued as of June 30, 2002 over
the course of the next 12 months.
The following table depicts the restructuring activity during the three
months ended June 30, 2002 (in thousands):
Balance at Expenditures Balance at
Category March 31, 2002 Additions Cash Non-cash June 30, 2002
- -------- -------------- --------- ---- -------- -------------
Excess facilities .............. $460 $ -- $163 $ -- $297
Employee severance ............. 259 625 235 -- 649
Equipment write-downs .......... -- 106 -- 106 --
Other exit costs ............... 44 -- -- 6 38
---- ---- ---- ---- ----
Total ....................... $763 $731 $398 $112 $984
==== ==== ==== ==== ====
During the three months ended June 30, 2001, the Company implemented
restructuring programs to better align operating expenses with anticipated
revenues. The Company recorded a $712,000 restructuring charge, which consisted
of $345,000 in facility exit costs and $367,000 in employee severance costs
across most of the expense line items in the Company's consolidated statement of
operations for the three months ended June 30, 2001. The restructuring programs
resulted in a reduction in force across all company functions of approximately
35 employees. At June 30, 2001, the Company had $397,000 of accrued
restructuring costs related to monthly rent for excess facility capacity,
employee severance payments and other exit costs. The Company paid these accrued
amounts out over the course of the 12 months subsequent to June 30, 2001.
The following table depicts the restructuring activity during the three
months ended June 30, 2001 (in thousands):
Balance at
Category Additions Cash Expenditures June 30, 2001
- -------- --------- ----------------- -------------
Excess facilities............. $ 345 $ -- $ 345
Employee severance............ 367 315 52
-------- -------- -------
Total...................... $ 712 $ 315 $ 397
======== ======== =======
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 business software
application users 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 its 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.
10
VIRAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
June 30, 2002
(unaudited)
The Company has experienced excess operating lease capacity and should it
continue to be unable to find a sub lessee at a rate equivalent to its operating
lease rate, the Company may be required to record a charge for the rental
payments that it owes to its landlord relating to any 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.
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; one current and one former officer of the Company; 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. On July 15, 2002, the Company (and the other issuer
defendants) filed a motion to dismiss. The Company believes that the allegations
against it and the individual defendants are without merit, and intends 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.
3. Stockholders' Equity
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 allowed 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
chose, provided that should an employee participate, any option granted to that
employee within the six months preceding February 6, 2002 was also 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 is required to grant its employees stock
options on August 7, 2002 at the closing market price as of that date (see Note
5).
11
VIRAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
June 30, 2002
(unaudited)
Warrant Issued to a Customer
In December 2000, the Company entered into a services agreement with a
customer 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 three months ended June 30, 2001, the Company recorded $216,000 as
contra-service revenues representing the pro-rata amortization of the warrant's
value for the aforementioned period (none during the three months ended June 30,
2002).
4. Segment Reporting
The Company has two reportable segments: the sale of software and related
software support services including revenues from U.S. government agencies
("software") and the sale of its application and professional services which
includes set-up fees, professional services fees, video processing fees, and
application hosting fees ("application 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 three months ended
June 30, 2002 and 2001 are as follows (in thousands):
Three Months Ended
June 30,
-------------------------
2002 2001
----------- -----------
Software:
Total revenues.................. $ 2,250 $ 2,586
Total cost of revenues.......... 386 358
----------- -----------
Gross profit.................... $ 1,864 $ 2,228
=========== ===========
Application and Professional Services:
Total revenues.................. $ 985 $ 1,404
Total cost of revenues.......... 960 2,385
----------- -----------
Gross profit (loss)............. $ 25 $ (981)
=========== ===========
12
VIRAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
June 30, 2002
(unaudited)
5. Subsequent Events (Unaudited)
NASDAQ National Market Trading Requirements
The Company's stock is currently traded on the NASDAQ National Market and the
bid price for its common stock has been under $1.00 per share for over 30
consecutive trading days. Under NASDAQ's listing maintenance standards, if the
closing bid price of the Company's common stock is under $1.00 per share for 30
consecutive trading days, NASDAQ may choose to notify the Company that it may
delist its common stock from the NASDAQ National Market. On July 24, 2002, the
Company received notice from NASDAQ that it is not in compliance with NASDAQ's
listing maintenance standards and that it has until October 22, 2002 to regain
compliance. If at any time before October 22, 2002 the bid price of the
Company's common stock closes at $1.00 per share or more for a minimum of 10
consecutive trading days, NASDAQ will consider notifying the Company that it
complies with the maintenance standards. If the Company is unable to meet this
minimum bid price requirement by October 22, 2002, the Company expects to have
the option of transferring to the NASDAQ SmallCap Market, which makes available
a 180 calendar day extended grace period for the minimum $1.00 bid price
requirement (instead of a 90 day grace period as provided by the NASDAQ National
Market). In addition, the Company expects that it may also be eligible for an
additional 180 calendar day grace period on the NASDAQ SmallCap Market (ie.
until July 21, 2003) provided that the Company meets the other non-bid price
related listing criteria. If the Company transfers to the NASDAQ SmallCap
Market, the Company expects that it may be eligible to transfer back to the
NASDAQ National Market if its bid price maintains the $1.00 per share
requirement for 30 consecutive trading days and it has maintained compliance
with all other continued listing requirements for the NASDAQ National Market.
There can be no assurance that the Company's common stock will remain eligible
for trading on the NASDAQ National Market or the NASDAQ SmallCap Market. If the
Company's stock were delisted, the ability of the Company's stockholders to sell
any of the Company's common stock at all would be severely, if not completely,
limited.
Issuance of Stock Options Pursuant to Voluntary Stock Option Cancellation and
Re-grant Program
On August 7, 2002, the Company issued 2,538,250 shares at $0.59 per share to
employees that participated in the Company's Voluntary Stock Option Cancellation
and Re-grant Program (described in Note 3 above).
13
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following discussion and analysis of our financial condition and results
of operations should be read in conjunction with the "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.
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.
Recent Events
Application Products
Recently, we introduced four new application products: VS Publishing, VS
Webcasting, VS Learning, and VS Production. 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. VS Webcasting allows corporations to self-produce live and
on-demand webcasting events such as executive communications, human resource
broadcasts and webinars. 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. Finally, VS Production is an integrated
software solution for media and entertainment enterprises that automates the
professional video production process from acquisition to distribution.
These products have been developed and have shipped, or are in their final
development stages, and we expect to have shipped them all by the end of our
second fiscal quarter. We continue to 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.
14
Business Restructuring Charges
During the three months ended June 30, 2002, we executed additional
restructuring measures to reduce headcount and infrastructure and to consolidate
operations worldwide. We re-evaluated our cost structure and further reduced
headcount and infrastructure across all functional areas of the company in our
continued efforts to limit our future expense growth. These headcount and
infrastructure changes resulted in a reduction in force of approximately 30
employees worldwide and the recording of $731,000 in business restructuring
charges during the quarter. A breakdown of our business restructuring charges
during the quarter and the remaining restructuring accrual as of June 30, 2002
is as follows:
Balance at Expenditures Balance at
Category March 31, 2002 Additions Cash Non-cash June 30, 2002
-------- -------------- --------- ---- -------- -------------
Excess facilities and other exit costs.. $ 504 $ -- $ 169 $ -- $ 335
Employee separation and other costs..... 259 625 235 -- 649
Equipment write-downs................... -- 106 -- 106 --
------- ------- ----- ----- -----
Total.............................. $ 763 $ 731 $ 404 $ 106 $ 984
======= ======= ===== ===== =====
Excess Facilities and Other Exit Costs: Excess facilities and other exit
costs relate to lease obligations and closure costs associated with offices we
have vacated as a result of our cost reduction initiatives. Cash expenditures
for excess facilities and other exit costs during the three months ended June
30, 2002 primarily represent contractual ongoing lease payments. In our San
Mateo, CA headquarters location, we have an operating lease commitment for
approximately 48,000 square feet of office space, an amount higher than our
current needs. It is our management's best estimate that some of this space will
continue to be under-utilized for the next nine months and that we will not be
able to recoup all losses from our rental payments for the period from July 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.
Should we continue to have excess operating lease capacity subsequent to March
31, 2003 and be unable to find a sub lessee at a rate equivalent to our
operating lease rate, we may be required to record additional charges for the
rental payments that we owe to our landlord relating to excess capacity within
this facility. Our management reviews our facility requirements and assesses
whether any excess capacity exists as part of our on-going financial processes.
Employee Severance: Employee separation and other costs, which include
severance, related taxes, outplacement and other benefits, totaled approximately
$625,000 during the three months ended June 30, 2002 (representing approximately
30 terminated employees), and $235,000 was paid in cash during the three months
ended June 30, 2002. Personnel affected by the cost reduction initiatives during
the three months ended June 30, 2002 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
non-sales personnel in our United Kingdom subsidiary.
Equipment Write-Downs: As part of our cost restructuring efforts, we decided
to substantially downsize our subsidiary in the United Kingdom, primarily in
response to weak market conditions in Europe. Pursuant to these efforts, we
reduced our European asset infrastructure by reducing a number of assets used by
terminated employees and wrote-off approximately $106,000 of assets at net book
value. 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 August 7, 2002, we issued 2,538,250 stock options to
current employees who participated in the program with a new exercise price
equal to $0.59 per share.
15
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.
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.
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.
16
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.
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 is 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.
17
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.
Results of Operations
The following table sets forth consolidated financial data for the periods
indicated, expressed as a percentage of total revenues.
Three Months Ended
June 30,
-------------------------
2002 2001
------- ------
Revenues:
License revenues...................... 50% 47%
Service revenues...................... 50 51
Other revenues........................ -- 2
---- ----
Total revenues................ 100 100
---- ----
Cost of revenues:
License revenues...................... 6 4
Service revenues...................... 36 63
Other revenues........................ -- 2
---- ----
Total cost of revenues........ 42 69
---- ----
Gross profit............................ 58 31
Operating expenses:
Research and development.............. 74 62
Sales and marketing................... 114 111
General and administrative............ 35 33
Stock-based compensation.............. 11 20
---- ----
Total operating expenses...... 234 226
---- ----
Loss from operations.................... (176) (195)
Interest and other income, net.......... 6 14
---- ----
Net loss................................ (170)% (181)%
==== ====
We incurred a net loss of $5,501,000 during the three months ended June 30,
2002. As of June 30, 2002, we had an accumulated deficit of $94,425,000. 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.
Revenues. Total revenues decreased to $3,235,000 for the three months ended
June 30, 2002 from $3,990,000 for the three months ended June 30, 2001, a
decrease of $755,000. This decrease was due to decreases in license, service and
other revenues. International revenues decreased to $714,000, or 22% of total
revenues, during the three months ended June 30, 2002 from $1,164,000, or 29% of
total revenues, during the three months ended June 30, 2001. No customer
accounted for more than 10% of total revenues for the three months ended June
30, 2002. Sales to two customers (one of which was a reseller of our products)
each accounted for 16% of total revenues for the three months ended June 30,
2001.
18
License revenues decreased to $1,611,000 during the three months ended June
30, 2002 from $1,882,000 during the three months ended June 30, 2001. This
decrease is primarily due to lower unit sales of the SmartEncode product suite
during the three months ended June 30, 2002 resulting from fewer signed deals
and in response to the weakened overall technology spending environment.
Service revenues decreased to $1,624,000 for the three months ended June
30, 2002 from $2,047,000 for the three months ended June 30, 2001, a decrease of
$423,000. This decrease is the result of lower revenues in our application
services business, primarily due to the non-renewal of our contract with Major
League Baseball Advanced Media ("MLBAM"). Service revenues during the three
months ended June 30, 2001 include $216,000 of warrant amortization recorded as
contra-service revenues resulting from a warrant issued to MLBAM.
Other revenues were $61,000 during the three months ended June 30, 2001
(none during the three months ended June 30, 2002). This decrease 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 decreased to
$1,346,000, or 42% of total revenues, for the three months ended June 30, 2002
from $2,743,000, or 69% of total revenues, for the three months ended June 30,
2001. This decrease in total cost of revenues was due primarily to a decrease in
our cost of service revenues, slightly offset by an increase in the cost of
license revenues. We expect our total cost of revenues to be relatively flat
during our second fiscal quarter in comparison to our first fiscal quarter ended
June 30, 2002, however our total cost of revenues is highly variable. Generally,
we expect that increases or decreases in the dollar amount of our total cost of
revenues will correlate with increases or decreases in the dollar amount of our
total revenues.
Cost of license revenues increased to $187,000, or 12% of license revenues,
during the three months ended June 30, 2002 from $154,000, or 8% of license
revenues, during the three months ended June 30, 2001. This increase was due to
higher unit sales of our products that are subject to unit-based (rather than
fixed-fee) license royalty payments for the three months ended June 30, 2002 in
comparison to the three months ended June 30, 2001.
Cost of service revenues decreased to $1,159,000, or 71% of service
revenues, for the three months ended June 30, 2002 from $2,532,000, or 124% of
service revenues for the three months ended June 30, 2001. This decrease was due
to lower expenditures for our application services business, primarily due to
the non-renewal of our contract with MLBAM.
Cost of other revenues was $57,000, or 93% of other revenues, during the
three months ended June 30, 2001 (none for the three months ended June 30,
2002). This decrease 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 decreased to $2,382,000, or 74% of total revenues, for
the three months ended June 30, 2002 from $2,473,000, or 62% of total revenues,
for the three months ended June 30, 2001. The decrease in absolute dollars was
primarily due to lower variable office and equipment costs and reduced product
development expenses. We expect research and development expenses to increase
modestly for the foreseeable future as we believe that 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.
19
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 decreased to $3,685,000, or 114% of total revenues,
during the three months ended June 30, 2002 from $4,439,000, or 111% of total
revenues, during the three months ended June 30, 2001. The decrease in absolute
dollars was primarily due to lower variable headcount costs and reduced
discretionary marketing program spending. We expect sales and marketing expenses
to remain in the range of relatively flat to a modest decrease for the
foreseeable future as we attempt to limit our overall expense growth and focus
our marketing activities in specific areas.
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 $1,142,000, or 35% of total revenues,
for the three months ended June 30, 2002 from $1,332,000 or 33% of total
revenues, for the three months ended June 30, 2001. The decrease in absolute
dollars was primarily due to lower variable headcount costs and reduced
professional services fees. We expect general and administrative expenses to
remain relatively flat for the foreseeable future as we attempt to limit our
overall expense growth.
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 $371,000 and
$782,000 for the three months ended June 30, 2002 and 2001, respectively, in
connection with the granting of stock options to our employees. Our stock-based
compensation expense for the three months ended June 30, 2002 decreased due to
the cancellation of stock options resulting from participation in our voluntary
stock option cancellation and re-grant program for our employees during the year
ended March 31, 2002. The implementation of this cancellation and re-grant
program resulted in the immediate expensing of the majority of our
employee-related deferred compensation in our fourth fiscal quarter of 2002. As
a result, our stock-based compensation expenses are, and are expected to
continue to be, lower than fiscal 2002 levels. 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. Interest and other income, net includes interest
income from cash and cash equivalents. Interest and other income decreased to
$190,000 for the three months ended June 30, 2002 from $568,000 for the three
months ended June 30, 2001, a decrease of $378,000. The decrease was a result of
lower interest rates and lower average cash balances during the three months
ended June 30, 2002.
Provision for Income Taxes. We have not recorded a provision for any
significant federal and state or foreign income taxes in either the three months
ended June 30, 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.
Liquidity and Capital Resources
As of June 30, 2002, we had cash, cash equivalents and short-term
investments of $25,532,000, a decrease of $5,162,000 from March 31, 2002 and our
working capital, defined as current assets less current liabilities, was
$19,801,000, a decrease of $4,276,000 in working capital from March 31, 2002.
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 $5,205,000, and
$6,102,000 for the three months ended June 30, 2002 and 2001, respectively. The
cash used in these periods was primarily attributable to net losses of
$5,501,000 and $7,211,000 in the three months ended June 30, 2002 and 2001,
respectively, offset by depreciation expense, losses on disposals of assets, and
non-cash, stock-based charges.
20
Investing activities resulted in cash inflows of $2,560,000 and cash
outflows of $7,164,000 for the three months ended June 30, 2002 and 2001,
respectively. Our investing activity cash inflows were due to the sale and
maturity of our short-term investments and our investing activity cash outflows
were primarily for the purchase of short-term investments and capital equipment
during both periods. 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 $161,000 and $478,000
during the three months ended June 30, 2002 and 2001, respectively. These
inflows were primarily from the proceeds of our employee stock purchase plan
during the three months ended June 30, 2002 and 2001.
At June 30, 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. For the remainder of
our fiscal year ended March 31, 2003, our total commitments amount to
$2,542,000. Future full fiscal year commitments are as follows: $3,466,000 in
2004, $3,382,000 in 2005, $3,240,000 in 2006 and $1,844,000 in 2007 ($14,474,000
in total commitments as of June 30, 2002).
We anticipate that our current cash, cash equivalents and short-term
investments will be sufficient to meet our anticipated cash needs for working
capital and capital expenditures for 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.
21
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 revenues, cost of revenues, and expense forecasts are based upon the best
information we have available, but our operating results have historically been
volatile and there are a number of risks that make it difficult for us to
foresee or accurately evaluate factors that may impact our forecasts.
Our quarterly operating results have varied significantly in the past and
are likely to vary significantly in the future. We believe that period-to-period
comparisons of our results of operations are not meaningful and should not be
relied upon as indicators of future performance. Our operating results have in
past quarters fallen below securities analyst expectations and will likely fall
below their expectations in some future quarter or quarters.
We have limited visibility into future demand, and our limited operating
history makes it difficult for us to foresee or accurately evaluate factors that
may impact such future demand. Our visibility over our potential sales is
typically limited to the current quarter and our visibility for even the current
quarter is rather limited. In order to provide a revenue forecast for the
current quarter, we must make assumptions about conversion of 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 perform professional services timely, 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 spending. In addition, 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. Our
assumptions about conversion of these potential sales into current quarter
revenues could be materially incorrect. We are reliant on third party resellers
for a significant portion of our license revenues and we have limited visibility
into the status of orders from such third parties.
For quarters beyond the current quarter, we have very limited visibility
into potential sales opportunities, and thus we have a lower confidence level in
any revenue forecast or forward-looking guidance. In developing a revenue
forecast for such quarters, we assess any customer indications about future
demand, general industry trends, marketing lead development activities,
productivity goals for the sales force and expected growth in sales personnel,
and any demand for products that we may have.
Our cost of sales and expense forecasts are based upon our budgets and
spending forecasts for each area of the Company. Circumstances we may not
foresee could increase cost and expense levels beyond the levels forecasted.
Such circumstances may include competitive threats in our markets which we may
need to address with additional sales and marketing expenses, 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.
22
The failure of any significant contracts to meet our policies for recognizing
revenue may prevent us from achieving our revenue objectives for a quarter or a
fiscal year, which would hurt our operating results.
Our sales contracts are typically based upon standard agreements that meet
our revenue recognition policies. However, our future sales may include site
licenses, 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 revenues and
operating results.
In addition, customers that license our products may require consulting,
implementation, maintenance and training services and obtain them from our
internal professional services, customer support and training organizations.
When we provide these services in connection with a software license
arrangement, our revenue recognition policy may require us to recognize the
software license fee as the implementation services are performed or defer the
fee until the completion of the services, which may hurt our reported revenues
and operating results.
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 such risks may
ultimately prove our business model invalid, thereby hurting our financial
results.
We have invested significant resources into developing and marketing our
recently introduced application products and do not know whether our business
model and strategy will be successful. The market for these products is in a
relatively early stage. 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 delivering these new products effectively and
creating market acceptance for these products. If we fail to do so, our products
and services will not achieve widespread market acceptance, and we may not
generate significant revenues to offset our development, sales and marketing
costs, which will hurt our business. Additionally, our future success will
continue to depend upon our ability to develop new products or product
enhancements that address future needs of our target markets and to respond to
these changing standards and practices.
In addition, resources may be required to fund development of our
application products' feature-sets beyond what we have planned due to
unanticipated marketplace demands. We may determine that we are unable to fund
these additional feature-sets due to financial constraints and may halt the
development of a product at a stage that the marketplace perceives as immature.
We may also encounter that the marketplace for an application product is not as
robust as we had expected and we may react to this by leaving the development of
a product at an early stage. Either of these product development scenarios may
impede market acceptance of any of our new application products and therefore
hurt our financial results.
The length of our sales and deployment cycle is uncertain, which may cause our
revenues and operating results to vary significantly from quarter to quarter.
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.
23
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.
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 June 30, 2002, we had an accumulated deficit of $94,425,000. 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 $25,532,000 as of June 30, 2002 and we used $5,205,000
in our operating activities during the three months ended June 30, 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 June 30,
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.
Failure to comply with NASDAQ's listing standards could result in our delisting
by NASDAQ from the NASDAQ National Market and severely limit the ability to sell
any of our common stock.
Our stock is currently traded on the NASDAQ National Market and the bid price
for our common stock has been under $1.00 per share for over 30 consecutive
trading days. Under NASDAQ's listing maintenance standards, if the closing bid
price of our common stock is under $1.00 per share for 30 consecutive trading
days, NASDAQ may choose to notify us that it may delist our common stock from
the NASDAQ National Market. On July 24, 2002, we received notice from NASDAQ
that we are not in compliance with NASDAQ's listing maintenance standards and
that we have until October 22, 2002 to regain compliance. If at anytime before
October 22, 2002, the bid price of our common stock closes at $1.00 per share or
more for a minimum of 10 consecutive trading days, NASDAQ will consider
notifying us that we comply with its maintenance standards. If we are unable to
meet this minimum bid price requirement by October 22, 2002, we expect to have
the option of transferring to the NASDAQ SmallCap Market, which makes available
a 180 calendar day extended grace period for the minimum $1.00 bid price
requirement. In addition, we expect that we may also be eligible for an
additional 180 calendar day grace period on the NASDAQ SmallCap Market (ie.
until July 21, 2003) provided that we meet the other non-bid price related
listing criteria. However, we believe that a transfer to the NASDAQ SmallCap may
be negatively perceived by the market, analysts who follow our stock and
stockholders. There can be no assurance that our common stock will remain
eligible for trading on the NASDAQ National Market or the NASDAQ SmallCap
Market. If our stock were delisted, the ability of our stockholders to sell any
of our common stock at all would be severely, if not completely, limited.
24
We expect the market price of our common stock to be volatile.
The market price of our common stock has experienced both significant
increases in valuation and significant decreases in valuation, over short
periods of time. We believe that factors such as announcements of developments
related to our business, fluctuations in our operating results, failure to meet
securities analysts' expectations, general conditions in the software and high
technology industries and the worldwide economy, announcements of technological
innovations, new systems or product enhancements by us or our competitors,
acquisitions, changes in governmental regulations, developments in patents or
other intellectual property rights and changes in our relationships with
customers and suppliers could cause the price of our common stock to continue to
fluctuate substantially. In addition, in recent years the stock market in
general, and the market for small capitalization and high technology stocks in
particular, has experienced extreme price fluctuations that have often been
unrelated to the operating performance of affected companies. Any of these
factors could adversely affect the market price of our common stock.
Our restructuring efforts may not result in the intended benefits. We may be
required to record additional restructuring charges and this may adversely
affect the morale and performance of our personnel we wish to retain and may
also adversely affect our ability to hire new personnel.
During the past few quarters, including the quarter ended June 30, 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 incurred
charges for employee severance and excess facility capacity. While we believe
that these steps help us achieve greater operating efficiency, we have limited
history with such measures and the results of these measures are less than
predictable. The Company currently believes additional steps may be required. We
believe workforce reductions and management changes create anxiety and
uncertainty and may adversely affect employee morale. These measures could
adversely affect our employees that we wish to retain and may also adversely
affect our ability to hire new personnel. They may also affect customers and/or
vendors, which could harm our ability to operate as intended and which would
harm our business.
In addition, should we continue to have excess operating lease capacity and
we are 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 any excess facility capacity, which
would harm our operating results. Our management reviews our facility
requirements and assesses whether any excess capacity exists as part of our
on-going financial processes.
The prices we charge for our products and services may decrease or the pricing
assumptions for our new applications products and services may be incorrect,
either of which may impact our ability to develop a sustainable business.
The prices we charge for our products and services may decrease as a result
of competitive pricing pressures, promotional programs and customers who
negotiate price reductions. For example, 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.
25
The average size of our customer license orders has been between
approximately $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 three months ended June 30, 2002, our sales and marketing
expenses totaled 114% of our total revenues. We 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.
Our service revenues and recently introduced VS Production solution product may
have substantially lower gross profit margins than our license revenues, and an
increase in service revenues or the VS Production application 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 50% and 51% of our total revenues for the three months ended
June 30, 2002 and 2001, respectively. In addition, our recently introduced VS
Production application 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
application may also have substantially lower gross profit margins than our
license revenues when we sell it with the hardware element. Our cost of service
revenues for the three months ended June 30, 2002 and 2001 were 71% and 124% of
our service revenues, respectively. An increase in the percentage of total
revenues represented by service revenues and/or our VS Production application
when sold with a hardware element could adversely affect our overall gross
profit margins.
Service revenues as a percentage of total revenues and cost of service
revenues as a percentage of total revenues have varied significantly from
quarter to quarter due to our relatively early stage of development.
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.
Because competition for qualified personnel is intense, we may not be able to
recruit or retain personnel, which could impact the development and acceptance
of our products and services.
Our future success depends to a significant extent on the continued services
of our senior management and other key personnel such as senior development
staff, product marketing staff and sales personnel. The loss of key employees
would likely have an adverse effect on our business. We do not have employment
agreements with most of our senior management team. If one or more of our senior
management team were to resign, the loss could result in loss of sales, delays
in new product development and diversion of management resources.
26
We may also be required to create additional performance and retention
incentives in order to retain our employees including the granting of additional
stock options to employees at 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.
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.
If the protection of our intellectual property is inadequate or third party
intellectual property is unavailable or if others bring infringement or other
claims against us, we may incur significant costs or lose customers.
We depend on our ability to develop and maintain the proprietary aspects of
our technology. Policing unauthorized use of our products is difficult and
software piracy may become a problem. We license our proprietary rights to third
parties, who may not abide by our compliance guidelines. To date, we have not
sought patent protection of our proprietary rights in any foreign jurisdiction,
and the laws of some foreign countries do not protect our proprietary rights to
as great an extent as do the laws of the United States. Our efforts to protect
our intellectual property rights may not be effective to prevent
misappropriation of our technology or may not prevent the development by others
of products competitive with those developed by us.
In addition, other companies may obtain patents or other proprietary rights
that would limit our ability to conduct our business and could assert that our
technologies infringe their proprietary rights. We could incur substantial costs
to defend any litigation, and intellectual property litigation could force us to
cease using key technology, obtain a license, or redesign our products. From
time to time, we have received notices claiming that our technology infringes
patents held by third parties and in addition may become involved in litigation
claims arising from our ordinary course of business. We believe that there are
no claims or actions pending or threatened against us, the ultimate disposition
of which would have a material adverse effect on us. However, in the event any
claim against us is successful, our operating results would be significantly
harmed.
Furthermore, we license technology from third parties, which may not
continue to be available on commercially reasonable terms, if at all. The loss
of any of these licenses could result in delays in the licensing of our products
until equivalent technology, if available, is developed or licensed for
potentially higher fees and integrated. In the event of any such loss, costs
could be increased and delays could be incurred, thereby harming our business.
Interruptions to our business or internal infrastructure from unforeseen,
adverse events or circumstances will disrupt our business and our operating
results will suffer.
The worldwide socio-political environment has changed dramatically since
September 11, 2001. Our customers, potential customers and vendors are located
worldwide and generally within major international metropolitan areas. In
addition, the significant majority of our operations are conducted at offices
within a 60-mile radius of the major metropolitan cities of San Francisco, New
York City, Boston and London. Our business also requires that certain personnel,
including our officers, travel in order to perform their jobs appropriately.
Should a major catastrophe occur within the vicinity of any of our operations,
our customers' and/or potential customers' and/or vendors' operations, our
operations may be adversely impacted and our business may be harmed.
27
Our communications and network infrastructure are a critical part of our
business operations. Our application services business is dependent upon
providing our customers with fast, efficient and reliable services. To meet our
customers' requirements, we must protect our network against damage from any and
all sources, including among other things:
o human error;
o physical or electronic security breaches;
o computer viruses;
o fire, earthquake, flood and other natural disasters;
o power loss;
o telecommunications failure; and
o sabotage and vandalism.
We have communications hardware and computer hardware operations located at
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. 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.
Our revenues may be harmed if general economic conditions do not improve.
Our revenues are dependent on the health of the economy (in particular, the
robustness of information technology spending) and the growth of our customers
and potential future customers. The economic environment has not been conducive
to companies involved in information technology infrastructure for several
quarters and if this trend continues, our customers may continue to delay or
reduce their spending on our software and service solutions. When economic
conditions for information technology products weaken, sales cycles for sales of
software products and related services tend to lengthen and companies'
information technology and business unit budgets tend to be reduced. 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.
Defects in our software products or services could diminish demand for our
products or could subject us to liability claims and negative publicity if our
customers' systems, information or video content is damaged through the use of
our products or our application services.
Our software products and related services are complex and may contain
errors that may be detected at any point in the life of the product or service.
We cannot assure you that, despite testing by us and our current and potential
customers, errors will not be found in new products or releases after shipment
or in the related services that we perform for our customers. If our customers'
systems, information or video content is damaged by software errors or services
that we perform for them, our business may be harmed. In addition, these errors
or defects 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.
28
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.
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.
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.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
At June 30, 2002, the Company's cash and cash equivalents consisted primarily
of bank deposits and money market funds. The Company's short-term investments
consisted of commercial paper, municipal bonds, and federal agency and related
securities. The Company did not hold any derivative financial instruments. The
Company's interest income is sensitive to changes in the general level of
interest rates. In this regard, changes in interest rates can affect the
interest earned on cash and cash equivalents and short-term investments.
29
PART II: OTHER INFORMATION
Item 1. 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. On July 15, 2002, we (and the other
issuer defendants) filed a motion to dismiss. 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.
Item 2. Changes in Securities and Use of Proceeds
(d) Use of Proceeds.
On July 5, 2000, we completed a firm commitment underwritten initial
public offering of 3,500,000 shares of our common stock, at a price of
$11.00 per share. Concurrently with our initial public offering, we
also sold 1,696,391 shares of common stock in a private placement at a
price of $11.00 per share. On July 17, 2000, our underwriters exercised
their over-allotment option for 525,000 shares of our common stock at a
price of $11.00 per share. The shares of the common stock sold in the
offering and exercised via our underwriters' over-allotment option were
registered under the Securities Act of 1933, as amended, on a
Registration Statement on Form S-1 (File No. 333-96315). The Securities
and Exchange Commission declared the Registration Statement effective
on June 28, 2000. The public offering was underwritten by a syndicate
of underwriters led by Credit Suisse First Boston, FleetBoston
Robertson Stephens Inc. and Wit SoundView Corporation, as their
representatives.
The initial public offering and private placement resulted in net
proceeds of $57,476,000, after deducting $3,099,000 in underwriting
discounts and commissions and $1,800,000 in costs and expenses related
to the offering. None of the costs and expenses related to the offering
or the private placement were paid directly or indirectly to any
director, officer, general partner of Virage or their associates,
persons owning 10 percent or more of any class of equity securities of
Virage or an affiliate of Virage. Proceeds from the offering and
private placement have been used for general corporate purposes,
including working capital and capital expenditures. The remaining net
proceeds have been invested in cash, cash equivalents and short-term
investments. The use of the proceeds from the offering and private
placement does not represent a material change in the use of proceeds
described in our prospectus.
30
Item 3. Defaults Upon Senior Securities
None.
Item 4. Submission of Matters to a Vote of Security Holders
None.
Item 5. Other Information
The Company's stock is currently traded on the NASDAQ National Market
and the bid price for its common stock has been under $1.00 per share
for over 30 consecutive trading days. Under NASDAQ's listing
maintenance standards, if the closing bid price of the Company's common
stock is under $1.00 per share for 30 consecutive trading days, NASDAQ
may choose to notify the Company that it may delist its common stock
from the NASDAQ National Market. On July 24, 2002, the Company received
notice from NASDAQ that it is not in compliance with NASDAQ's listing
maintenance standards and that it has until October 22, 2002 to regain
compliance. If at any time before October 22, 2002 the bid price of the
Company's common stock closes at $1.00 per share or more for a minimum
of 10 consecutive trading days, NASDAQ will consider notifying the
Company that it complies with the maintenance standards. If the Company
is unable to meet this minimum bid price requirement by October 22,
2002, the Company expects to have the option of transferring to the
NASDAQ SmallCap Market, which makes available a 180 calendar day
extended grace period for the minimum $1.00 bid price requirement
(instead of a 90 day grace period as provided by the NASDAQ National
Market). In addition, the Company expects that it may also be eligible
for an additional 180 calendar day grace period on the NASDAQ SmallCap
Market (ie. until July 21, 2003) provided that the Company meets the
other non-bid price related listing criteria. If the Company transfers
to the NASDAQ SmallCap Market, the Company expects that it may be
eligible to transfer back to the NASDAQ National Market if its bid
price maintains the $1.00 per share requirement for 30 consecutive
trading days and it has maintained compliance with all other continued
listing requirements for the NASDAQ National Market. There can be no
assurance that the Company's common stock will remain eligible for
trading on the NASDAQ National Market or the NASDAQ SmallCap Market. If
the Company's stock were delisted, the ability of the Company's
stockholders to sell any of the Company's common stock at all would be
severely, if not completely, limited.
Item 6. Exhibits and Report on Form 8-K.
(a) Exhibits
Exhibit 99.1 Certification Pursuant to 18 U.S.C. Section 1350
(b) Reports on Form 8-K
None
31
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
VIRAGE, INC.
Date: August 14, 2002 By: /s/ Scott Gawel
--------------------------------
Scott Gawel
Vice President, Finance &
Acting Chief Financial Officer
(Duly Authorized Officer and
Principal Financial Officer)
32