UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
FORM 10-K
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|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
FOR THE FISCAL YEAR ENDED MARCH 31, 2003
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
COMMISSION FILE NUMBER: 0-30903
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VIRAGE, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 38-3171505
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
411 BOREL AVENUE, 100 SOUTH
SAN MATEO, CALIFORNIA 94402-3116
(650) 573-3210
(Address, including zip code, and telephone number,
including area code, of the registrant's principal executive offices)
------------------------
Securities Registered Pursuant to Section 12(b) of the Act: None
Securities Registered Pursuant to Section 12(g) of the Act:
Common Stock, $0.001 par value
(Title of Class)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. |X| Yes |_| No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. |_|
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). [ ] Yes [ X ] No
As of June 16, 2003, there were approximately 21,237,000 shares of the
registrant's Common Stock outstanding. The aggregate market value of the voting
and non-voting stock held by non-affiliates of the registrant, based on the
closing sale price of the Common Stock on September 30, 2002 as reported on the
Nasdaq National Market was approximately $9,716,000. Shares of Common Stock held
by each current executive officer and director have been excluded from this
computation in that such persons may be deemed to be affiliates of the Company.
This determination of affiliate status is not a conclusive determination for
other purposes.
Documents Incorporated by Reference
Portions of the registrant's Proxy Statement for the registrant's 2003 Annual
Meeting of Stockholders are incorporated by reference into Part III of this Form
10-K to the extent stated herein. The Proxy Statement will be filed within 120
days of registrant's fiscal year ended March 31, 2003.
VIRAGE, INC.
INDEX
PAGE
PART I
Item 1. Business...................................................................................1
Item 2. Properties................................................................................19
Item 3. Legal Proceedings.........................................................................20
Item 4. Submission of Matters to a Vote of Security Holders.......................................20
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.....................22
Item 6. Selected Consolidated Financial Data......................................................24
Item 7. Management's Discussion and Analysis of Financial Condition and Results of
Operations...........................................................................25
Item 7A. Quantitative and Qualitative Disclosures About Market Risk................................41
Item 8. Financial Statements and Supplementary Data...............................................42
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial
Disclosure...........................................................................71
PART III
Item 10. Directors and Executive Officers of the Registrant........................................71
Item 11. Executive Compensation....................................................................71
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related
Stockholder Matters..................................................................71
Item 13. Certain Relationships and Related Transactions............................................71
Item 14. Controls and Procedures...................................................................71
PART IV
Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K...........................73
Signatures................................................................................74
PART I
This annual report on Form 10-K contains forward-looking statements within
the meaning of Section 27A of the Securities Act of 1933 (the "Securities Act"),
as amended, and Section 21E of the Securities Exchange Act of 1934, as amended
(the "Exchange Act"), including statements using terminology such as "can,"
"may," "believe," "designed to," "will," "expect," "plan," "anticipate,"
"estimate," "potential," or "continue," or the negative thereof or other
comparable terminology regarding beliefs, plans, expectations or intentions
regarding the future. Forward-looking statements involve risks and uncertainties
and actual results could differ materially from those discussed in the
forward-looking statements. All forward-looking statements and risk factors
included in this document are made as of the date hereof, based on information
available to the Company as of the date thereof, and the Company assumes no
obligation to update any forward-looking statement or risk factors.
Item 1. Business
Overview
Virage, Inc. is a provider of video and rich media communication software
products, professional services and application services. We sell these products
and services to corporations, media and entertainment companies, government
agencies, and universities worldwide.
Our application products became an increasingly significant part of our
revenues during our fiscal year ended March 31, 2003, following their
introduction to the marketplace late in our fiscal year ended March 31, 2002.
Our strongest performing application product was VS Webcasting(TM), which allows
corporations to schedule and manage live webcast events and then easily turn
each into a searchable, on-demand presentation. Our other application products
include VS Publishing(TM), a complete workflow solution that allows media and
entertainment companies and others with branded content to turn their content
into compelling, rich media programming for the Internet or corporate intranet;
and VS Production(TM), an integrated software solution that automates a
customer's video production process from acquisition to distribution.
All of our application products are built around, and work in conjunction
with, certain of our platform products, which provide much of the underlying
technology and core functionality. More specifically, our platform products
provide the video encoding, indexing and content management capabilities that
are shared by each of our application products. In addition to providing core
functionality to our application products, our platform products are marketed
and sold as stand-alone products. Historically, these products have represented
the majority of our revenues. Our platform products include our SmartEncode(TM)
products, which encode and index video within a single automated process, and
our server products, which provide basic content management capabilities for
video and rich media.
Owners of rich media content can leverage our technology and know-how
either by licensing our products and engaging our professional services or by
employing our application services to outsource their needs.
We are based in San Mateo, California. We were founded in April 1994 and
incorporated in Delaware in March 1995. In this report, "Virage," "the Company,"
"our," "us," "we" and similar expressions refer to Virage, Inc. Our principal
executive offices are located at 411 Borel Avenue, 100 South, San Mateo,
California 94402 and our telephone number is (650) 573-3210.
1
Business Background and Strategy
Our application products became an increasingly significant part of our
total revenues during our fiscal year ended March 31, 2003. We first introduced
these products late in our fiscal year ended March 31, 2002 in order to expand
the market for our technology and to provide customers with complete software
solutions. Our application products are designed to work "out-of-the-box" for a
specific video or rich media workflow, such as training, communications,
Internet and intranet publishing, or video production. Our development efforts
for these application products focus on functions, features, and intuitive user
interfaces that allow our customers to implement the intended workflow quickly
and easily. Our application products include VS Webcasting, VS Publishing and VS
Production.
Our application products are marketed directly to users such as executives
and managers in sales, marketing, communication and training positions, in
addition to information technology executives. For example, we market our VS
Webcasting product to sales and marketing executives to assist with new product
introductions and sales training. The VS Webcasting product can be used for a
live event transmission to a widely distributed field sales team, and also can
provide an on-demand playback capability for later viewing or review. An
investment in VS Webcasting can thus save travel time and costs, and allow a
sales representative to review materials or topics of interest whenever more
information is required. We market and sell our application products by
demonstrating both cost savings and productivity increases for the users, thus
establishing a quantifiable return on our customer's investment.
We were able to demonstrate this return on investment for our application
products to a number of corporate enterprise customers during our fiscal year
ended March 31, 2003, particularly our VS Webcasting product for which demand
was strongest. As a result, corporate enterprise customers accounted for the
greatest percentage of our total revenues of any of our targeted marketplaces.
This was a measurable shift in the results of our business as, historically,
customers within the media and entertainment marketplace purchased our platform
products and contributed most significantly to our revenues.
Our application products are designed to further our enterprise strategy
and to provide enhanced solutions to customers in all of our target markets. In
addition to licensing our products, we offer our customers the option of
outsourcing their requirements to us by leveraging our application services
offerings. We believe our application services offerings are an important,
initially lower-cost, easily deployable alternative to licensing our products.
These outsourced offerings are a fast and efficient way for a customer to obtain
the functionality and value that our technology offers. As a key customer
acquisition tool, our application services offerings enable our customers to
choose either a longer-term application services contract or a licensed software
solution that may be deployed by the customer in-house.
2
In addition, we continue to derive a significant portion of our revenues
from our platform products. Our platform products include our SmartEncode
products, which encode and index video within a single automated process, and
our server products, which enable the publishing and distribution of streaming
video. Users of our platform products typically have some in-house video
expertise or are willing to invest in consulting or other resources in order to
use our platform as part of a video and rich media solution. During our fiscal
year ended March 31, 2003, we experienced the strongest demand for our platform
products from government customers, particularly defense and security agencies,
who often purchased our platform products and engaged our professional services
to build highly sophisticated computer systems, including video-monitoring
systems. This demand by government customers for our platform products was
offset by weakness from customers within the media and entertainment
marketplace. Historically, media and entertainment companies purchasing our
platform products have comprised a substantial portion of our total revenues.
However, during our fiscal year ended March 31, 2003, we experienced a
measurable decline in purchases from our media and entertainment customers. We
believe this is primarily a function of unfavorable global macroeconomic
conditions affecting a number of our potential customers in markets such as
media and entertainment and resulting in weak demand for information technology
products. We expect that a significant portion of our revenues will continue to
be derived from our platform products. However, if demand for our platform
products does not improve, particularly with respect to our media and
entertainment customers, we may not be able to grow our revenues to levels
required to develop a profitable and sustainable business.
We actively market our products and services to new prospects as well as to
our installed base of customers. We believe that successful development and
marketing of our products is critical to increasing our future sales to a level
required for profitability. We have focused our sales force on establishing new
relationships and developing existing relationships by offering application
services and other programs in order to demonstrate the value proposition that
our products offer. In addition, we are working with strategic channel partners
such as Sony, RealNetworks, and Sumitomo to extend our sales reach beyond our
own sales force. There is no guarantee that our products will succeed in the
marketplace or grow to levels required for profitability. If our products do not
succeed, we may not be able to develop a profitable and sustainable business.
Products and Services
We are a provider of video and rich media communication software products,
professional services and application services. We sell these products and
services to corporations, media and entertainment companies, government
agencies, and universities worldwide.
APPLICATION PRODUCTS
VS Webcasting
VS Webcasting allows corporations to schedule and manage live webcast
events--and then turn each quickly and easily into a searchable on-demand event.
VS Webcasting enriches the live experience by integrating streaming video with
slides, documents, surveys and other pertinent online media. At the same time,
it automatically creates a searchable, on-demand presentation that can be
available for review within minutes after an event's conclusion.
VS Publishing
VS Publishing is a complete workflow solution that allows media and
entertainment companies and others with branded content to turn their content
into compelling rich media programming for the Internet or corporate intranet.
With VS Publishing, video can be processed, assembled, reviewed and published
minutes after its creation. Whether content comes from an archive or direct from
on-air production, VS Publishing streamlines the workflow to the Internet and
lets content owners deliver video where and when it is most valuable to their
viewers.
3
VS Production
VS Production is an integrated software solution that automates the
professional video production process from acquisition to distribution. By
transforming video into a digital asset that is easy to manage, access, share
and distribute, VS Production helps content owners streamline the process of
producing high-quality video content for on-air, tape or digital distribution.
PLATFORM PRODUCTS
SMARTENCODE PRODUCTS
VideoLogger(R) and Media Analysis Plug-ins
Our VideoLogger product indexes video while simultaneously encoding (or
digitizing) the source video into multiple digital formats - all in real time.
The resulting video index and digital video files are time synchronized,
allowing the index data to reference particular moments in the video. The
indexing process converts video into data that computers can recognize. The
index, or video database, acts like an index found at the back of a book,
allowing pinpoint access into video content. Indexing information can be derived
from automated analysis of the video stream, from external sources of time-coded
data, or from information entered by a user. Our customers can elect to leverage
our media analysis plug-ins in order to automatically extract information such
as a visual storyboard of scene changes, a transcription of spoken words (via
speech recognition), audio classification, closed captioning or teletext, names
of recognized faces and speakers, on-screen text, and time code. External
sources of data could include an "edit decision list" from non-linear video
editing software, a transcript of words spoken, or a real-time statistics feed
from a sports stadium. User entered information can include clip titles, clip
descriptions, categories, clip in and out points, event dates, and other custom
descriptions. Once the index is produced, it can be integrated with a number of
different back-end solutions, including the Virage Solution Server. The Virage
SmartEncode process is available either through the latest release of the Virage
VideoLogger product or in an outsourced fashion through our application
services.
Customers or third-party developers can enhance the SmartEncode process
through the VideoLogger Software Developer Kit (SDK). The VideoLogger SDK
provides developers and systems integrators access to the full range of
VideoLogger functions through a programming interface. This enables reliable
integration into a wide variety of automated workflows and allows developers to
add additional indexing and encoding functionality to VideoLogger as necessary.
Virage ControlCenter(TM)
The Virage ControlCenter product is a workflow application that remotely
schedules, controls, and manages the SmartEncode process for multiple
VideoLoggers from a central console. Capture of the source video signal is the
starting point. Virage software can accept video from a multitude of analog or
digital sources: camera, satellite feed, television, videotape, or digital file.
Capture of multiple video feeds can be automated and managed centrally via
ControlCenter for greater efficiency.
MediaSync(TM)
Our MediaSync product provides a fully integrated, end-to-end solution for
rapidly assembling, synchronizing and publishing streaming video with PowerPoint
slides to a website.
Database Plug-Ins
Virage Database Plug-Ins for Oracle(R) and Informix(R) products help system
integrators build sophisticated video management solutions with the Virage
VideoLogger and relational databases.
4
SERVER PRODUCTS
Virage Solution Server(TM)
The Virage Solution Server provides a comprehensive platform for
publishing, managing and distributing Virage-enabled content on the web. The
Virage Solution Server hosts the video index generated by the SmartEncode
process. It is designed for high performance and can scale to enterprise-wide
and Internet-wide deployments. The Virage Solution Server content management
capabilities include account setup, deleting or inserting video assets from the
databases, editing existing video assets, and managing multiple video
collections.
The Virage Solution Server is used to publish and distribute content to
video-rich websites. With the Virage Solution Server, a customer can efficiently
publish on-demand video throughout a website, seamlessly integrated with the
existing website look and feel. Sample web templates provide an easy
"out-of-the-box" experience, or customers can develop their own HTML templates
to create search and results pages and player windows tailored to their specific
needs. The Virage Solution Server supports all common streaming formats
including RealVideo, Windows Media, QuickTime, and MPEG. It can also extend the
viewing experience beyond the PC-based Internet to set top boxes, game consoles
and handheld and wireless devices.
Key features of the Virage Solution Server include:
o Search: with Virage Solution Server, content owners can deliver video
content to end-users through well-understood navigation paradigms. This
allows users to quickly find the content of interest;
o Dynamic Publishing: Virage Solution Server can automate the process of
delivering video clips throughout a web site. Content can be
automatically published based on its category or keywords.
o Content Distribution Network Management: because many content owners
use multiple content distribution networks (CDNs), the Virage Solution
Server provides an abstraction layer to simplify content distribution;
o Personalization: Virage Solution Server provides a range of
capabilities that allow content owners to deploy personalized viewing
experiences;
o Syndication: Because Virage Solution Server separates the content
database from the HTML templates, it allows a single content collection
to be syndicated to multiple sites, each with a unique look and feel.
Virage Solution Server SDK
The Virage Solution Server Software Developer Kit (SDK) allows developers
and systems integrators to build custom applications on the Virage Solution
Server to suit any publishing environment.
SERVICE OFFERINGS
Software installation and training
Licensed software customers have the option to contract with Virage for
generally basic software installation and training support. These services
ensure that customers can begin to use Virage software as quickly as possible.
These services are typically billed on an hourly or daily basis.
5
Development and implementation services
Virage offers a variety of professional services aimed at helping customers
to implement, integrate or customize our commercial software. The services
typically consist of building custom web templates, implementing our products,
building specialized plug-ins to our products and integrating our products with
websites or existing customer infrastructure. We offer these services to
customers regardless of whether they license software products, or opt for our
application services. These services are typically billed on an hourly or daily
basis, though in some cases we offer a fixed fee project based upon the size of
the project.
Application services
Our application services consist of SmartEncode services and application
hosting services. These services allow customers to outsource their needs to
Virage, in lieu of purchasing our software and installing and managing it
themselves.
Using our own SmartEncode products, we process content on behalf of
customers from a variety of analog or digital sources. As part of the service,
we produce multiple formats and bit rates of high quality encoded video files
along with a rich video database. Our editorial services include custom
headlines, descriptions, keywords, and other useful information added by our
expert content editors to suit a customer's requirements. We can also transcribe
content to produce an exact text of the speech. We typically bill for such
services as a charge per hour of video processed depending upon the level of
services required.
Customers interested in our application products can also opt for
Virage-hosted offerings. These services allow customers to access Virage
software directly from a Virage datacenter. For example, some customers have
chosen to deliver live or on-demand webcasts by leveraging our VS Webcasting
software, hosted in a Virage datacenter.
As part of most application service agreements, we provide daily, weekly,
and monthly traffic reports to the content owner. We also provide a secure
administration and publishing interface that provides our customers complete
control of how and where their content gets published. We typically charge a
fixed monthly minimum charge for our application hosting services that increases
based upon accesses to our video database. Our data center provides
fault-tolerant servers and 24-by-7 monitoring to ensure reliable and scalable
hosting.
We believe our application services offerings are an important, lower-cost,
easily deployable alternative to demonstrate the functionality and value that
our technology and services bring to the customer. We also believe that these
service offerings will help us engage our customers in longer-term application
services contracts for these solutions or in a comprehensive end-to-end software
licensing sale.
Sales and Marketing
Sales and distribution strategy
We sell our products and application services through a direct sales force
and through indirect distribution channels. We currently target customers in
several markets including corporate enterprises, media and entertainment
companies, government entities and educational institutions. Our sales strategy
is to pursue multiple opportunities for large-scale deployments within each
customer account. We want to provide business users with a quick, reliable and
scalable solution to their problems and afford them a definitive return on their
investment.
6
Through our direct sales force in Boston, Chicago, Houston, London, Los
Angeles, Miami, New York, San Francisco, Singapore, Houston, and Washington
D.C., we focus on larger customers in North America, Europe, Latin America, and
Asia. In addition, our direct sales force manages local relationships with key
resellers. Our indirect distribution channels include major high-technology
industry vendors, domestic and international distributors, system integrators
and value-added resellers. Together, these distributors and value-added
resellers accounted for approximately 26% of total revenues for the year ended
March 31, 2003. If we were to lose one of our channel partners or any of our
channel partners were to delay or default on obligations under their contracts
with us, our future operating results could be significantly harmed.
Marketing activities
Since our inception, we have invested a substantial percentage of our
revenues in a broad range of marketing activities to generate demand, gain
corporate brand identity and educate the market about our products and services.
These activities have focused primarily on direct marketing, direct mail and
email, webinars, seminars, telemarketing, public relations, co-marketing and
branding with our major customer accounts and strategic partners, targeted trade
shows, conferences, speaking engagements, and product information through print
collateral and our Internet site. In addition, we have an established developer
relationship function to encourage independent software developers to develop
products and solutions that are compatible with our products and technologies.
Recently, we have decided to focus a large percentage of our marketing program
spending on telemarketing campaigns. We have significantly reduced our spending
budgets for trade shows and other areas in order to fund an increased investment
in these campaigns. Should our recent focus on telemarketing campaigns fail to
attract new customers, our revenues may be adversely impacted.
Customers
Our customers represent large global enterprises, media and entertainment
corporations, educational institutions and government entities. No customer
accounted for more than 10% of our total revenues in either of the years ended
March 31, 2003 or 2001. For the year ended March 31, 2002, one customer
accounted for 14% of our total revenues.
International revenues represented 25%, 24% and 29% of our total revenues
during the years ended March 31, 2003, 2002 and 2001, respectively.
Research and Development
We believe that our future success will depend in part on our ability to
continue to develop new, and to enhance existing, products and services.
Accordingly, we invest a significant amount of our resources in research and
product development activities. Our research and development expenses totaled
$9,248,000, $9,172,000, and $9,101,000 for the years ended March 31, 2003, 2002
and 2001, respectively. Our focus on application product development has
increased the complexity and difficulty of our product development efforts. In
particular, we now have several small application product development teams who
must coordinate their efforts with each other and with our platform product
development teams. Our ability to successfully manage product development in a
more complex environment is important in our ability to execute our product
plans, which we believe will help to improve our revenues.
7
Competition
The digital media marketplace is new, rapidly evolving and intensely
competitive. As more companies begin to leverage streaming video technologies,
we expect competition to intensify. We currently compete directly with other
providers in the market for web-based video solutions including Convera
Corporation, Sonic Foundry, Inc. and Yahoo! Broadcast Solutions. We may also
compete indirectly with larger system integrators who embed or integrate these
directly competing technologies into their product offerings. It is possible
that we may work with these same larger companies on one customer bid and
compete with them on another. In the future, we may compete with other video
services vendors as well as web conferencing vendors. In addition, we may
compete with our current and potential customers who may develop software or
perform application services internally.
We believe we compete favorably with our competitors. However, the market
for our products is relatively small today, and therefore even continued success
against competitors does not guarantee that we can grow our business to
profitable levels. Our ability to become a profitable and sustainable business
is highly dependent on the growth of the Internet and intranet streaming video
business.
Intellectual Property
We depend on our ability to develop and maintain the proprietary aspects of
our technology. To protect our proprietary technology, we rely primarily on a
combination of patent, trademark and copyright laws, as well as confidentiality
and license agreements with our employees and others. We actively seek patent
protection for our intellectual property. We have filed 20 U.S. patent
applications on our proprietary technology. Eight patents have been issued by
the Patent and Trademark Office. Our remaining twelve patent applications are
currently pending. In 2002, we renewed a five-year patent cross-licensing
agreement with IBM. The terms of this agreement include our nonexclusive license
of IBM's multimedia software patents in return for an annual fee and a license
to IBM of all of our current patents as described above and any patents that may
be issued to us in the future.
We have twenty trademarks, four of which are registered. We seek to avoid
disclosure of our trade secrets by limiting access to our proprietary technology
and restricting access to our source code. Despite these precautions, it may be
possible for unauthorized third parties to copy particular portions of our
technology or reverse engineer or obtain and use information that we regard as
proprietary. In addition, the laws of some foreign countries do not protect
proprietary rights to the same extent as the laws of the United States. Our
means of protecting our proprietary rights in the United States or abroad may
not be adequate and competing companies may independently develop similar
technology.
Employees
As of March 31, 2003, we had 108 employees and 6 full-time contractors. Of
our 114 total staff, 20 were employed in services, 41 were employed in
engineering, 38 were employed in sales and marketing, and 15 were employed in
general and administrative positions. None of our employees are subject to a
collective bargaining agreement, and we have never experienced a work stoppage.
We consider our relations with our employees to be good.
8
Risk Factors
The occurrence of any of the following risks could materially and adversely
affect our business, financial condition and operating results. In this case,
the trading price of our common stock could decline and you might lose all or
part of your investment.
Risks Related to Our Business
We have not been profitable and if we do not achieve profitability, our business
may fail. If we need additional financing we may not obtain the required
financing on favorable terms and conditions.
We have experienced operating losses in each quarterly and annual period
since we were formed and we expect to incur significant losses in the future. As
of March 31, 2003, we had an accumulated deficit of $107,044,000. We have made
efforts to reduce our expenses over the past several quarters, but it is
possible that we could incur increasing research and development, sales and
marketing and general and administrative expenses at some point in the future.
Our revenues have been relatively flat for the past four quarters and any
inability to increase our revenues significantly in the future will result in
continuing losses and a deteriorating cash position, which will harm our
business. In addition, our cash, cash equivalent and short-term investment
resources (collectively, "cash resources") totaled $16,317,000 as of March 31,
2003 and we used $14,510,000 in our operating activities during the year ended
March 31, 2003. We anticipate that our operating activities will use a
substantial portion of our remaining cash resources over the next 12 months.
Absent a significant interim improvement in our operating results or a
successful effort to raise additional capital, this will leave us with a
deteriorated cash position in comparison to our cash position as of March 31,
2003 and this may affect our ability to transact future strategic operating and
investing activities, which may harm our business and cause our stock price to
fall. In addition, we may experience reluctance on the part of prospects to
purchase from us if they believe our financial viability is in question. The
current business environment is not conducive to raising additional financing.
If we require additional financing, the terms of such financing may heavily
dilute the ownership interests of current investors, and cause our stock price
to fall significantly or we may not be able to secure financing upon acceptable
terms at all. Accordingly, our stock price and business' viability is heavily
dependent upon our ability to grow our revenues and manage our costs in order to
preserve cash resources.
Failure to comply with NASDAQ's listing standards could result in our delisting
by NASDAQ from the NASDAQ National Market and severely limit the ability to sell
any of our common stock.
Our stock is currently traded on the NASDAQ National Market and the bid
price for our common stock has been under $1.00 per share for over 30
consecutive trading days. Under NASDAQ's listing maintenance standards, if the
closing bid price of our common stock is under $1.00 per share for 30
consecutive trading days, NASDAQ may choose to notify us that it may delist our
common stock from the NASDAQ National Market.
We received a NASDAQ letter on May 1, 2003 that we were not in compliance
with the NASDAQ's minimum bid price listing requirement and that we had seven
calendar days to do one of the following:
o Submit an application for transfer of our securities for trading to the
NASDAQ SmallCap Market;
o Request a hearing to appeal the delisting notice; or
o Have our securities delisted from the NASDAQ National Market.
9
We decided to initiate an appeal process with NASDAQ whereby we have
requested an in-person hearing with NASDAQ regulators to present relevant
measures the Company is taking in order to improve its operating results and, as
a result, bolster its stock price to levels required by NASDAQ. Should NASDAQ
dismiss our appeal, we believe we will submit an application for transfer to the
NASDAQ SmallCap Market, where we believe we will have at least 180 days from the
date of transfer to attempt to regain compliance with NASDAQ's listing
requirements. If we transfer to the NASDAQ SmallCap Market, we may be eligible
to transfer back to the NASDAQ National Market if our bid price maintains the
$1.00 per share requirement for 30 consecutive trading days and we have
maintained compliance with all other continued listing requirements for the
NASDAQ National Market.
There can be no assurance that the NASDAQ will approve our appeal, that we
will comply with other non-bid price related listing criteria or that our common
stock will remain eligible for trading on the NASDAQ National Market or the
NASDAQ SmallCap Market. If our stock were delisted, the ability of our
stockholders to sell any of our common stock at all would be severely, if not
completely, limited.
Our revenues, cost of revenues, expense and cash balance/cash usage forecasts
are based upon the best information we have available, but our operating results
have historically been volatile and there are a number of risks that make it
difficult for us to foresee or accurately evaluate factors that may impact our
forecasts.
Our quarterly and annual operating results have varied significantly in the
past and are likely to vary significantly in the future. We believe that
period-to-period comparisons of our results of operations are not meaningful and
should not be relied upon as indicators of future performance. Our operating
results have in past quarters fallen below securities analyst expectations and
will likely fall below their expectations in some future quarter or quarters.
We have limited visibility into future demand, and our limited operating
history makes it difficult for us to foresee or accurately evaluate factors that
may impact such future demand. Our visibility over our potential sales is
typically limited to the current quarter and our visibility for even the current
quarter is rather limited. In order to provide a revenue forecast for the
current quarter, we must make assumptions about conversion of sales prospects
into current quarter revenues. Such assumptions may be materially incorrect due
to competition for the customer order, pricing pressures, sales execution
issues, customer selection criteria or length of the customer selection cycle,
the failure of sales contracts to meet our revenue recognition criteria, our
inability to timely perform professional services, our inability to hire and
retain qualified personnel, our inability to develop new markets domestically
and internationally, the strength of information technology spending, and other
factors that may be beyond our control. In addition, our application products
are relatively early in their product life cycles and we cannot predict how the
market for these products will develop. Our assumptions about conversion of
potential application product sales and/or our potential platform product sales
into current quarter revenues could be materially incorrect. We are reliant on
third party resellers for a significant portion of our license revenues and we
have limited visibility into the status of orders from these third parties.
For quarters beyond the current quarter, we have very limited visibility
into potential sales opportunities, and thus we have a lower confidence level in
any revenue forecast or forward-looking guidance. In developing a revenue
forecast for such quarters, we assess any customer indications about future
demand, general industry trends, marketing lead development activities,
productivity goals for the sales force and expected growth in sales personnel,
and any demand for products that we may have. Because visibility into outlying
quarters is so limited, we have not provided guidance beyond the current quarter
for the past several quarters.
10
Our cost of sales and expense forecasts are based upon our budgets and
spending forecasts for each area of the Company. Circumstances we may not
foresee could increase cost and expense levels beyond the levels forecasted.
Such circumstances may include competitive threats in our markets which we may
need to address with additional sales and marketing expenses, severance for
involuntary reductions in headcount should we determine cost cutting measures
are necessary, write-downs of equipment and/or facilities in the event of
unforeseen excess capacity, legal claims, employee turnover, additional royalty
expenses should we lose a source of current technology, losses of key management
personnel, unknown defects in our products, and other factors we cannot foresee.
In addition, many expenditures are planned or committed in advance in
anticipation of future revenues, and if our revenues in a particular quarter are
lower than we anticipate, we may be unable to reduce spending in that quarter.
As a result, any shortfall in revenues or a failure to improve gross profit
margin would likely hurt our quarterly and/or annual operating results.
Our cash balance and cash usage forecasts are typically limited to the
current quarter and are based upon a number of factors including our revenue and
expense forecasts, which are also subject to a number of risks described above.
In addition, in deriving our cash forecasts, we make a number of assumptions
that are subject to other uncertainties including our expected cash payments to
employees, vendors and other parties, expected cash receipts from customers and
interest earned on our cash and investment balances. Such assumptions may be
materially incorrect due to unexpected payments that are required to be made to
employees or vendors, delayed payments from our customers, unfavorable
fluctuations in interest rates and other factors that may be beyond our control.
The failure of any significant contracts to meet our policies for recognizing
revenue may prevent us from achieving our revenue objectives for a quarter or a
fiscal year, which would hurt our operating results.
Our sales contracts are typically based upon standard agreements that meet
our revenue recognition policies. However, our future sales may include site
licenses, professional services or other transactions with customers who may
negotiate special terms and conditions that are not part of our standard sales
contracts. In addition, customers may insist on an extended payment schedule or
may delay payments to us, which may require us to recognize from sales to those
customers' when amounts become due, rather than upon delivery of our software to
the customer. If these special terms and conditions cause sales under these
contracts to not qualify under our revenue recognition policies, we would defer
revenues to future periods when all revenue recognition criteria are met, which
may impair our revenues and operating results.
In addition, customers that license our products may require consulting,
implementation, maintenance and training services and obtain them from our
internal professional services, customer support and training organizations.
When we provide significant services in connection with a software license
arrangement, our revenue recognition policy may require us to recognize the
software license fee as the implementation services are performed. Customers may
opt to defer the implementation of significant services, which will cause us to
recognize revenues from the license as we perform the services or we may be
required to defer revenues from the license until the completion of the
services. Either of these scenarios may impair our revenues and operating
results.
11
We have allocated significant product development, sales and marketing resources
toward the deployment of our application products, we face a number of risks
that may impede market acceptance of these products and such risks may
ultimately prove our business model invalid, thereby hurting our financial
results.
We have invested significant resources into developing and marketing our
application products and do not know whether our business model and strategy
will be successful. The market for these products is in a relatively early stage
and one of our key assumptions about the market is that digital video will
continue to develop as a more relevant communication medium. We cannot predict
how the market for our applications will develop, and part of our strategic
challenge will be to convince enterprise customers of the productivity, improved
communications, cost savings and other benefits of our application products. Our
future revenues and revenue growth rates will depend in large part on our
success in delivering these products effectively and creating market acceptance
for these products. If we fail to do so, our products and services will not
achieve widespread market acceptance, and we may not generate significant
revenues to offset our development and sales and marketing costs, which will
hurt our business. Additionally, our future success will continue to depend upon
our ability to develop new products or product enhancements that address future
needs of our target markets and to respond to these changing standards and
practices.
In addition, resources may be required to fund development of our
application products' feature-sets beyond what we have planned due to
unanticipated marketplace demands. We may determine that we are unable to fund
these additional feature-sets due to financial constraints and may halt the
development of a product at a stage that the marketplace perceives as immature.
We may also encounter that the marketplace for an application product is not as
robust as we had expected and we may react to this by leaving the development of
a product at an early stage or combining key features of one or more of our
application products into a single product. Either of these product development
scenarios may impede market acceptance of any of our application products and
therefore hurt our financial results.
The length of our sales and deployment cycle is uncertain, which may cause our
revenues and operating results to vary significantly from quarter to quarter and
year to year.
During our sales cycle, we spend considerable time and expense providing
information to prospective customers about the use and benefits of our products
and services without generating corresponding revenues. Our expense levels are
relatively fixed in the short-term and based in part on our expectations of
future revenues. Therefore, any delay in our sales cycle could cause significant
variations in our operating results, particularly because a relatively small
number of customer orders represent a large portion of our revenues.
Some of our largest sources of revenues are government entities and large
corporations that often require long testing and approval processes before
making a decision to license our products. In general, the process of entering
into a licensing arrangement with a potential customer may involve lengthy
negotiations. As a result, our sales cycle has been and may continue to be
unpredictable. In the past, our sales cycle has ranged from one to 12 months.
Our sales cycle is also subject to delays as a result of customer-specific
factors over which we have little or no control, including budgetary constraints
and internal approval procedures. In addition, because our technology must often
be integrated with the products and services of other vendors, there may be a
significant delay between the use of our software and services in a pilot system
and our customers' volume deployment of our products and services.
Our application products are aimed toward a broadened business user base
within our key markets. These products are relatively early in their product
life cycles and we are relatively inexperienced with their sales cycle. We
cannot predict how the market for our application products will develop and part
of our strategic challenge will be to convince targeted users of the
productivity, improved communications, cost savings and other benefits.
Accordingly, it is likely that delays in our sales cycles with these application
products will occur and this could cause significant variations in our operating
results.
12
We expect the market price of our common stock to be volatile.
The market price of our common stock has experienced significant swings in
price over short periods of time. We believe that factors such as announcements
of developments related to our business, fluctuations in our operating results,
failure to meet securities analysts' expectations, our ability to remain an
active listing on the NASDAQ National Market or NASDAQ Small Cap Market, general
conditions in the software and high technology industries and the worldwide
economy, announcements of technological innovations, new systems or product
enhancements by us or our competitors, acquisitions, changes in governmental
regulations, developments in patents or other intellectual property rights and
changes in our relationships with customers and suppliers could cause the price
of our common stock to continue to fluctuate substantially. Historically, there
has been a relatively small number of buyers and sellers of our common stock and
trading volume of our common stock is relatively low in comparison to many
companies listed on the NASDAQ National Market and other well-known stock
exchanges. This low trading volume contributes to the volatility of our stock.
In addition, in recent years the stock market in general, and the market for
small capitalization and high technology stocks in particular, has experienced
extreme price fluctuations. Any of these factors could adversely affect the
market price of our common stock.
Our revenues may be harmed if general economic conditions do not improve.
Our revenues are dependent on the health of the economy (in particular, the
robustness of information technology spending) and the growth of our customers
and potential future customers. The economic environment has not been favorable
to companies involved in information technology infrastructure for several
quarters. In addition, potential conflicts with countries such as North Korea
create a great deal of uncertainty for businesses and this uncertainty generally
results in businesses delaying investments in such areas as information
technology. If the economic trend continues, our customers and potential
customers may continue to delay or reduce their spending on our software and
service solutions. When economic conditions for information technology products
weaken, sales cycles for sales of software products and related services tend to
lengthen and companies' information technology and business unit budgets tend to
be reduced. We believe that global economic conditions have become progressively
weaker over the past 24 months and believe that this has contributed to our
decline in revenues for our current year periods in comparison to our prior year
periods. If global economic conditions continue to weaken or if potential
conflicts continue or worsen, our revenues could continue to suffer and our
stock price could decline further.
Our restructuring efforts may not result in the intended benefits. We may be
required to record additional restructuring charges and this may adversely
affect the morale and performance of our personnel we wish to retain and may
also adversely affect our ability to hire new personnel.
During the past several quarters, we took steps to better align the
resources required to operate efficiently in the prevailing market. Through
these steps, we reduced our headcount and incurred charges for employee
severance, excess facility capacity and excess equipment. While we believe that
these steps help us achieve greater operating efficiency, we have limited
history with such measures and the results of these measures are less than
predictable. We monitor our expenses closely and benchmark our expenses against
expected revenues. Should our revenues not meet internal or external
expectations or other circumstances arise that require us to better align
resources required to operate efficiently in the prevailing market, additional
restructuring efforts will be required. We believe workforce reductions,
management changes and facility consolidation create anxiety and uncertainty and
may adversely affect employee morale. These measures could adversely affect our
employees that we wish to retain and may also adversely affect our ability to
hire new personnel. They may also affect customers and/or vendors, which could
harm our ability to operate as intended and which would harm our business.
13
As we have better aligned our resources over the past several quarters, we
have consolidated our operations into facility space that is less than our
current facility commitment, resulting in excess operating lease capacity.
During the year ended March 31, 2003, we adopted the Financial Accounting
Standards Board's Statement No. 146, "Accounting for Costs Associated with Exit
and Disposal Activities" ("FAS 146"). We consolidated our space in March 2003
and recorded charges related to our consolidation of approximately $2,239,000 as
FAS 146 requires us to record a charge for excess space as of the date we cease
to use the space. This charge was our best estimate based upon a number of
assumptions and estimates that could prove inaccurate including length of period
that it will take to sublease our excess space, assumed sublease rate and other
collateral we expect to forfeit to our landlord upon commencement of a sublease.
In addition, should we continue to have excess operating lease capacity and we
are unable to find a sublessee at a rate equivalent to our operating lease rate,
we would be required to record additional charges for the rental payments that
we owe to our landlord relating to any excess facility capacity, which would
harm our operating results. Our management reviews our facility requirements and
assesses whether any excess capacity exists as part of our on-going financial
processes.
We have experienced rapid growth followed by substantial downsizing and we may
encounter difficulties in managing these size changes, which could adversely
impact our results of operations
We have experienced a period of rapid growth in our business and related
expenses, followed by a period of rapid and substantial downsizing of our
workforce and related expenses. These periods have placed a serious strain on
our managerial, administrative and financial personnel and our internal
infrastructure. To manage the changes these periods of expansion and contraction
of our business and personnel have brought to our operations and personnel, we
will be required to continue to improve existing and implement new operational,
financial and management controls, reporting systems and procedures. We may not
be able to install adequate management information and control systems in an
efficient and timely manner and our current or planned personnel systems,
procedures and controls may not be adequate to support our future operations. If
we are unable to manage further growth or reductions effectively, we may not be
able to capitalize on attractive business opportunities.
The prices we charge for our products and services may decrease or our pricing
assumptions may be incorrect, either of which may impact our ability to develop
a sustainable business.
The prices we charge for our products and services may decrease as a result
of competitive pricing pressures, promotional programs and customers who
negotiate price reductions. For example, we recently reduced the list price of
our VideoLogger product, one of our key platform products, in order to better
compete in the marketplace. In addition, some of our competitors have provided
their services without charge in order to gain market share or new customers and
key accounts. The prices at which we sell and license our products and services
to our customers depend on many factors, including:
o purchase volumes;
o competitive pricing;
o the specific requirements of the order;
o the duration of the licensing arrangement; and
o the level of sales and service support.
Our applications products are intended to increase both our revenues and
the average size of our customers' orders. These products have pricing models
based upon a number of assumptions about the market for our products. If our
assumptions are incorrect or our pricing does not work as intended, we may not
be able to increase the average size of our customer orders or reduce the costs
of selling and marketing for our products and, therefore, we may not be able to
develop a profitable and sustainable business.
Our sales and marketing costs are a high percentage of the revenues from
our orders, due partly to the expense of developing leads and relatively long
sales cycles involved in selling products that are not yet considered
"mainstream" technology investments. For the years ended March 31, 2003, 2002
and 2001, sales and marketing expenses were 91%, 103%, and 150% of our total
revenues, respectively.
14
Our service revenues have substantially lower gross profit margins than our
license revenues, and an increase in service revenues relative to license
revenues could harm our gross margins.
Our service revenues, which include fees for our application services as
well as professional services such as consulting, implementation, maintenance
and training, were 53%, 56% and 46% of our total revenues for the years ended
March 31, 2003, 2002 and 2001, respectively. Our service revenues have
substantially lower gross profit margins than our license revenues. Our cost of
service revenues for the years ended March 31, 2003, 2002 and 2001 were 67%, 94%
and 144% of service revenues, respectively. An increase in the percentage of
total revenues represented by service revenues could adversely affect our
overall gross profit margins.
Service revenues as a percentage of total revenues and cost of service
revenues as a percentage of total revenues have varied significantly from
quarter to quarter due to our relatively early stage of development. Recently,
we have experienced an increase in the percentage of license customers
requesting professional services. We expect that the amount and profitability of
our professional services will depend in large part on:
o the software solution that has been licensed;
o the complexity of the customers' information technology environments;
o the resources directed by customers to their implementation projects;
o the size and complexity of customer implementations; and
o the extent to which outside consulting organizations provide services
directly to customers.
The relative amount of service revenues as compared to license revenues has
also varied based on customer demand for our application services. Our
application services require a relatively fixed level of investment in staff,
facilities and equipment. In the past, we have operated our application service
business at a loss due to fixed investments that exceeded actual levels of
revenues realized. We have reduced the application service fixed investments
over the past year. However, there is no assurance that the current level of
application service revenues will continue to allow us to recover our fixed
costs and make a positive gross profit margin.
Service revenues from contracts with federal government agencies comprised
10% of total service revenues during the year ended March 31, 2003 (less than
10% for the years ended March 31, 2002 and 2001). Service revenues from
contracts with federal government agencies comprised less than 10% of total
revenues in each of the years ended March 31, 2003, 2002, and 2001. Contract
costs for service revenues to federal government agencies, including indirect
expenses, are subject to audit and subsequent adjustment by negotiation between
U.S. Government representatives and us. Service revenues are recorded in amounts
expected to be realized upon final settlement and in accordance with our revenue
recognition policies. While historically we have had no adverse impact related
to our revenues from such an audit and believes that the results of any future
audit will have no material effect on our financial position or results of
operations, there can be no assurance that no adjustment will be made and that,
if made, such adjustment will not have a material effect on our financial
position or results of operations (including our gross profit margin).
15
Because competition for qualified personnel is intense, we may not be able to
recruit or retain personnel, which could impact the development and acceptance
of our products and services.
Our future success depends to a significant extent on the continued
services of our senior management and other key personnel such as senior
development staff, product marketing staff and sales personnel. The loss of key
employees would likely have an adverse effect on our business. We do not have
employment agreements with most of our senior management team. If one or more of
our senior management team were to resign, the loss could result in loss of
sales, delays in new product development and diversion of management resources.
We may also be required to create additional performance and retention
incentives in order to retain our employees including the granting of additional
stock options to employees at or below current prices or issuing incentive cash
bonuses. Such incentives may either dilute our existing stockholder base or
result in unforeseen operating expenses, which may cause our stock price to
fall. For example, in February 2002, we introduced a Voluntary Stock Option
Cancellation and Re-grant Program in which a number of our employees cancelled
stock options that had significantly higher exercise prices in comparison to
where our common stock price currently trades. These employees received
2,538,250 shares at $0.59 per share in August 2002. This may cause dilution to
our existing stockholder base, which may cause our stock price to fall.
We may need to hire sales, development, marketing and administrative
personnel in the foreseeable future. We may be unable to attract or assimilate
other highly qualified employees in the future particularly given our continued
operating losses and weakening cash position. We have in the past experienced,
and we expect to continue to experience, difficulty in hiring highly skilled
employees with appropriate qualifications. In addition, new hires frequently
require extensive training before they achieve desired levels of productivity.
We may fail to attract and retain qualified personnel, which could have a
negative impact on our business.
If requirements relating to accounting treatment for employee stock options are
changed, we may be forced to change our business practices.
We currently account for the issuance of stock options under follow
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees." If proposals currently under consideration by administrative and
governmental authorities are adopted, we may be required to treat the value of
the stock options granted to employees as compensation expense. Such a change
could have a negative effect on our earnings. In response to a requirement to
expense the value of stock options, we could decide to decrease the number of
employee stock options granted to our employees. Such a reduction could affect
our ability to retain existing employees and attract qualified candidates, and
increase the cash compensation we would have to pay to them.
Recently enacted and proposed changes in securities laws and regulations will
increase our costs.
The Sarbanes-Oxley Act ("the Act") of 2002 that became law in July 2002
requires changes in some of our corporate governance and securities disclosure
and/or compliance practices. The Act also requires the SEC to promulgate new
rules on a variety of subjects, in addition to rule proposals already made, and
the NASDAQ National Market has proposed revisions to its requirements for
companies like Virage that are listed on NASDAQ. We believe these developments
will increase our legal and accounting compliance costs. We also expect these
developments to make it more difficult and more expensive for us to obtain
director and officer liability insurance, and we may be required to accept
reduced coverage or incur substantially higher costs to obtain coverage. These
developments could make it more difficult for us to attract and retain qualified
members of our board of directors, or qualified executive officers. We are
presently evaluating and monitoring regulatory developments and cannot reliably
estimate the timing or magnitude of additional costs we will incur as a result
of the Act or other, related legislation.
16
If the protection of our intellectual property is inadequate or third party
intellectual property is unavailable or if others bring infringement or other
claims against us, we may incur significant costs or lose customers.
We depend on our ability to develop and maintain the proprietary aspects of
our technology. Policing unauthorized use of our products is difficult and
software piracy may become a problem. We license our proprietary rights to third
parties, who may not abide by our compliance guidelines. To date, we have not
sought patent protection of our proprietary rights in any foreign jurisdiction,
and the laws of some foreign countries do not protect our proprietary rights to
as great an extent as do the laws of the United States. Our efforts to protect
our intellectual property rights may not be effective to prevent
misappropriation of our technology or may not prevent the development by others
of products competitive with those developed by us.
In addition, other companies may obtain patents or other proprietary rights
that would limit our ability to conduct our business and could assert that our
technologies infringe their proprietary rights. We could incur substantial costs
to defend any litigation, and intellectual property litigation could force us to
cease using key technology, obtain a license, or redesign our products. From
time to time, we have received notices claiming that our technology infringes
patents held by third parties and in addition may become involved in litigation
claims arising from our ordinary course of business. We believe that there are
no claims or actions pending or threatened against us, the ultimate disposition
of which would have a material adverse effect on us. However, in the event any
claim against us is successful, our operating results would be significantly
harmed.
Furthermore, we license technology from third parties, which may not
continue to be available on commercially reasonable terms, if at all. Although
we do not believe that we are substantially dependent on any licensed
technology, some of the software we license from third parties could be
difficult for us to replace. The loss of any of these licenses could result in
delays in the licensing of our products until equivalent technology, if
available, is developed or licensed for potentially higher fees and integrated.
In the event of any such loss, costs could be increased and delays could be
incurred, thereby harming our business. The use of additional third-party
software would require us to negotiate license agreements with other parties,
which could result in higher royalty payments and a loss of product
differentiation. In addition, the effective implementation of our products
depends upon the successful operation of third-party licensed products in
conjunction with our products, and therefore any undetected errors in these
licensed products could prevent the implementation or impair the functionality
of our products, delay new product introductions and/or damage our reputation.
Interruptions to our business or internal infrastructure from unforeseen,
adverse events or circumstances will disrupt our business and our operating
results will suffer.
The worldwide socio-political environment has changed dramatically since
September 11, 2001 and potential conflicts with countries such as North Korea
create a great deal of global uncertainty. Our customers, potential customers
and vendors are located worldwide and generally within major international
metropolitan areas. In addition, the significant majority of our operations are
conducted at offices within a 60-mile radius of the major metropolitan cities of
San Francisco, New York City, Boston and London. Our business also requires that
certain personnel, including our officers, travel in order to perform their jobs
appropriately. A terrorist attack or military conflict or adverse biological
event (such as the recent outbreak of SARS globally, and in particular, in Asia
and Canada) could reduce our ability to travel or could limit our ability to
enter foreign countries, either of which would diminish our effectiveness in
closing international customer opportunities. Should a major catastrophe occur
within the vicinity of any of our operations, our customers' and/or potential
customers' operations and/or vendors' operations, our operations may be
adversely impacted and our business may be harmed.
17
Our communications and network infrastructure are a critical part of our
business operations. Our application services business is dependent upon
providing our customers with fast, efficient and reliable services. To meet our
customers' requirements, we must protect our network against damage from any and
all sources, including among other things:
o human error;
o physical or electronic security breaches;
o computer viruses;
o fire, earthquake, flood and other natural disasters;
o power loss;
o telecommunications failure; and
o sabotage and vandalism.
We have communications hardware and computer hardware operations located at
third party facilities in Santa Clara, California and Palo Alto, California. We
do not have complete backup systems for these operations. A problem with, or
failure of, our communications hardware or operations could result in
interruptions or increases in response times on the Internet sites of our
customers. Furthermore, if these third party partners fail to adequately
maintain or operate our communications hardware or do not perform our computer
hardware operations adequately, our services to our customers may not be
available. We have experienced system failures in the past. Any disruptions
could damage our reputation, reduce our revenues or otherwise harm our business.
Our insurance policies may not adequately compensate us for any losses that may
occur due to any failures or interruptions in our systems.
Defects in our software products or services could diminish demand for our
products or could subject us to liability claims and negative publicity if our
customers' systems, information or video content is damaged through the use of
our products and/or our application services.
Our software products and related services are complex and may contain
errors that may be detected at any point in the life of the product or service.
Our software products must operate within our customers' hardware and network
environment in order to function as intended. We cannot assure you that, despite
testing by us and our current and potential customers, errors will not be found
in new products or releases after shipment or in the related services that we
perform for our customers. If our customers' systems, information or video
content is damaged by software errors or services that we perform for them, our
business may be harmed. In addition, these errors or defects or the
incompatibility of our products to work within a customers' hardware and network
environment may cause severe customer service and public relations problems.
Errors, bugs, viruses, incompatibility or misimplementation of our products or
services may cause liability claims and negative publicity ultimately resulting
in the loss of market acceptance of our products and services. Our agreements
with customers that attempt to limit our exposure to liability claims may not be
enforceable in jurisdictions where we operate.
We may need to make acquisitions or form strategic alliances or partnerships in
order to remain competitive in our market, and potential future acquisitions,
strategic alliances or partnerships could be difficult to integrate, disrupt our
business and dilute stockholder value.
We may acquire or form strategic alliances or partnerships with other
businesses in the future in order to remain competitive or to acquire new
technologies. As a result of these acquisitions, strategic alliances or
partnerships, we may need to integrate products, technologies, widely dispersed
operations and distinct corporate cultures. The products, services or
technologies of the acquired companies may need to be altered or redesigned in
order to be made compatible with our software products and services, or the
software architecture of our customers. These integration efforts may not
succeed or may distract our management from operating our existing business. Our
failure to successfully manage future acquisitions, strategic alliances or
partnerships could seriously harm our operating results. In addition, our
stockholders would be diluted if we finance the acquisitions, strategic
alliances or partnerships by incurring convertible debt or issuing equity
securities.
18
In addition to the above-stated risks, under the Financial Accounting
Standards Board's Statement of Financial Accounting Standards No. 142, "Goodwill
and Other Intangible Assets" ("FAS 142"), any future goodwill resulting from any
future acquisitions we may undertake will not be amortized but instead reviewed
at least annually for impairment. We will be required to test goodwill for
impairment using the two-step process prescribed in FAS 142. The first step is a
screen for potential impairment, while the second step measures the amount of
impairment, if any. Should we enter into any future acquisition transactions and
general macroeconomic conditions deteriorate subsequent to the acquisition,
which affects our business and operating results over the long-term, and/or
should the future acquisition target not provide the results that are
anticipated when the merger is consummated, we could be required to record
accelerated impairment charges related to goodwill, which could adversely affect
our financial results.
As we operate internationally, we face significant risks in doing business in
foreign countries.
We are subject to a number of risks associated with international business
activities, including:
o costs of customizing our products and services for foreign countries,
including localization, translation and conversion to international and
other foreign technology standards;
o compliance with multiple, conflicting and changing governmental laws
and regulations, including changes in regulatory requirements that may
limit our ability to enter or sell our products and services in
particular countries;
o import and export restrictions, tariffs and greater difficulty in
collecting accounts receivable; and
o foreign currency-related risks if a significant portion of our revenues
become denominated in foreign currencies.
Item 2. Properties
We currently lease approximately 48,000 square feet of our facility in San
Mateo, California for our principal administrative, research and development,
sales, services and marketing activities. This lease expires in September 2006.
In addition, we lease a property in New York City for services and sales under a
lease that expires in March 2005, a property near Boston, Massachusetts where
the Company performs research and development under a lease that expires in July
2003, a property near Chicago where the Company performs sales and marketing
activities that expires in September 2003 and a property near London, England
where the Company performs sales, services, and marketing activities and that
expires in June 2003.
In March 2003, we consolidated our employees at our San Mateo headquarters,
leaving approximately 24,000 square feet available for potential sublease. Our
lease for this excess property expires in September 2006. See Note 2 of Notes to
Consolidated Financial Statements for information regarding our lease
obligations.
19
Item 3. Legal Proceedings
Beginning on August 22, 2001, purported securities fraud class action
complaints were filed in the United States District Court for the Southern
District of New York. The cases were consolidated and the litigation is now
captioned as In re Virage, Inc. Initial Public Offering Securities Litigation,
Civ. No. 01-7866 (SAS) (S.D.N.Y.), related to In re Initial Public Offering
Securities Litigation, 21 MC 92 (SAS) (S.D.N.Y.). On or about April 19, 2002,
the plaintiffs electronically served an amended complaint. The amended complaint
is brought purportedly on behalf of all persons who purchased the Company's
common stock from June 28, 2000 through December 6, 2000. It names as defendants
the Company, one current and one former officer of the Company, and several
investment banking firms that served as underwriters of our initial public
offering. The complaint alleges liability under Sections 11 and 15 of the
Securities Act of 1933 and Sections 10(b) and 20(a) of the Securities Exchange
Act of 1934, on the grounds that the registration statement for the offering did
not disclose that: (1) the underwriters had agreed to allow certain customers to
purchase shares in the offerings in exchange for excess commissions paid to the
underwriters; and (2) the underwriters had arranged for certain customers to
purchase additional shares in the aftermarket at predetermined prices. The
amended complaint also alleges that false analyst reports were issued. No
specific damages are claimed.
We are aware that similar allegations have been made in other lawsuits
filed in the Southern District of New York challenging over 300 other initial
public offerings and secondary offerings conducted in 1999 and 2000. Those cases
have been consolidated for pretrial purposes before the Honorable Judge Shira A.
Scheindlin. On July 15, 2002, we (and the other issuer defendants) filed a
motion to dismiss. On February 19, 2003, the Court issued a ruling on the
motions. The Court denied the motions to dismiss the claims under the Securities
Act of 1933. The Court granted the motions to dismiss the claims under the
Securities Exchange Act of 1934 with prejudice. We believe we have meritorious
defenses to these claims and intend to defend against them vigorously.
From time to time, we may become involved in litigation claims arising from
its ordinary course of business. We believe that there are no claims or actions
pending or threatened against us, the ultimate disposition of which would have a
material adverse effect on us.
Item 4. Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of security holders during the fourth
quarter of our fiscal year ended March 31, 2003.
Executive Officers of the Registrant
The following table sets forth certain information regarding our executive
officers as of June 10, 2003:
Name Age Position
---- --- --------
Paul G. Lego............................. 44 President, Chief Executive Officer and Chairman of
the Board of Directors
Scott C. Gawel........................... 32 Vice President, Finance and Acting Chief
Financial Officer
Stanford S. Au........................... 43 Vice President, Engineering
David J. Girouard........................ 37 Senior Vice President, Marketing and Corporate
Strategy
Michael H. Lock.......................... 40 Senior Vice President, Worldwide Sales
Frank H. Pao............................. 34 Vice President, Business Affairs
20
Paul G. Lego, chairman of the board of directors, president and chief
executive officer, joined Virage in January 1996. From January 1995 to January
1996, Mr. Lego was an associate at Sutter Hill Ventures, a venture capital firm.
From June 1988 to December 1994, Mr. Lego was the chief operating officer at
Digidesign, a manufacturer of digital audio recording and editing systems, which
was acquired by Avid Technology in January 1995. Mr. Lego has also held various
marketing, manufacturing and engineering positions with Pyramid Technology
Corporation, the General Electric Company and Digital Equipment Corporation. Mr.
Lego holds a B.S. in electrical engineering from Cornell University and an
M.B.A. from Harvard Business School.
Scott C. Gawel has served as our vice president, finance and acting chief
financial officer since August 2002. Mr. Gawel joined Virage as the Company's
senior director of finance and corporate controller in January 2000. Prior to
joining Virage, Mr. Gawel worked with a wide array of high technology companies
while holding various staff and managerial positions within Ernst & Young's
Silicon Valley practice, most recently as an audit manager. Mr. Gawel is a
certified public accountant in the state of California and holds a B.S. in
Economics with honors from California Polytechnic State University, San Luis
Obispo.
Stanford S. Au, vice president, engineering, joined Virage in January 2002.
Mr. Au came to Virage from AOL-Time Warner's Netscape Communications, where he
held various positions from 1998 to 2002, most recently as vice president and
general manager of AOL's IBPP business unit. Prior to Netscape, he was an
original member of KIVA software's executive staff, which was acquired by
Netscape. Mr. Au has also held various engineering and senior management
positions at Apple Computer, Sun Microsystems, and Hewlett-Packard. Mr. Au holds
a B.S. in electrical engineering and computer science from the University of
California, Berkeley.
David J. Girouard, senior vice president, marketing and corporate strategy,
joined Virage in May 1997. Prior to becoming our senior vice president,
marketing and corporate strategy, Mr. Girouard was our vice president and
general manager, Virage Interactive, and was as a director of product marketing.
From December 1994 to April 1997, Mr. Girouard was a product manager in the
worldwide product marketing group at Apple Computer. Mr. Girouard holds a B.A.
in engineering sciences and a B.E. from Dartmouth College. He also holds an
M.B.A. from the University of Michigan.
Michael H. Lock, senior vice president, worldwide sales, joined Virage in
January 2001. Prior to joining Virage, Mr. Lock held various sales and marketing
positions at Oracle Corporation, most recently as Vice President, Sales and
Marketing, from 1996 to 2000. Mr. Lock also has served in a variety of sales,
marketing and general management positions with IBM, Dun and Bradstreet Software
and Drake International. Mr. Lock received a B.S. in Business Administration
from Wilfrid Laurier University in Ontario, Canada.
Frank H. Pao, vice president, business affairs, joined Virage in April
1997. From September 1994 to March 1997, Mr. Pao specialized in intellectual
property and licensing transactions at the law firm of Gray Cary Ware &
Freidenrich. He has also held various engineering positions at Advanced
Cardiovascular Systems and Lawrence Berkeley Laboratories. Mr. Pao holds a B.S.
in bioengineering from the University of California at Berkeley and a J.D. from
Boalt Hall School of Law at the University of California at Berkeley.
21
PART II
Item 5 Market for Registrant's Common Equity and Related Stockholder Matters
(a) Our stock is currently traded on the NASDAQ National Market under the
symbol "VRGE". The bid price for our common stock has been under $1.00
per share for over 30 consecutive trading days. Under NASDAQ's listing
maintenance standards, if the closing bid price of our common stock is
under $1.00 per share for 30 consecutive trading days, NASDAQ may choose
to notify us that it may delist our common stock from the NASDAQ
National Market.
We received a NASDAQ letter on May 1, 2003 that we were not in
compliance with the NASDAQ's minimum bid price listing requirement and
that we had seven calendar days to do one of the following:
o Submit an application to transfer our securities for to the
NASDAQ SmallCap Market;
o Request a hearing to appeal the delisting notice; or
o Have our securities delisted from the NASDAQ National Market.
We initiated an appeal process with NASDAQ whereby we have requested an
in-person hearing with NASDAQ regulators to present relevant measures
the Company is taking in order to improve its operating results and, as
a result, bolster its stock price to levels required by NASDAQ. Should
NASDAQ dismiss our appeal, we believe we will submit an application for
transfer to the NASDAQ SmallCap Market, where we believe we will have at
least 180 days from the date of transfer to attempt to regain compliance
with NASDAQ's listing requirements. If we transfer to the NASDAQ
SmallCap Market, we may be eligible to transfer back to the NASDAQ
National Market if our bid price maintains the $1.00 per share
requirement for 30 consecutive trading days and we have maintained
compliance with all other continued listing requirements for the NASDAQ
National Market.
There can be no assurance that the NASDAQ will approve our appeal, that
we will comply with other non-bid price related listing criteria or that
our common stock will remain eligible for trading on the NASDAQ National
Market or the NASDAQ SmallCap Market. If our stock were delisted, the
ability of our stockholders to sell any of our common stock at all would
be severely, if not completely, limited.
The following high and low closing sales prices were reported by NASDAQ
in each period indicated:
High Low
---- ---
Year Ended March 31, 2003
-------------------------
Fourth quarter.......................... $ 0.85 $ 0.56
Third quarter........................... $ 0.98 $ 0.50
Second quarter.......................... $ 1.20 $ 0.50
First quarter........................... $ 2.60 $ 0.75
Year Ended March 31, 2002
-------------------------
Fourth quarter.......................... $ 3.56 $ 2.00
Third quarter........................... $ 3.47 $ 1.61
Second quarter.......................... $ 4.15 $ 1.65
First quarter........................... $ 5.90 $ 1.81
22
The reported last sale price of our common stock on the Nasdaq National
Market on June 9, 2003 was $0.98. The approximate number of holders of
record of the shares of our common stock was 220 as of June 9, 2003.
This number does not include stockholders whose shares are held in trust
by other entities. Because many of our shares of common stock are held
by brokers and other institutions on behalf of stockholders, we are
unable to estimate the total number of stockholders represented by these
record holders.
We have not paid any cash dividends on our capital stock. We currently
intend to retain future earnings, if any, to fund the development and
growth of our business and, therefore, do not anticipate paying any cash
dividends in the foreseeable future. See Item 7, "Management's
Discussion and Analysis of Financial Condition and Results of
Operations-Liquidity and Capital Resources."
Equity Compensation Plans
At March 31, 2003, common stock reserved for future issuance was as
follows:
Number of Securities
to be Issued upon
Exercise of Weighted- Shares
Outstanding Options, Average Available
Warrants and Rights Exercise Price for Grant
------------------- -------------- ---------
Equity compensation plans approved
by stockholders ............................ 6,866,805 $ 1.96 2,832,050
Equity compensation plans not approved
by stockholders ............................ 1,200,020 $ 2.17 99,980
------------- -----------
Total..................................... 8,066,825 $ 1.99 2,932,030
============= ============ ===========
Included in the 2,832,050 shares available for grant for equity
compensation plans approved by stockholders are 1,401,184 shares
reserved pursuant to the Company's Employee Stock Purchase Plan.
(b) There has been no change to the disclosure contained in our report on
Form 10-Q for the nine months ended December 31, 2002 regarding the use
of proceeds generated by our initial public offering.
23
Item 6. Selected Consolidated Financial Data
SELECTED CONSOLIDATED FINANCIAL DATA
You should read the selected consolidated financial data set forth below in
conjunction with Item 7, "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and our Consolidated Financial Statements
and the Notes thereto included elsewhere in this annual report. Historical
results are not necessarily indicative of results that may be expected for any
future period. Certain prior year balances have been reclassified to conform
with current year presentation.
Fiscal Years Ended
March 31,
------------------------------------------------------
2003 2002 2001 2000 1999
-------- ---------- ---------- ---------- ----------
(in thousands, except per share data)
Consolidated Statements of Operations Data:
Revenues:
License revenues........................$ 6,029 $ 7,414 $ 6,161 $ 4,188 $ 1,956
Service revenues........................ 6,900 9,331 5,240 1,373 253
Other revenues.......................... -- -- -- -- 1,141
-------- ------- --------- -------- -------
Total revenues................... 12,929 16,745 11,401 5,561 3,350
Cost of revenues:
License revenues........................ 738 705 723 870 397
Service revenues........................ 4,601 8,760 7,530 2,660 426
Other revenues.......................... -- -- -- -- 859
-------- ------- --------- -------- -------
Total cost of revenues........... 5,339 9,465 8,253 3,530 1,682
-------- ------- --------- -------- -------
Gross profit.............................. 7,590 7,280 3,148 2,031 1,668
Operating expenses:
Research and development................ 9,248 9,172 9,101 4,182 2,325
Sales and marketing..................... 11,775 17,301 17,129 8,349 4,362
General and administrative.............. 3,935 4,985 5,298 2,653 1,273
Stock-based compensation................ 1,306 5,113 3,294 1,070 --
-------- ------- --------- -------- -------
Total operating expenses......... 26,264 36,571 34,822 16,254 7,960
-------- ------- --------- -------- -------
Loss from operations...................... (18,674) (29,291) (31,674) (14,223) (6,292)
Interest and other income, net............ 554 1,541 2,800 384 123
-------- ------- --------- -------- -------
Loss before income taxes.................. (18,120) (27,750) (28,874) (13,839) (6,169)
Provision for income taxes................ -- -- -- (36) --
-------- ------- --------- --------- -------
Net loss.................................. (18,120) (27,750) (28,874) (13,875) (6,169)
Series E convertible preferred stock
dividend................................ -- -- -- (4,544) --
-------- ------- --------- --------- -------
Net loss applicable to common
stockholders......................... $(18,120) $(27,750) $ (28,874) $(18,419) $(6,169)
======== ======== ========= ======== =======
Basic and diluted net loss per share
applicable to common stockholders.... $ (0.87) $ (1.37) $ (1.88) $ (8.06) $ (3.67)
======== ======== ========= ======== =======
Shares used in computation of basic and
diluted net loss per share applicable
to common stockholders................ 20,834 20,327 15,397 2,286 1,679
March 31,
-------------------------------------------------------
2003 2002 2001 2000 1999
-------- -------- --------- ---------- -------
(in thousands)
Consolidated Balance Sheets Data:
Cash, cash equivalents and short-term investments... $ 16,317 $ 30,694 $ 48,131 $ 10,107 $ 4,357
Working capital..................................... 11,061 24,077 40,588 8,101 3,879
Total assets........................................ 22,318 39,552 60,206 18,872 6,605
Long-term obligations, net of current portion....... -- -- -- 83 241
Redeemable convertible preferred stock.............. -- -- -- 36,995 17,936
Accumulated deficit................................. (107,044) (88,924) (61,174) (32,300) (13,881)
Total stockholders' equity (net capital deficiency). $ 13,701 $ 30,059 $ 49,706 $ (23,221) $ (13,326)
24
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following discussion and analysis of our financial condition and
results of operations should be read in conjunction with the "Selected
Consolidated Financial Data", the condensed consolidated financial statements
and related notes contained herein. This discussion contains forward-looking
statements within the meaning of Section 27A of the Securities Act and Section
21E of the Exchange Act. We may identify these statements by the use of words
such as "believe", "expect", "anticipate", "intend", "plan" and similar
expressions. These forward-looking statements involve several risks and
uncertainties. Our actual results may differ materially from those set forth in
these forward-looking statements as a result of a number of factors, including
those described under the caption "Risk Factors" herein. These forward-looking
statements speak only as of the date of this report, and we caution you not to
rely on these statements without also considering the risks and uncertainties
associated with these statements and our business as addressed elsewhere in this
report.
Fiscal Year 2003 Overview
Virage, Inc. is a provider of software products, professional services and
application services that enable owners of rich media and video assets to more
effectively communicate, manage, retrieve and distribute these rich media assets
for improved productivity and communication. We sell to the corporate, media and
entertainment, government and educational marketplaces.
Application Products
During the past year, we continued to market and sell our new application
products that we introduced late in our fiscal year ended March 31, 2002: VS
Webcasting, VS Publishing, and VS Production. VS Webcasting allows corporations
to schedule and manage live webcast events and then easily turn each into a
searchable, on-demand event. VS Publishing is a complete workflow solution that
allows media and entertainment companies to turn their content into compelling,
rich media programming for the Internet. VS Production is an integrated software
solution that automates a customer's video production process from acquisition
to distribution.
Though we have sold each of these products to date, our VS Webcasting
product has received the greatest level of interest from its target markets. We
have sold it into various enterprise environments, including financial
institutions, high technology companies, and universities. The VS Publishing and
VS Production products were released at a later date than VS Webcasting and, as
a result, are newer in the marketplace. To date, VS Publishing and VS Production
have been sold into a wide array of corporate and media and entertainment
environments, but have not yet experienced the interest levels that our VS
Webcasting product has. We may discover that the marketplace for a product is
not as robust as we had expected. We monitor anticipated market demand and sales
success for our products as we evaluate the allocation and prioritization of our
resources amongst our various product lines. We may react to slack product
demand by leaving the development of a product at an early stage or combining
key features of one or more of our application products into a single product.
This may impede market acceptance of any of our products and therefore hurt our
financial results.
Our strategy of introducing an application product suite has had an
important impact on our business trends. First, our application products bring a
more readily identifiable value proposition and quantifiable
return-on-investment than our standard platform products. As a result, our
application products command a higher price point with our customers and we are
experiencing a gradual increase in our average license deal size. Historically,
our average license deal size was in the range of $50,000 to $100,000 per
customer. Because of our application products, we are now seeing an average deal
size of over $100,000 per customer.
25
Second, we are seeing a shift in the industry mix of our end users as more
corporate enterprise customers are purchasing our products and as we experience
weak sales to media and entertainment companies. Corporate customers accounted
for 31% of total revenues during the year ended March 31, 2003 versus 24% of
total revenues during the year ended March 31, 2002. Historically, the media and
entertainment marketplace has been our strongest market. Media and entertainment
customers declined from 44% of total revenues to 21% of total revenues during
the years ended March 31, 2002 and 2003, respectively. We believe the reduction
in revenues from media and entertainment customers during the year ended March
31, 2003 is primarily a function of unfavorable global macroeconomic conditions
affecting a number of our potential customers and resulting in weak demand for
information technology products. The corporate market is our primary target
market, followed by government, education, and media and entertainment.
We continue to believe that the success of our application products,
particularly VS Webcasting, is critical to our future and have heavily invested
our resources in the development, marketing, and sale of them. The market for
our application products is in a relatively early stage. We cannot predict how
much the market for our application products will develop, what our future
average deal sizes will be, or whether our target industries will increasingly
adopt our products, and part of our strategic challenge will be to convince
customers of the productivity, communications, cost, and other benefits of these
products. Our future revenues and revenue growth rates will depend in large part
on our success in creating market acceptance for our application products.
U.S. Government Defense and Security Business
As a result of an increased focus on national security due primarily to the
September 2001 terrorist attacks and the war in Iraq, we saw higher demand from
U.S. Government Defense and Security Agencies, either from direct arrangements
or subcontracts with other U.S. Government contractors. We generally perform
these services in conjunction with existing or potential software license sales.
Our success is due, in large part, to the efforts of our Advanced Technology
Group. During fiscal 2003, our Advanced Technology Group obtained over
$1,000,000 in funds for sophisticated projects such as news monitoring and
motion mining. This funding represents a 143% increase over the $422,000 in
funding signed in fiscal 2002. Service revenues from these agencies represented
10% of total service revenues in the year ended March 31, 2003 (less than 10%
for the years ended March 31, 2002 and 2001).
Operating Lease Amendment
In December 2002, we amended our lease for our headquarters (the "Lease
Amendment"). The Lease Amendment reduces, from December 2002 until December
2003, our rent rate to half of what the rent rate was under the original
operating lease agreement. In December 2003, and on each annual anniversary
thereafter through the Amendment's termination date of September 2006, our rent
rate will be adjusted to fair market value as to be mutually determined between
us and our landlord, subject to a minimum rate that is equivalent to the Lease
Amendment's initial reduced rate discussed above (the "Minimum Rate").
In addition we, and our landlord, will use best efforts to have the
landlord lease, to a third party, certain space that we abandoned in March 2003.
If the space is leased to a third party, the space will be excluded from the
Lease Amendment as of the date an agreement for the third party lease is
executed, subject to us guaranteeing our landlord the Minimum Rate for the
leased space. This guarantee will continue for a minimum of 24 months after the
date of execution for the leased space.
Furthermore, if we are acquired by an unrelated entity, the acquirer may
terminate the lease obligation for a termination fee equal to 67% of the total
minimum monthly rent payable for the remaining term of the lease subsequent to
such acquisition.
26
In consideration for the above, we issued our landlord a warrant to
purchase 200,000 shares of the Company's common stock at $0.57 per share. The
fair value of this warrant was determined to be $86,000 and pro-rata amounts are
being expensed over the earlier of the life of the operating lease (September
2006) and the date that we abandoned certain excess facilities (March 2003). In
addition, we forfeited $1,250,000 of $2,000,000 of restricted cash used to
collateralize a letter of credit. We also forgave approximately $240,000 of
security deposits. The $2,000,000 of restricted cash and $240,000 of security
deposits were classified as other assets on the Company's consolidated balance
sheet at March 31, 2002.
We are obligated to forfeit $750,000 of restricted cash, which
collateralizes our obligation and is classified as other assets on our
consolidated balance sheet, to our landlord if our landlord is able to lease our
excess space. We estimate we will also incur approximately $359,000 of other
collateral forfeitures relating to certain provisions set forth within the Lease
Amendment.
In addition, the landlord, under certain limited conditions and exceptions
specified in the Lease Amendment, may have the option to extend the term of the
Lease Amendment for an additional five (5) years, with the base rent for the
renewal term based on fair market value.
We are amortizing the payments and other collateral described above as rent
expense over the life of the lease. In March 2003, we abandoned approximately
half of our headquarters facility to facilitate the leasing of the excess space
to a third party. As a result of this, we incurred charges of approximately
$2,239,000 (including $89,000 of equipment write-downs) during the year ended
March 31, 2003. The charges are related to the write-off of approximately half
of the unamortized portion of payments and other collateral forfeiture described
above and the accrual of approximately $1,026,000 relating to the expected
leasing of the excess space to a third party at a rate that is below the Minimum
Rate guarantee.
We have made a number of assumptions, such as length of time required to
engage a sublessee, and estimates, such as the assumed sublease rate, in
deriving the accounting for our lease amendment and excess facility space. Our
assumptions and estimates are based upon the best information that we have at
the time any charges are derived. There are a number of external factors outside
of our control that could materially change our assumptions and require us to
record additional charges in future periods. We monitor all of these external
factors and the impact on our assumptions and estimates as part of our on-going
financial reporting processes.
Business Restructuring Charges
During the year ended March 31, 2003, we implemented additional
restructuring programs to better align operating expenses with anticipated
revenues. We recorded a $3,215,000 restructuring charge, which consisted of
$2,150,000 of excess facility charges (recorded in our fiscal fourth quarter of
the year ended March 31, 2003), $849,000 in employee severance costs (the
significant majority of which was recorded during the three months ended June
30, 2002) and $216,000 in equipment write-downs across most of the expense line
items in our consolidated statement of operations for the year ended March 31,
2003. The restructuring programs resulted in a reduction in force across all
company functions of approximately 50 employees. At March 31, 2003, we had
$1,515,000 of accrued restructuring costs related to rent for excess facility
capacity, and potential cash payments and potential forfeiture of cash-based
collateral in conjunction with the Lease Amendment described above. We expect to
pay out the excess facility charges accrued as of March 31, 2003 over the life
of the operating lease, which runs through September 2006. We expect to forfeit
our cash-based collateral and pay out cash payments related to our Lease
Amendment over the course of the next twelve months.
During the year ended March 31, 2003, we made an adjustment of $66,000 to
accrued excess facilities costs. The excess facility accrual was originally
recorded pursuant to the FASB's Emerging Issues Task Force Issue 94-3,
"Liability Recognition for Certain Employee Termination Benefits and Other Costs
to Exit an Activity ("EITF 94-3")." The adjustment is a result of us
re-occupying certain space in March 2003 that we had previously written-off and
had not intended to use until April 2003.
27
It is difficult for us to precisely quantify the material effects of our
fiscal 2003 restructuring plans on our future operating results and cash flows.
However, for the fourth quarter of our fiscal 2003 our cost of sales and
operating expenses totaled $7,842,000 (including non-cash, stock-based charges
of $356,000 and net charges of $1,413,000) and compared to our cost of sales and
operating expenses during our fourth quarter of fiscal 2002 totaling $12,433,000
(including non-cash, stock-based charges of $3,865,000 and other net charges of
$396,000). Excluding non-cash, stock-based charges and other net charges
totaling $1,769,000 and $4,261,000 during our fiscal fourth quarters ended March
31, 2003 and 2002, respectively, our total cost of sales and operating expenses
totaled $6,073,000 and $8,172,000 during our fiscal fourth quarters ended March
31, 2003 and 2002, respectively. We believe these numbers are useful in order to
calculate the decrease in our expenses associated with our restructuring plans.
Based upon the previous, we believe our restructuring plans implemented during
fiscal 2003 will reduce our total expenses and cash usage on an annual basis in
comparison to our expense rate and cash usage prior to implementing these plans.
The significant majority of these expense reductions are cash based.
The following table depicts the restructuring activity during the year
ended March 31, 2003 (in thousands):
Expenditures
Balance at ------------------- Balance at
Category March 31, 2002 Additions Cash Non-cash Adjustments March 31, 2003
-------- -------------- --------- ---- -------- ----------- --------------
Excess facilities and
other exit costs..... $ 504 $ 2,150 $1,073 $ -- $ 66 $ 1,515
Employee severance....... 259 849 1,108 -- -- --
Equipment write-downs.... -- 216 -- 216 -- --
-------- --------- ------- -------- -------- -----------
Total................ $ 763 $ 3,215 $ 2,181 $ 216 $ 66 $ 1,515
======== ========= ======= ======== ======== ===========
Excess Facilities and Other Exit Costs: Excess facilities and other exit
costs relate to lease obligations and closure costs associated with offices we
have vacated as a result of our cost reduction initiatives and the restructuring
of our San Mateo office lease (see "Operating Lease Amendment" discussion
above). Cash expenditures for excess facilities and other exit costs during the
year ended March 31, 2003 represent the forfeiture of security deposits and
other cash-based collateral, and contractual ongoing lease payments. It is
management's best estimate that we will not be able to recoup the losses from
our lease rental payments recorded as excess facilities by earning a profit from
a sub lessee at some point over the course of our obligation period, which
continues through September 2006. The current commercial real estate market in
Northern California is poor for sublessors looking for tenants, and while we
will make every attempt to secure a sublease, we believe that we will be unable
to sublease this additional space at a rate that is consistent with the Minimum
Rate described above. We have made a number of assumptions, such as length of
time required to engage a sublessee, and estimates, such as the assumed sublease
rate, in deriving the accounting for our lease amendment and excess facility
space. Our assumptions and estimates are based upon the best information that we
have at the time any charges are derived. There are a number of external factors
outside of our control that could prove our assumptions and estimates materially
inaccurate and require us to record additional charges in future periods. We
monitor all of these external factors and the impact on its assumptions and
estimates as part of our on-going financial processes.
Employee Severance: Employee severance, which includes severance payments,
related taxes, outplacement and other benefits, totaled approximately $849,000
during the year ended March 31, 2003 (representing approximately 50 terminated
employees), and $1,108,000 was paid in cash during the year ended March 31,
2003. Personnel affected by the cost reduction initiatives during the year ended
March 31, 2003 include employees in positions throughout the company in sales,
marketing, services, engineering, and general and administrative functions in
all geographies.
28
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 assets
previously used by terminated employees. We also abandoned certain areas of our
headquarters' facility in March 2003 and were required to write-off certain
tenant improvements and excess furniture. The combination of these two events
resulted in a write-off of approximately $216,000 of assets at net book value.
Our management reviews its equipment requirements and assesses whether any
excess equipment 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.
We believe that this program has helped, and will continue to 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, provisions for revenue adjustments and
doubtful accounts, 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. Service revenues include revenues from maintenance
contracts, application services, and professional services, including
professional services performed directly for and via subcontract for the U.S.
Government.
29
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
longer than normal not to be fixed and determinable. Our normal payment terms
are generally considered to be "net 30 days" to "net 60 days." For arrangements
involving extended payment terms, revenue recognition generally occurs when
payments become due provided all other revenue recognition criteria are met. No
customer has the right of return and arrangements generally do not have
acceptance criteria. If right of return or customer acceptance does exist within
an arrangement, revenue is deferred until the earlier of the end of the right of
return/acceptance period or until written notice of acceptance/cancellation of
right of return is received from the customer.
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). Customers that enter into maintenance
contracts have the ability to renew such contracts at the renewal rate.
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 upon, we recognize revenue on the 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
upon or other criteria in SOP 97-2 are not met. We recognize royalty revenues
upon receipt of the quarterly reports from the vendors.
When licenses and maintenance are sold together with professional services
such as consulting and implementation, license fees are recognized upon
shipment, provided that (1) the criteria in the previous paragraph have been
met, (2) payment of the license fee is not dependent upon the performance of the
professional services, (3) the services do not include significant alterations
to the features and functionality of the software and (4) the services are
deemed "perfunctory" both in level of effort to perform and in magnitude of
dollars based upon our objective evidence of fair value for the services
relative to the total arrangement fee.
30
Should professional services be essential to the functionality of the
licenses in a license arrangement that 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. For arrangements that include customer
acceptance clauses that we do not have an established history of meeting or
which are not considered to be routine, we recognize revenues when the
arrangement has been completed and accepted by the customer.
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. 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
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. We recognize revenues on transaction fees that are subject to
monthly minimums based upon the monthly minimum rate 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 provided all other revenue recognition
criteria are met.
Included as part of our service revenues are services performed for U.S.
Government defense and security agencies, either from direct arrangements or
subcontracts with other U.S. Government contractors. We generally perform these
services in conjunction with existing or potential software license sales.
Should software be included as part of the arrangement, we account for any
software license fee according to our revenue recognition accounting policy
described above.
Virtually all of our services with such U.S. Government agencies are
performed under various firm-fixed-price, time-and-material, and
cost-plus-fixed-fee reimbursement contracts. Revenues on firm-fixed-price
contracts are generally recognized according to SOP 81-1 based upon costs
incurred in relation to total estimated costs from input measures such as hours
or days. Revenues on time-and-material contracts are recognized to the extent of
billable rates multiplied by hours worked plus materials expense incurred.
Revenues for cost-plus-fixed-fee contracts are recognized as costs are incurred,
including a proportionate amount of the fee earned.
Service revenues from contracts with federal government agencies comprised
10% of total service revenues during the year ended March 31, 2003 (less than
10% for the years ended March 31, 2002 and 2001). Service revenues from
contracts with federal government agencies comprised less than 10% of total
revenues in each of the years ended March 31, 2003, 2002, and 2001. Contract
costs for service revenues to federal government agencies, including indirect
expenses, are subject to audit and subsequent adjustment by negotiation between
U.S. Government representatives and us. Service revenues are recorded in amounts
expected to be realized upon final settlement and in accordance with revenue
recognition policies described above. While historically we have had no adverse
impact related to our revenues from such an audit and believes that the results
of any future audit will have no material effect on our financial position or
results of operations, there can be no assurance that no adjustment will be made
and that, if made, such adjustment will not have a material effect on our
financial position or results of operations.
31
Customer billings that have not been recognized as revenue in accordance
with the above policies are shown on the balance sheet as deferred revenue.
Allowance for Revenue Adjustments and Doubtful Accounts
If we determine that payment from the customer is not probable at the time
all other revenue recognition criteria (as described above) have been met, we
defer revenues until payment from the customer is received. We also make
judgments as to our ability to collect outstanding receivables (that have not
been deferred) and provide an allowance for the portion of receivables when
collection becomes doubtful. We also provide an allowance for returns and
revenue adjustments in the same period as the related revenues are recorded.
Allowances are made based upon a specific review of all significant outstanding
invoices. Allowances recorded offset the Company's gross accounts receivable
balance. Allowances totaled $502,000 and $1,153,000 at March 31, 2003 and 2002,
respectively.
Restructuring Costs
During the years ended March 31, 2003 and 2002, we undertook plans to
restructure our operations in order to reduce operating expenses. Our
restructuring expenses have included excess facilities, employee severance,
asset write-downs and other exit costs. Given the significance of, and timing of
the execution of such activities, this process is complex and involves periodic
reassessments of estimates made at the time the original decisions were made.
Our restructuring expenses involved significant estimates made by management
using the best information available at the time that the estimates were made,
some of which were based upon information provided by third parties. We
continually evaluate the adequacy of the remaining liabilities under our
restructuring initiatives. Although we believe that these estimates accurately
reflect the costs of our restructuring plans, actual results may differ, thereby
requiring us to record additional provisions or reverse a portion of such
provisions.
As discussed in Note 2 of Notes to Consolidated Financial Statements
included in Part II, Item 8, hereof, we have recorded significant restructuring
expenses in connection with our abandonment of certain leased facilities. These
excess facility costs were estimated to include remaining lease liabilities,
forfeiture of certain collateral pursuant to our lease amendment and brokerage
fees offset by estimated sublease income. Estimates related to sublease costs
and income are based on assumptions regarding the period required to sublease
the facilities and the likely sublease rates. These estimates are based on
market trend information analyses provided by commercial real estate brokerage
firms retained by us. We review these estimates each reporting period and, to
the extent that our assumptions change, adjustments to the restructuring accrual
are recorded. If the real estate market continues to worsen and we are not able
to sublease the properties as early as, or at the rates estimated, the accrual
will be increased, which would result in additional restructuring costs in the
period in which such determination is made. If the real estate market
strengthens and we are able to sublease the properties earlier or at more
favorable rates than projected, the accrual may be decreased, which would
increase net income in the period in which such determination is made.
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. 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.
32
From time to time, we may become involved in litigation claims arising from
our ordinary course of business. We provide further detail about one of these
claims in the notes to our consolidated financial statements included elsewhere
in this annual report. 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 the our consolidated financial position, results of operations
or cash flows.
Results of Operations
The following table sets forth consolidated financial data for the periods
indicated, expressed as a percentage of total revenues. Certain prior year
balances have been reclassified to conform with current year presentation.
Fiscal Years Ended
March 31,
2003 2002 2001
------- ------- ------
Revenues:
License revenues...................... 47% 44% 54%
Service revenues...................... 53 56 46
---- ---- ----
Total revenues................ 100 100 100
---- ---- ----
Cost of revenues:
License revenues...................... 6 4 6
Other revenues........................ 35 53 66
---- ---- ----
Total cost of revenues........ 41 57 72
---- ---- ----
Gross profit............................ 59 43 28
Operating expenses:
Research and development.............. 72 55 80
Sales and marketing................... 91 103 150
General and administrative............ 30 30 47
Stock-based compensation.............. 10 30 29
---- ---- ----
Total operating expenses...... 203 218 306
---- ---- ----
Loss from operations.................... (144) (175) (278)
Interest and other income, net.......... 4 9 25
---- ---- ----
Net loss................................ (140)% (166)% (253)%
==== ==== ====
We incurred net losses of $18,120,000, $27,750,000, and $28,874,000 during
the three years ended March 31, 2003, 2002, and 2001, respectively. As of March
31, 2003, we had an accumulated deficit of $107,044,000. 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. Any historic revenue growth rates are not necessarily sustainable
or indicative of any future growth.
Revenues
The following table sets forth a breakdown of our revenues for the years
ended March 31, 2003 (fiscal 2003), 2002 (fiscal 2002) and 2001 (fiscal 2001),
with changes expressed in whole dollar amounts and percentages versus results
from the immediately preceding fiscal year. Certain prior year balances have
been reclassified to conform with current year presentation (all amounts
presented are in thousands, except percentages):
Increase/(Decrease) Increase/(Decrease)
vs. Prior Year vs. Prior Year
Year Ended ------------------ Year Ended ---------------- Year Ended
March 31, 2003 Amount Percent March 31,2002 Amount Percent March 31, 2001
---------- --------- ------- ------------- -------- ------- --------------
License revenues.............. $ 6,029 $ (1,385) (19)% $ 7,414 $ 1,253 20% $ 6,161
Customer support revenues..... 2,737 83 3% 2,654 901 51% 1,753
Professional service revenues. 2,200 (345) (14)% 2,545 2,401 1,667% 144
Application service revenues.. 1,963 (2,169) (53)% 4,132 789 24% 3,343
--------- --------- ------------ -------- -------------
Total service revenues....... 6,900 (2,431) (26)% 9,331 4,091 78% 5,240
--------- --------- ------------ -------- -------------
Total revenues.............. $ 12,929 $ (3,816) (23)% $ 16,745 $ 5,344 47% $ 11,401
======== ========= ======== ============ ======== ======= =============
33
Fiscal 2003 Revenues vs. Fiscal 2002 Revenues
Total revenues decreased to $12,929,000 in fiscal 2003 from $16,745,000 in
fiscal 2002, a decrease of $3,816,000 or 23%. This decrease was a result of
decreases in license, professional service, and application service revenues,
and was slightly offset by increases in customer support revenues. International
revenues decreased in absolute dollars to $3,285,000, or 25% of total revenues,
in fiscal 2003 from $3,997,000, or 24% of total revenues, in fiscal 2002. There
were no customers who accounted for more than 10% of total revenues in fiscal
2003. One customer accounted for 14% of total revenues in fiscal 2002.
License revenues decreased to $6,029,000 in fiscal 2003 from $7,414,000 in
fiscal 2002, a decline of $1,385,000 or 19%. This decrease was a result of lower
sales of our platform products and was offset in part by increased revenues from
our application products. The lower sales performance for our platform business
during fiscal 2003 resulted primarily from weak technology spending by our
target markets in the United States and abroad, causing delays in the closure of
deals for our platform license products or a reduction in the size of those
deals. The reduction in our platform license revenues also stemmed from the loss
of a reseller that sold our platform products. In late fiscal 2002, our largest
commercial, platform reseller announced that it would divest its business in
which our products were most compatible. This reseller was responsible for
$1,280,000 and $1,015,0000 of platform license revenues during fiscal 2002 and
2001, respectively (none during fiscal 2003).
We believe that our platform products remain an important component of our
business and have invested resources in the enhancement of this product line. We
are working on the next generation of our platform products and continually
evaluate the level of research and development and sales and marketing resources
we allocate to these products. We hope to see improved performance in our
platform business during our fiscal 2004, but cannot predict what our sales will
be or whether the overall economy will improve our revenue results in this area.
The decline in platform license revenues was offset by increased sales of
our application products, particularly VS Webcasting. As discussed in the
"Fiscal Year 2003 Overview" section, above, we have experienced some initial
demand for our VS Webcasting product and, to a lesser extent, for our VS
Publishing and VS Production applications, driving revenue growth in this area.
Service revenues decreased to $6,900,000 in fiscal 2003 from $9,331,000 in
fiscal 2002, a decrease of $2,431,000 or 26%. Customer support revenues remained
relatively flat year over year. We experienced a number of existing customers
renew their support agreements with us during fiscal 2003. These renewals,
combined with the significant majority of our new customers purchasing
maintenance contracts, resulted in our customer support revenues remaining
relatively flat, despite a decline in license revenues. Professional and
application service revenues declined 14% and 53%, respectively, in fiscal 2003
in comparison to fiscal 2002. Professional service revenues typically correlate
with fluctuations in our license business as consulting contracts are frequently
signed upon the purchase of our software. Consistent with the decrease in our
license revenues in fiscal 2003, we generated lower professional service
revenues from our commercial customers. These decreases were partially offset by
an increase in revenues earned from defense related entities of the U.S.
Government, resulting in these agencies comprising 10% of our total service
revenues in fiscal 2003. The decline in application service revenues during
fiscal 2003 is due to lower revenues from Major League Baseball Advanced Media
("MLBAM"), which accounted for 14% of total revenues during the year ended March
31, 2002. We completed our application services contract with MLBAM in the year
ended March 31, 2002 and were unable to reach mutually agreeable terms for a
renewal. Application service revenues in fiscal 2002 include $648,000 of warrant
amortization recorded as contra-service revenues resulting from a warrant issued
to MLBAM.
34
Fiscal 2002 Revenues vs. Fiscal 2001 Revenues
Total revenues increased to $16,745,000 in fiscal 2002 from $11,401,000 in
fiscal 2001, an increase of $5,344,000 or 47%. This increase was due to
increases in all revenue streams. International revenues increased in absolute
dollars to $3,997,000, or 24% of total revenues, in fiscal 2002 from $3,341,000,
or 29% of total revenues, in fiscal 2001. One customer accounted for 14% of
total revenues in fiscal 2002. There were no customers who accounted for more
than 10% of total revenues in fiscal 2001.
License revenues increased to $7,414,000 in fiscal 2002 from $6,161,000 in
fiscal 2001. This increase was a result of higher unit sales of our SmartEncode
and Virage Solution Server products (our platform products).
Service revenues increased to $9,331,000 in fiscal 2002 from $5,240,000 in
fiscal 2001, an increase of $4,091,000 or 78%. The increase in service revenues
is attributable to increases in customer support, professional service and
application service revenues. Customer support revenues increased due to an
increase in license revenues as customer support contracts are sold with the
significant majority of our license deals. In addition, the customer support
business was able to renew customer support contracts with a number of existing
customers in fiscal 2002. We began to offer professional services as an offering
in late fiscal 2001 and were successful in promoting and selling the business
during fiscal 2002, causing a significant increase in revenues in this area. We
also experienced an increase in revenues generated from U.S. Government entities
during fiscal 2002. The growth in application service revenues was primarily
attributable to higher revenues from MLBAM, which accounted for 14% of total
revenues during the year ended March 31, 2002. Service revenues in fiscal 2002
include $648,000 of warrant amortization recorded as contra-service revenues
resulting from a warrant issued to MLBAM.
Cost of Revenues
The following table sets forth a breakdown of our different cost of
revenues for fiscal 2003, fiscal 2002 and fiscal 2001, with changes expressed in
whole dollar amounts and percentages versus results from the immediately
preceding fiscal year. Certain prior year balances have been reclassified to
conform with current year presentation (all amounts presented are in thousands,
except percentages):
Increase/(Decrease) Increase/(Decrease)
vs. Prior Year vs. Prior Year
Year Ended ------------------- Year Ended ------------------- Year Ended
March 31, 2003 Amount Percent March 31, 2002 Amount Percent March 31, 2001
-------------- -------- ------- -------------- -------- ------- --------------
Cost of license revenues.... $ 738 $ 33 5% $ 705 $ (18) (3)% $ 723
Cost of customer
support revenues......... 851 249 41% 602 126 27% 476
Cost of professional
service revenues.......... 1,978 (79) (4)% 2,057 1,888 1,117% 169
Cost of application
service revenues.......... 1,772 (4,329) (71)% 6,101 (784) (11)% 6,885
-------------- -------- ------------- ------- --------------
Total cost of service
revenues.................... 4,601 (4,159) (48)% 8,760 1,230 16% 7,530
-------------- -------- ------------- ------- --------------
Total cost of revenues.... $ 5,339 $ (4,126) (44)% $ 9,465 $ 1,212 15% $ 8,253
============== ======== ====== ============= ======= ======== ==============
License gross profit........ 88% 90% 88%
Customer support
gross profit................ 69% 77% 73%
Professional service
gross profit................ 10% 19% 17%
Application service gross
profit/(loss)............. 10% (48)% (106)%
Total service gross profit 33% 6% (44)%
Total gross profit...... 59% 43% 28%
=== ===== =====
35
Fiscal 2003 Cost of Revenues vs. Fiscal 2002 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 equipment depreciation costs for maintenance and support activities and
application and professional services. Total cost of revenues decreased to
$5,339,000, or 41% of total revenues, in fiscal 2003 from $9,465,000, or 57% of
total revenues, in fiscal 2002. This decrease in total cost of revenues was due
primarily to a significant decrease in the cost of application service revenues.
We generally 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. However, our total cost of revenues is highly
variable and has, in the past, been inconsistent with our expectations.
Cost of license revenues increased to $738,000, or 12% of license revenues,
in fiscal 2003 from $705,000, or 10% of license revenues, in fiscal 2002. This
increase was primarily due to the introduction of our new application products
and other recently introduced products for which we incur a unit-based royalty
to certain technology providers.
Cost of service revenues decreased to $4,601,000, or 67% of service
revenues, in fiscal 2003 from $8,760,000, or 94% of service revenues in fiscal
2002. This decrease was a result of reductions in the cost of professional and
application service revenues, and was slightly offset by increases in the cost
of customer support revenues. The cost of customer support revenues increased by
41% year over year, primarily due to the allocation of the one-time charge
recorded in connection with our restructured headquarters lease (as discussed
under "Operating Lease Amendment" above) as we allocate rent expense to all of
our departments. Cost of professional service revenues declined as we moderately
reduced headcount over the year in response to lower professional service
revenues. The decrease in the cost of application service revenues of 71% is
attributable to the termination of our relationship with MLBAM, and the
subsequent removal of the costs and infrastructure we had implemented to service
this customer. We expect our cost of service revenues to remain in the range of
relatively flat to a slight decrease in absolute dollars in the foreseeable
future as we continue our efforts to control costs and maintain gross profit
margins in this area.
Fiscal 2002 Cost of Revenues vs. Fiscal 2001 Cost of Revenues
Total cost of revenues increased to $9,465,000, or 57% of total revenues,
in fiscal 2002 from $8,253,000, or 72% of total revenues, in fiscal 2001. This
increase in total cost of revenues was due to an increase in the cost of service
revenues, slightly offset by a decrease in the cost of license revenues.
Cost of license revenues decreased to $705,000, or 10% of license revenues,
in fiscal 2002 from $723,000, or 12% of license revenues, in fiscal 2001. This
decrease was due to slightly lower unit sales of our products that are subject
to unit-based (rather than fixed-fee) license royalty payments in fiscal 2002 in
comparison to fiscal 2001.
Cost of service revenues increased to $8,760,000, or 94% of service
revenues, in fiscal 2002 from $7,530,000, or 144% of service revenues in fiscal
2001. This increase in absolute dollars was due primarily to expenditures to
develop the professional services organization during the year.
36
Operating Expenses
The following table sets forth a breakdown of our different operating
expenses for fiscal 2003, fiscal 2002 and fiscal 2001, with changes expressed in
whole dollar amounts and percentages versus results from the immediately
preceding fiscal year (all amounts presented are in thousands, except
percentages):
Increase/(Decrease) Increase/(Decrease)
vs. Prior Year vs. Prior Year
Year Ended -------------------- Year Ended ----------------- Year Ended
March 31, 2003 Amount Percent March 31,2002 Amount Percent March 31, 2001
-------------- ----------- ------- ------------- -------- ------- --------------
Research and development... $ 9,248 $ 76 1% $ 9,172 $ 71 1% $ 9,101
Sales and marketing........ 11,775 (5,526) (32)% 17,301 172 1% 17,129
General and administrative. 3,935 (1,050) (21)% 4,985 (313) (6)% 5,298
Stock-based compensation... 1,306 (3,807) (75)% 5,113 1,819 55% 3,294
-------------- ---------- ----------- ------- --------------
Total operating expenses.. $ 26,264 $ (10,307) (28)% $ 36,571 $ 1,749 5% $ 34,822
============== ========== ======= =========== ======= ====== ==============
Research and Development Expenses. Research and development expenses
consist primarily of personnel and related costs for our development efforts.
Increases in fiscal 2003 and fiscal 2002 were due to increases in our facilities
expenses for our research and development departments of $739,000 and $823,000,
respectively, due to an increase in our rental rates and facilities
restructuring charges for each of these periods. These increases were offset by
modest reductions of our research and development headcount in fiscal 2003 and
fiscal 2002, resulting in a reduction of payroll and related expenses of
approximately $569,000 and $519,000, respectively, in comparison to fiscal 2002
and fiscal 2001, respectively. As a result of these increases and decreases,
research and development expenses remained relatively flat from fiscal 2001
through fiscal 2003. We expect research and development expenses to decrease in
the next fiscal year as we spent considerable effort managing headcount and
other costs during fiscal 2003, and expect to realize those savings over the
course of fiscal 2004. To date, we have not capitalized any software development
costs as they have been insignificant after establishing technological
feasibility.
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 discretionary marketing programs including trade shows,
telemarketing campaigns and seminars. Sales and marketing expenses decreased to
$11,775,000, or 91% of total revenues, in fiscal 2003 from $17,301,000, or 103%
of total revenues, in fiscal 2002. The decrease was primarily due to reductions
in headcount, resulting in savings of $2,729,000 in comparison to fiscal 2002,
and discretionary marketing spending, resulting in savings of $1,743,000 in
comparison to fiscal 2002. Sales and marketing expenses increased to
$17,301,000, or 103% of total revenues, in fiscal 2002 from $17,129,000, or 150%
of total revenues, in fiscal 2001. The increase in absolute dollars was
primarily due to an increase in facilities expenses for our sales and marketing
departments of $676,000 (a result of an increase in our rental rates and
facilities restructuring charges) and was partially offset by lower
discretionary marketing spending of $637,000. We expect sales and marketing
expenses to decrease during fiscal 2004 as we continue our efforts to limit
overall expense growth for the company and to focus our marketing activities in
specific areas, particularly with respect to our new application products.
37
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 $3,935,000, or 30% of total revenues,
in fiscal 2003 from $4,985,000 or 30% of total revenues, in fiscal 2002. The
decrease in absolute dollars was primarily due to lower payroll and related
expenses of $563,000, reduced professional services fees of $294,000, and a
reduction in our bad debt reserve of $365,000. General and administrative
expenses decreased to $4,985,000, or 30% of total revenues, in fiscal 2002 from
$5,298,000 or 47% of total revenues, in fiscal 2001. The decrease was primarily
due to lower headcount and related costs of $584,000, and reduced professional
services fees of $221,000, and was partially offset by an increase in facilities
expenses for our general and administrative departments of $552,000 (a result of
an increase in our rental rates and facilities restructuring charges). We expect
general and administrative expenses to be in the range of relatively flat to a
modest increase during fiscal 2004 as the cost benefits we expect receive from
our fiscal 2002 and 2003 restructuring programs in fiscal 2004 are offset by
increasing internal and external expenses required for compliance with recent
legislation such as the Sarbanes-Oxley Act.
Stock-Based Compensation Expense. We follow the intrinsic value method of
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees" ("APB Opinion No. 25"), in accounting for our employee stock options
because the alternative fair value accounting provided for under the FASB's
Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation" ("FAS 123"), requires use of option valuation models that were not
developed for use in valuing employee stock options. Under APB Opinion No. 25,
compensation expense is based on the difference, if any, on the date of grant,
between the estimated fair value of the Company's common stock and the exercise
price. Stock based compensation expense represents the amortization of this
deferred compensation for stock options granted to our employees. We recognized
stock-based compensation expense of $1,306,000, $5,113,000 and $3,294,000 in
fiscal 2003, 2002 and 2001, respectively, in connection with the granting of
stock options to our employees. Our stock-based compensation expense increased
in fiscal 2002 due to the cancellation of stock options and recognition of the
related remaining unamortized deferred stock compensation resulting from
participation in our voluntary stock option cancellation and re-grant program
for our employees. Stock-based compensation expense subsequently decreased in
fiscal 2003 due to the immediate expensing of the majority of our
employee-related deferred compensation in our fourth fiscal quarter of 2002. We
will continue to amortize the remaining deferred compensation balance as expense
for employees who did not participate in our voluntary stock option cancellation
and re-grant program, and expect these charges to taper off significantly in the
December 2003 quarter.
Interest and Other Income, Net. Interest and other income, net, includes
interest income from cash and cash equivalents offset (in fiscal 2001) by
interest on capital leases and bank debt. Interest and other income, net,
decreased to $554,000 in fiscal 2003 from $1,541,000 in fiscal 2002 and
$2,800,000 in fiscal 2001. The decreases were a result of lower interest rates
and lower average cash balances during fiscal 2003, 2002 and 2001.
Provision for Income Taxes. We have not recorded a provision for federal
and state or foreign income taxes in fiscal 2003, 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 March 31, 2003, we had cash, cash equivalents and short-term
investments of $16,317,000, a decrease of $14,377,000 from March 31, 2002 and
our working capital, defined as current assets less current liabilities, was
$11,061,000, a decrease of $13,016,000 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.
38
Our operating activities resulted in net cash outflows of $14,510,000,
$17,871,000, and $16,863,000 for the years ended March 31, 2003, 2002 and 2001,
respectively. The cash used in these periods was primarily attributable to net
losses of $18,120,000, $27,750,000, and $28,874,000 in the years ended March 31,
2003, 2002 and 2001, respectively, offset by depreciation, losses on disposals
of assets, and non-cash, stock-based charges.
Investing activities resulted in cash inflows of $12,567,000 and $1,968,000
for the years ended March 31, 2003 and 2002, respectively, and cash outflows of
$34,770,000 for the year ended March 31, 2001. Our investing inflows were
primarily from the maturity of our short-term investments and our outflows were
primarily for the purchase of short-term investments and capital equipment. We
expect that we will continue to invest in short-term investments and purchase
capital equipment as we replace older equipment with newer models.
Financing activities provided net cash inflows of $291,000, $809,000, and
$61,206,000 during the years ended March 31, 2003, 2002, and 2001, respectively.
These inflows were primarily from the proceeds of our employee stock purchase
plan during fiscal 2003 and 2002 and from sales of our common stock (including
our IPO) during fiscal 2001.
At March 31, 2003, we have contractual and commercial commitments not
included on our balance sheet for our San Mateo, California facility that we
have an obligation to lease through September 2006, for royalty commitments and
for other business commitments. Future full fiscal year commitments are as
follows: $3,188,000 in 2004, $1,972,000 in 2005, $1,715,000 in 2006 and
$1,057,000 in 2007 ($7,932,000 in total commitments as of March 31, 2003). The
aforementioned amounts include our best estimate of expected fair market rental
rates in fiscal years ending March 31, 2004 to March 31, 2007 and if we
underestimate these fair market rental rates, the amount of our contractual
commitments will increase. The aforementioned amounts also include payments of
cash and forfeiture of other collateral of $1,000,000 for the year ending March
31, 2004, pursuant to our Lease Amendment described above. Additional
information regarding our contractual and commercial commitments is provided in
Note 2 of our Consolidated Financial Statements and Notes thereto included in
Part II, Item 8, of this Annual Report.
Management believes the Company has adequate cash to sustain operations at
least through fiscal 2004 and is managing its business in the short-term to
control the amount of cash used and in the long-term to manage towards
profitability utilizing existing assets. During fiscal 2003, we continued to
reduce operating expenses by renegotiating our lease commitments, reducing
purchases of other services and making workforce reductions. We are committed to
the successful execution of our operating plan and will take further
restructuring actions as necessary to align our revenue and reduce expenses.
Although our existing cash, cash equivalents and investments will be
sufficient to meet our anticipated cash needs for working capital and capital
expenditures for the next 12 months, higher than anticipated expenses and lower
than anticipated receipts may result in lower cash, cash equivalents and
investments balances than presently anticipated and we may find it necessary to
obtain additional equity or debt financing. 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.
39
Recent Accounting Pronouncements
In July 2002, the FASB issued Statement of Financial Accounting Standards
No. 146, "Accounting for Costs Associated with Exit and Disposal Activities
("FAS 146")." This statement revises the accounting for exit and disposal
activities under the FASB's Emerging Issues Task Force Issue 94-3, "Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit an
Activity ("EITF 94-3")." Pursuant to FAS 146, companies will record exit or
disposal costs when they are "incurred" and can be measured at fair value, and
are also required to subsequently adjust the recorded liability for changes in
estimated cash flows. Liabilities that a company previously recorded under EITF
94-3 are grandfathered. We adopted FAS 146 during the year ended March 31, 2003
and recorded certain charges related to excess space as of the date it ceased to
use the space. Based upon the facts and circumstances around charges that we
historically have been required to record, we believe that the adoption of FAS
146 may affect the timing of, but ultimately will not have a materially
different impact on, our operations, financial position or cash flows.
In December 2002, the FASB issued Statement of Financial Accounting
Standards No. 148, "Accounting for Stock-Based Compensation--Transition and
Disclosure ("FAS 148")." FAS 148 amends Statement of Financial Accounting
Standards No. 123, "Accounting for Stock-Based Compensation ("FAS 123")," to
provide alternative methods of transition to FAS 123's fair value method of
accounting for stock-based employee compensation. FAS 148 also amends the
disclosure provisions of FAS 123 and Accounting Principles Board's Opinion No.
28, "Interim Financial Reporting," to require disclosure in the summary of
significant accounting policies of the effects of an entity's accounting policy
with respect to stock-based employee compensation on reported net income and
earnings (loss) per share in annual and interim financial statements. FAS 148
does not require companies to account for employee stock options using the fair
value method of accounting (ie. the expensing of stock option grants in a
company's statement of operations). We adopted the disclosure provisions only of
FAS 148 in the fiscal fourth quarter of our year ended March 31, 2003. FAS 148
did not have a material effect on our operations, financial position or cash
flows as we will continue to account for employee stock options using the
intrinsic value method of accounting. However, we will be required to provide
additional disclosures with our interim and annual financial statements
regarding the impact of employee stock options as if we had accounted for
employee stock options using the fair value method of accounting.
In December 2002, the FASB issued Interpretation No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others ("FIN 45")." FIN 45 elaborates on the
disclosures to be made by a guarantor in its interim and annual financial
statements about its obligations under certain guarantees that it has issued. It
also clarifies that a guarantor is required to recognize, at the inception of a
guarantee, a liability for the fair value of the obligation undertaken in
issuing the guarantee. We have adopted the disclosure requirements of FIN 45 as
of March 31, 2003. In addition, we adopted the initial recognition and
measurement of the fair value of the obligation undertaken in issuing the
guarantee on a prospective basis for all guarantees. The effect of the adoption
of FIN 45 on our operations, financial position or cash flows was not material.
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities ("FIN 46")." FIN 46 requires an investor with a
majority of the variable interests in a variable interest entity ("VIE") to
consolidate the entity and also requires majority and significant variable
interest investors to provide certain disclosures. A VIE is an entity in which
the equity investors do not have a controlling interest, or the equity
investment at risk is insufficient to finance the entity's activities without
receiving additional subordinated financial support from the other parties. For
arrangements entered into with VIEs created prior to January 31, 2003, the
provisions of FIN 46 are required to be adopted at the beginning of the first
interim or annual period beginning after June 15, 2003. The provisions of FIN 46
are effective immediately for all arrangements entered into with new VIEs
created after January 31, 2003. To date, we have not invested in any VIE's and
do not expect the adoption of FIN 46 to be material on our operations, financial
position or cash flows.
40
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Foreign Currency Exchange Rate Risk
We develop products in the United States. We currently license our products
from the United States and from our subsidiary in the United Kingdom.
Substantially all of our sales from the United States operation are denominated
in U.S. dollars. Our subsidiary based in the United Kingdom incurs most of its
expenses in pounds sterling and most of its sales are denominated in US dollars.
We expect that future license and service revenues will continue to be derived
from international markets and may be denominated in the currency of the
applicable market. As a result, our financial results could be affected
adversely by various factors, including foreign currency exchange rates or weak
economic conditions in foreign markets. Although we will continue to monitor our
exposure to currency fluctuations and, when appropriate, may use economic
hedging techniques in the future to minimize the effect of these fluctuations,
we cannot assure you that exchange rate fluctuations will not adversely affect
our financial results in the future. Through March 31, 2003, we have not engaged
in any foreign currency hedging activities.
Interest Rate Risk
Our exposure to financial market risk, including changes in interest rates,
relates primarily to our investment portfolio. We typically do not attempt to
reduce or eliminate our market exposure on our investment securities because a
substantial majority of our investments are in fixed rate securities with
maturities not exceeding 12 months. We do not invest in any derivative
instruments. The fair value of our investment portfolio or related income as of
March 31, 2003, would decrease by approximately $47,000 for a 100 basis point
increase and increase by approximately $46,000 for a 100 basis point decrease in
interest rates. Our investment instruments are mainly fixed-rate and relatively
short-term.
41
Item 8. Financial Statements and Supplementary Data
VIRAGE, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Report of Ernst & Young LLP, Independent Auditors............................43
Consolidated Balance Sheets..................................................44
Consolidated Statements of Operations........................................45
Consolidated Statements of Redeemable Convertible Preferred
Stock and Stockholders' Equity (Net Capital Deficiency)....................46
Consolidated Statements of Cash Flows........................................47
Notes to Consolidated Financial Statements...................................48
42
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
The Board of Directors and Stockholders
Virage, Inc.
We have audited the accompanying consolidated balance sheets of Virage, Inc. as
of March 31, 2003 and 2002, and the related consolidated statements of
operations, redeemable convertible preferred stock and stockholders' equity (net
capital deficiency), and cash flows for each of the three years in the period
ended March 31, 2003. Our audits also included the financial statement schedule
listed in the Index at item 14(a). These financial statements and schedule are
the responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements and schedule based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Virage, Inc. at
March 31, 2003 and 2002, and the consolidated results of its operations and its
cash flows for each of the three years in the period ended March 31, 2003, in
conformity with accounting principles generally accepted in the United States.
Also, in our opinion, the related financial statement schedule, when considered
in relation to the basic financial statements taken as a whole, presents fairly
in all material respects, the information set forth therein.
/s/ Ernst & Young LLP
San Jose, California
April 18, 2003
43
VIRAGE, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
March 31,
--------------------------------
2003 2002
--------------- ---------------
ASSETS
Current assets:
Cash and cash equivalents....................................... $ 2,934 $ 4,586
Short-term investments.......................................... 13,383 26,108
Accounts receivable, net of allowance for revenue
adjustments and doubtful accounts of $502 and $1,153 at
March 31, 2003 and 2002, respectively......................... 2,441 2,366
Prepaid expenses and other current assets....................... 920 220
--------------- ---------------
Total current assets........................................ 19,678 33,280
Property and equipment:
Computer equipment and software................................. 5,974 6,143
Furniture....................................................... 996 1,406
Leasehold improvements.......................................... 1,943 1,943
--------------- ---------------
8,913 9,492
Less: accumulated depreciation................................. 7,566 5,791
--------------- ---------------
1,347 3,701
Other assets...................................................... 1,293 2,571
--------------- ---------------
Total assets................................................ $ 22,318 $ 39,552
=============== ===============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable................................................ $ 614 $ 831
Accrued payroll and related expenses............................ 1,353 2,376
Accrued expenses................................................ 1,923 2,183
Accrued restructuring charges................................... 1,515 763
Deferred revenue................................................ 3,212 3,050
--------------- ---------------
Total current liabilities................................... 8,617 9,203
Deferred rent..................................................... -- 290
Commitments and contingencies
Stockholders' equity:
Preferred stock, $0.001 par value:
Authorized shares -- 2,000,000
Issued and outstanding shares-- none.......................... -- --
Common stock, $0.001 par value:
Authorized shares -- 100,000,000
Issued and outstanding shares-- 20,987,390 and 20,621,535 at
March 31, 2003 and 2002, respectively....................... 21 21
Additional paid-in capital...................................... 121,513 121,387
Deferred compensation........................................... (789) (2,425)
Accumulated deficit............................................. (107,044) (88,924)
--------------- ---------------
Total stockholders' equity.................................. 13,701 30,059
--------------- ---------------
Total liabilities and stockholders' equity.................. $ 22,318 $ 39,552
=============== ===============
See accompanying notes.
44
VIRAGE, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
Years Ended March 31,
-------------------------------------------
2003 2002 2001
------------- ------------- -------------
Revenues:
License revenues........................... $ 6,029 $ 7,414 $ 6,161
Service revenues........................... 6,900 9,331 5,240
------------ ------------ -------------
Total revenues........................... 12,929 16,745 11,401
Cost of revenues:
License revenues........................... 738 705 723
Service revenues(1)........................ 4,601 8,760 7,530
------------ ------------ -------------
Total cost of revenues................... 5,339 9,465 8,253
------------ ------------ -------------
Gross profit................................. 7,590 7,280 3,148
Operating expenses:
Research and development(2)................ 9,248 9,172 9,101
Sales and marketing(3)..................... 11,775 17,301 17,129
General and administrative(4).............. 3,935 4,985 5,298
Stock-based compensation................... 1,306 5,113 3,294
------------ ------------ -------------
Total operating expenses................. 26,264 36,571 34,822
------------ ------------ -------------
Loss from operations......................... (18,674) (29,291) (31,674)
Interest and other income.................... 554 1,541 2,822
Interest expense............................. -- -- (22)
------------ ------------ -------------
Loss before income taxes..................... (18,120) (27,750) (28,874)
Provision for income taxes................... -- -- --
------------ ------------ -------------
Net loss..................................... $ (18,120) $ (27,750) $ (28,874)
============ ============ =============
Basic and diluted net loss per share......... $ (0.87) $ (1.37) $ (1.88)
============ ============ =============
Shares used in computation of basic and
diluted net loss per share................. 20,834 20,327 15,397
============ ============ =============
(1) Excluding $21, $443 and $301 in amortization of deferred stock-based
compensation for the years ended March 31, 2003, 2002 and 2001,
respectively.
(2) Excluding $89, $833 and $536 in amortization of deferred stock-based
compensation for the years ended March 31, 2003, 2002 and 2001,
respectively.
(3) Excluding $106, $2,095 and $983 in amortization of deferred stock-based
compensation for the years ended March 31, 2003, 2002 and 2001,
respectively.
(4) Excluding $1,090, $1,742 and $1,474 in amortization of deferred stock-based
compensation for the years ended March 31, 2003, 2002 and 2001,
respectively.
See accompanying notes.
45
VIRAGE, INC.
CONSOLIDATED STATEMENTS OF REDEEMABLE
CONVERTIBLE PREFERRED STOCK AND
STOCKHOLDERS' EQUITY (NET CAPITAL DEFICIENCY)
(in thousands, except share data)
Stockholders' Equity (Net Capital Deficiency)
-------------------------------------------------------------------------------
Total
Redeemable Convertible Stockholders'
Preferred Stock Common Stock Additional Equity (Net
---------------------- ----------------------- Paid-In Deferred Accumulated Capital
Shares Amount Shares Amount Capital Compensation Deficit Deficiency)
---------- -------- ---------- -------- --------- ------------ ----------- -----------
Balance at March 31, 2000... 10,316,199 $ 36,995 3,698,146 $ 3 $ 23,671 $ (14,595) $ (32,300) $ (23,221)
Exercise of warrants for
cash and net exercise of
warrants to purchase preferred
and common stock......... 53,252 125 204,039 -- 2,000 -- -- 2,000
Conversion of preferred
stock to common upon initial
public offering............. (10,369,451) (37,120) 10,369,451 11 37,109 -- -- 37,120
Issuance of common stock
from initial public offering
and underwriter overallotment -- -- 4,025,000 4 39,472 -- -- 39,476
Issuance of common stock..... -- -- 1,636,361 2 17,998 -- -- 18,000
Issuance of common stock
from exercise of options,
net of repurchases and
issuance of ESPP stock..... -- -- 295,755 -- 1,034 -- -- 1,034
Amortization of warrant
fair values................ -- -- -- -- 6 -- -- 6
Amortization of deferred
compensation............... -- -- -- -- -- 4,165 -- 4,165
Issuance and
remeasurement of
stock options to
consultants................ -- -- -- -- 71 (71) -- --
Reversal of deferred
compensation upon
employee termination....... -- -- -- -- (654) 654 -- --
Net loss and comprehensive
net loss................... -- -- -- -- -- -- (28,874) (28,874)
------------ -------- ---------- ------- --------- ---------- ---------- ----------
Balance at March 31, 2001.... -- -- 20,228,752 20 120,707 (9,847) (61,174) 49,706
Issuance of common stock
from exercise of options,
net of repurchases and
issuance of ESPP stock..... -- -- 392,783 1 808 -- -- 809
Amortization of warrant
fair values................ -- -- -- -- 660 -- -- 660
Amortization of deferred
compensation............... -- -- -- -- -- 6,511 -- 6,511
Acceleration of stock
option Vesting............. -- -- -- -- 123 -- -- 123
Reversal of deferred
compensation upon employee
termination................ -- -- -- -- (911) 911 -- --
Net loss and
comprehensive net loss...... -- -- -- -- -- -- (27,750) (27,750)
------------ -------- ---------- ------- --------- ---------- ---------- ----------
Balance at March 31, 2002.... -- -- 20,621,535 21 121,387 (2,425) (88,924) 30,059
Issuance of common stock
from exercise of options,
net of repurchases and
issuance of ESPP stock..... -- -- 365,855 -- 291 -- -- 291
Amortization of warrant
fair values................ -- -- -- -- 78 -- -- 78
Amortization of deferred
compensation............... -- -- -- -- -- 1,306 -- 1,306
Deferred compensation
related to stock options... -- -- -- -- 69 (69) -- --
Issuance, remeasurement
and acceleration of stock
options to consultants..... -- -- -- -- 87 -- -- 87
Reversal of deferred
compensation upon employee
termination................ -- -- -- -- (399) 399 -- --
Net loss and
comprehensive net loss..... -- -- -- -- -- -- (18,120) (18,120)
------------ -------- ---------- ------- --------- ---------- ---------- ----------
Balance at March 31, 2003.... -- $ -- 20,987,390 $ 21 $ 121,513 $ (789) $ (107,044) $ 13,701
============ ======== ========== ======= ========= ========== ========== ==========
See accompanying notes.
46
VIRAGE, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
Years Ended March 31,
-----------------------------------------
2003 2002 2001
------------ ------------ -------------
Cash flows from operating activities:
Net loss......................................... $ (18,120) $ (27,750) $ (28,874)
Adjustments to reconcile net loss to net cash used
in operating activities:
Depreciation and amortization.................. 2,296 2,911 1,947
Loss on disposal of assets..................... 216 455 --
Amortization of deferred compensation related to
stock options................................ 1,306 6,511 4,165
Issuance of stock options to consultants....... 87 -- --
Amortization of warrant fair values............ 114 695 627
Acceleration of stock option vesting........... -- 123 --
Changes in operating assets and liabilities:
Accounts receivable.......................... (75) (35) (539)
Prepaid expenses and other current assets.... (700) 295 116
Other assets................................. 1,242 (69) 52
Accounts payable............................. (217) (322) 380
Accrued payroll and related expenses ........ (1,023) (903) 2,620
Accrued expenses and accrued restructuring
charges ................................... 492 (57) 1,234
Deferred revenue............................. 162 96 1,298
Deferred rent................................ (290) 179 111
----------- ----------- -----------
Net cash used in operating activities............ (14,510) (17,871) (16,863)
Cash flows from investing activities:
Purchase of property and equipment............... (158) (375) (6,319)
Purchases of short-term investments.............. (58,700) (59,419) (49,383)
Sales and maturities of short-term investments... 71,425 61,762 20,932
----------- ----------- -----------
Net cash provided by (used in) investing activities 12,567 1,968 (34,770)
Cash flows from financing activities:
Proceeds from bank line of credit................ -- -- 806
Principal payments on loans and capital leases... -- -- (1,047)
Proceeds from exercise of stock options, net of
repurchases.................................. 100 42 537
Proceeds from employee stock purchase plan....... 191 767 497
Proceeds from exercise of warrants to purchase
preferred and common stock................... -- -- 2,125
Proceeds from issuance of common stock, net of
offering costs............................... -- -- 58,288
----------- ----------- -----------
Net cash provided by financing activities........ 291 809 61,206
----------- ----------- -----------
Net increase (decrease) in cash and cash
equivalents.................................. (1,652) (15,094) 9,573
Cash and cash equivalents at beginning of period. 4,586 19,680 10,107
----------- ----------- -----------
Cash and cash equivalents at end of period....... $ 2,934 $ 4,586 $ 19,680
=========== =========== ===========
Supplemental disclosures of cash flow information:
Cash paid for interest........................... $ -- $ -- $ 22
Supplemental disclosures of non-cash operating,
investing and financing activities:
Conversion of prepaid offering costs to equity at
IPO.......................................... $ -- $ -- $ 812
Conversion of redeemable preferred stock to equity
at IPO....................................... $ -- $ -- $ 37,120
Deferred compensation related to stock options... $ 69 $ -- $ 71
Reversal of deferred compensation upon employee
termination.................................... $ 399 $ 911 $ 654
See accompanying notes.
47
VIRAGE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Organization and Summary of Significant Accounting Policies
Description of Business
Virage, Inc. ("Virage" or "the Company") is a provider of software
products, professional services and application services that enable owners of
rich media and video assets to more effectively communicate manage, retrieve and
distribute these assets for improved productivity and communication. The Company
sells worldwide to corporations, media and entertainment enterprises,
educational institutions and government entities. The Company's customers can
leverage the Company's technology and know-how either by licensing the Company's
products and engaging its professional services or by employing the Company's
application services to outsource the customer's needs.
Management believes that its restructuring activities, including the
restructuring of its headquarters facility, have reduced its ongoing operating
expense such that the Company will have sufficient working capital to support
planned activities through fiscal 2004. As of March 31, 2003, the Company had
working capital of approximately $11,061,000 and stockholders' equity of
approximately $13,701,000. During the year ended March 31, 2003, the Company
used cash and cash equivalents in operating activities of approximately
$14,510,000. During the fourth quarter of fiscal 2003, the Company used cash and
cash equivalents in operating activities of approximately $2,622,000. Management
is committed to the successful execution of the Company's operating plan and
will take further action as necessary to align the Company's operations and
reduce expenses to ensure the Company continues as a going concern through at
least March 31, 2004.
Basis of Presentation
The consolidated financial statements include the accounts of the Company
and its wholly-owned subsidiaries, Virage Europe, Ltd. and Virage GmbH. All
significant intercompany accounts and transactions have been eliminated in
consolidation.
Reclassifications
Certain prior year balances have been reclassified to conform to current
year presentation.
Cash Equivalents and Short-Term Investments
The Company invests its excess cash in money market accounts and debt
instruments and considers all highly liquid debt instruments purchased with an
original maturity of three months or less to be cash equivalents. Investments
with an original maturity at the time of purchase of over three months are
classified as short-term investments regardless of maturity date, as all such
instruments are classified as available-for-sale and can be readily liquidated
to meet current operational needs. At March 31, 2003, all of the Company's cash
equivalents and short-term investments were classified as available-for-sale and
consisted of obligations issued by U.S. government agencies and multinational
corporations, maturing within one year.
48
VIRAGE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued)
Short-term investments at each year-end, including those instruments
classified as cash equivalents and restricted instruments classified as other
assets, were as follows (in thousands):
March 31,
--------------------------
2003 2002
----------- ------------
Money market funds.............. $ 2,337 $ 2,805
Commercial paper and corporate
bonds.......................... 6,919 11,818
US government obligations....... 7,214 17,379
----------- ------------
Total investments............. 16,470 32,002
Amounts classified as cash
equivalents.................... (2,337) (3,805)
Amounts classified as
other assets................... (750) (2,089)
----------- ------------
$ 13,383 $ 26,108
=========== ============
As of March 31, 2003, the Company had collateralized a letter of credit for
its primary operating facility with certain short-term investment instruments
and has classified these collateralized instruments totaling $750,000 as other
assets in the Company's balance sheet. As of March 31, 2003 and 2002, the fair
value approximated the amortized cost of available-for-sale securities. Realized
gains and losses from sales of investments were insignificant for all periods
presented.
Property and Equipment
Property and equipment are carried at cost less accumulated depreciation.
Property and equipment are depreciated for financial reporting purposes using
the straight-line method over the estimated useful lives of generally one to
three years or, in the case of leasehold improvements, over the lesser of the
useful life of the assets or lease term.
Revenue Recognition
The Company enters into arrangements for the sale of licenses of software
products and related maintenance contracts, application services and
professional services offerings. Service revenues include revenues from
maintenance contracts, application services, and professional services,
including professional services performed directly for and via subcontract for
the U.S. Government.
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 longer than normal not to be fixed and
determinable. The Company's normal payment terms are generally considered to be
"net 30 days" to "net 60 days." For arrangements involving extended payment
terms, revenue recognition generally occurs when payments become due provided
all other revenue recognition criteria are met. No customer has the right of
return and arrangements generally do not have acceptance criteria. If right of
return or customer acceptance does exist within an arrangement, revenue is
deferred until the earlier of the end of the right of return/acceptance period
or until written notice of acceptance/cancellation of right of return is
received from the customer.
49
VIRAGE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued)
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).
Customers that enter into maintenance contracts have the ability to renew such
contracts at the renewal rate. 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 upon, the Company recognizes revenue on the 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 upon 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, (3) the services do not include significant alterations
to the features and functionality of the software and (4) the services are
deemed "perfunctory" both in level of effort to perform and in magnitude of
dollars based upon the Company's objective evidence of fair value for the
services relative to the total arrangement fee.
Should professional services be essential to the functionality of the
licenses in a license arrangement that 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. For arrangements that include
customer acceptance clauses that the Company does not have an established
history of meeting or which are not considered to be routine, the Company
recognizes revenue when the arrangement has been completed and accepted by the
customer.
50
VIRAGE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued)
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.
Included as part of the Company's service revenues are services performed
for U.S. Government Defense and other security agencies, either from direct
arrangements or subcontracts with other U.S. Government contractors. The Company
generally performs these services in conjunction with existing or potential
software license sales. Should software be included as part of the arrangement,
the Company accounts for any software license fee according to its revenue
recognition accounting policy described above.
Virtually all of the Company's services with such U.S. Government entities
are performed under various firm-fixed-price, time-and-material, and
cost-plus-fixed-fee reimbursement contracts. Revenues on firm-fixed-price
contracts are generally recognized according to SOP 81-1 based upon costs
incurred in relation to total estimated costs from input measures such as hours
or days. Revenues on time-and-material contracts are recognized to the extent of
billable rates multiplied by hours worked plus materials expense incurred.
Revenues for cost-plus-fixed-fee contracts are recognized as costs are incurred,
including a proportionate amount of the fee earned.
Customer billings that have not been recognized as revenue in accordance
with the above policies are shown on the balance sheet as deferred revenue.
Allowance for Revenue Adjustments and Doubtful Accounts
If the Company determines that payment from the customer is not probable at
the time all other revenue recognition criteria (as described above) have been
met, the Company defers revenues until payment from the customer is received.
The Company also makes judgments as to its ability to collect outstanding
receivables (that have not been deferred) and provides an allowance for the
portion of receivables when collection becomes doubtful. The Company also
provides an allowance for returns and revenue adjustments in the same period as
the related revenues are recorded. Allowances are made based upon a specific
review of all significant outstanding invoices. Allowances recorded offset the
Company's gross accounts receivable balance. Allowances totaled approximately
$502,000 and $1,153,000 at March 31, 2003 and 2002, respectively.
Concentration of Revenues and Credit Risk
The Company performs ongoing credit evaluations of its customers and
maintains reserves for potential credit losses, and such losses have been within
management's expectations. The Company generally requires no collateral from its
customers. If the Company determines that payment from the customer is not
probable, the Company defers revenues until payment from the customer is
received and all other criteria for revenue recognition (as described above)
have been met.
51
VIRAGE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued)
Major customers (non-federal government agencies). For the years ended
March 31, 2003 and 2001, there were no customers that accounted for 10% or more
of the Company's total revenues. For the year ended March 31, 2002, the Company
had one customer, Major League Baseball Advanced Media L.P. ("MLBAM"), which
accounted for 14% of the Company's total revenues.
European customers accounted for approximately 12% and 10% of the Company's
accounts receivable balance as of March 31, 2003 and 2002, respectively.
Federal Government Agencies. For the years ended March 31, 2003, 2002 and
2001 direct and indirect revenues from federal government agencies accounted for
13%, 14%, and 10%, respectively, of total revenues. No single federal government
agency accounted for more than 10% of total revenues for the years ended March
31, 2003, 2002 or 2001.
Service revenues from contracts with federal government agencies comprised
10% of total service revenues during the year ended March 31, 2003 (less than
10% for the years ended March 31, 2002 and 2001). Service revenues from
contracts with federal government agencies comprised less than 10% of total
revenues in each of the years ended March 31, 2003, 2002, and 2001. Contract
costs for service revenues to federal government agencies, including indirect
expenses, are subject to audit and subsequent adjustment by negotiation between
the Company and U.S. Government representatives. Service revenues are recorded
in amounts expected to be realized upon final settlement and in accordance with
revenue recognition policies described above. Historically, the Company has had
no adverse impact related to its revenues from such an audit and believes that
the results of any future audit will have no material effect on the Company's
financial position or results of operations.
Advertising Costs
Advertising costs are expensed as incurred. Advertising expense (including
the amortization of the fair value of a warrant during the year ended March 31,
2001--see Note 3), totaled $6,000, $54,000 and $697,000 for the years ended
March 31, 2003, 2002 and 2001, respectively.
Stock-Based Compensation
The Company has elected to follow the intrinsic value method of Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees"
("APB Opinion No. 25"), in accounting for its employee stock options because, as
discussed below, the alternative fair value accounting provided for under the
FASB's Statement of Financial Accounting Standards No. 123, "Accounting for
Stock-Based Compensation" ("FAS 123"), requires use of option valuation models
that were not developed for use in valuing employee stock options. Under APB
Opinion No. 25, compensation expense is based on the difference, if any, on the
date of grant, between the estimated fair value of the Company's common stock
and the exercise price. FAS 123 defines a "fair value" based method of
accounting for an employee stock option or similar equity investment. The
Company accounts for equity instruments issued to nonemployees in accordance
with the provisions of FAS 123 and the FASB's Emerging Issues Task Force Issue
No. 96-18, "Accounting for Equity Instruments That Are Issued to Other Than
Employees for Acquiring or in Conjunction with Selling, Goods or Services ("EITF
96-18")."
52
VIRAGE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued)
Pro Forma Disclosures of the Effect of Stock-Based Compensation
As described above, the Company has elected to follow APB Opinion No. 25
and related interpretations in accounting for its employee stock plans. However,
FAS 123 requires pro forma information regarding net loss as if the Company had
accounted for and calculated the related non-cash, stock-based expense for its
employee stock plans under the fair value method prescribed under FAS 123.
In order to determine this pro forma net loss, the fair value for the
Company's options was estimated at the date of grant using the Black-Scholes
option valuation model with the following assumptions for the years ended March
31, 2003, 2002 and 2001: risk-free interest rates of 2.7%, 3.0% and 6.5%,
respectively, volatility factors of 112%, 113% and 90%, respectively, no
dividend yield and an expected life of the options of four years. The fair value
of shares issued and to be issued pursuant to the Company's employee stock
purchase plan in the years ended March 31, 2003, 2002 and 2001 were estimated
using the following weighted average assumptions: risk-free interest rate of
1.7%, 4.4%, and 6.5%, respectively, no dividend yield, volatility factors of
112%, 113% and 90%, respectively, and an expected life of the option of six
months. For purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the options' vesting period.
The Black-Scholes option valuation model used by the Company to determine
fair value for purposes of its pro forma disclosure was developed for use in
estimating the fair value of traded options that have no vesting restrictions
and are fully transferable. In addition, option valuation models require the
input of highly subjective assumptions, including the expected price volatility.
Because the Company's employee stock options and stock purchase plan shares have
characteristics significantly different from those of traded options and because
changes in the subjective input assumptions can materially affect the fair value
estimate, in the Company's opinion, the existing models do not necessarily
provide a reliable single measure of the fair value of its employee stock
options.
Had compensation expense for the Company's employee stock plans been
determined using the fair value at the grant dates for awards under those plans
calculated using the Black-Scholes valuation model, the Company's net loss and
basic and diluted net loss per share would have been increased to the pro forma
amounts indicated below (in thousands, except per share amounts):
Years Ended March 31,
--------------------------
2003 2002 2001
------------ ------------ -----------
Net loss, as reported................................... $ (18,120) $ (27,750) $ (28,874)
Add: stock-based compensation expense included in
reported net loss, net of related tax effects......... 1,393 6,634 4,165
Deduct: total stock-based compensation expense determined
under fair value method for all awards................ (3,960) (8,032) (6,169)
------------ ----------- -----------
Net loss, pro forma..................................... $ (20,687) $ (29,148) $ (30,878)
============ =========== ===========
Basic and diluted net loss per share, as reported....... $ (0.87) $ (1.37) $ (1.88)
============ =========== ===========
Basic and diluted net loss per share, pro forma......... $ (0.99) $ (1.43) $ (2.01)
============ =========== ===========
These pro forma amounts may not be representative of the effects on
reported net loss for future years as options vest over several years and
additional awards are generally made each year.
The weighted-average grant date fair value of options granted during the
years ended March 31, 2003, 2002 and 2001 was $0.60, $2.35 and $5.78,
respectively, and the weighted-average grant date fair value of ESPP shares was
$0.52, $1.04 and $2.07 during the years ended March 31, 2003, 2002 and 2001,
respectively.
53
VIRAGE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued)
Comprehensive Net Loss
The Company has adopted the FASB's Statement of Financial Accounting
Standards No. 130, "Reporting Comprehensive Income" ("FAS 130"). FAS 130
establishes standards for the reporting and display of comprehensive income
(loss) and its components in a full set of general purpose financial statements.
To date, the Company has had no other comprehensive income (loss) of a
significant nature, and consequently, net loss equals total comprehensive net
loss.
Use of Estimates
The preparation of the Company's consolidated financial statements in
conformity with generally accepted accounting principles requires management to
make estimates and assumptions that affect the amounts reported in the Company's
consolidated financial statements and accompanying notes. Actual results could
differ materially from those estimates.
Net Loss per Share
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 (in thousands,
except per share data):
Years Ended March 31,
-----------------------------------------
2003 2002 2001
----------- ----------- -----------
Net loss........................ $ (18,120) $ (27,750) $ (28,874)
=========== =========== ===========
Weighted-average shares of common
stock outstanding............. 20,842 20,452 15,781
Less weighted-average shares of
common stock subject to
repurchase.................... (8) (125) (384)
----------- ----------- -----------
Weighted-average shares used in
computation of basic and
diluted net loss per share.... 20,834 20,327 15,397
=========== =========== ===========
Basic and diluted net loss per
share......................... $ (0.87) $ (1.37) $ (1.88)
=========== =========== ===========
The Company has excluded all outstanding stock options, warrants and shares
subject to repurchase from the calculation of basic and diluted net loss per
share because these securities are antidilutive for all periods presented.
Options and warrants to purchase 8,066,825, 7,630,293 and 6,502,656 shares of
common stock and common stock equivalents were outstanding at March 31, 2003,
2002 and 2001, respectively. Such securities, had they been dilutive, would have
been included in the computation of diluted net loss per share using the
treasury stock method.
Fair Value of Financial Instruments
The Company has evaluated the estimated fair value of financial instruments
at March 31, 2003 and 2002. The amounts reported for cash and cash equivalents,
short-term investments, accounts receivable and accounts payable approximate
carrying values due to the short-term maturities of these instruments.
54
VIRAGE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued)
Segment Information
The Company has adopted the FASB's Statement of Financial Accounting
Standards No. 131, "Disclosures about Segments of an Enterprise and Related
Information," which establishes standards for reporting information about
operating segments. Operating segments are defined as components of an
enterprise about which separate financial information is available that is
evaluated regularly by the chief operating decision maker or group in deciding
how to allocate resources and in assessing performance. The Company's segment
information is presented in Note 7.
Long-Lived Assets
The Company has adopted the FASB's Statement of Financial Accounting
Standards No. 144, "Accounting for the Impairment or Disposal of Long-Lived
Assets," ("FAS 144") which requires impairment losses to be recorded for
long-lived assets used in operations, such as property, equipment and
improvements, and intangible assets, when indicators of impairment are present
and the undiscounted cash flows estimated to be generated by those assets are
less than the carrying amount of the assets. Through March 31, 2003, FAS 144 has
had no impact on the Company's financial position or results of operations.
Impact of Recently Issued Accounting Standards
In July 2002, the FASB issued Statement of Financial Accounting Standards
No. 146, "Accounting for Costs Associated with Exit and Disposal Activities
("FAS 146")." This statement revises the accounting for exit and disposal
activities under the FASB's Emerging Issues Task Force Issue 94-3, "Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit an
Activity ("EITF 94-3")." Pursuant to FAS 146, companies will record exit or
disposal costs when they are "incurred" and can be measured at fair value, and
are also required to subsequently adjust the recorded liability for changes in
estimated cash flows. Liabilities that a company previously recorded under EITF
94-3 are grandfathered. The Company adopted FAS 146 during the year ended March
31, 2003 and recorded certain charges related to excess space as of the date it
ceased to use the space. Based upon the facts and circumstances around charges
that the Company historically has been required to record, the Company currently
believes that the adoption of FAS 146 may affect the timing of, but ultimately
will not have a materially different impact on, its operations, financial
position or cash flows.
55
VIRAGE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued)
In December 2002, the FASB issued Statement of Financial Accounting
Standards No. 148, "Accounting for Stock-Based Compensation--Transition and
Disclosure ("FAS 148")." FAS 148 amends Statement of Financial Accounting
Standards No. 123, "Accounting for Stock-Based Compensation ("FAS 123")," to
provide alternative methods of transition to FAS 123's fair value method of
accounting for stock-based employee compensation. FAS 148 also amends the
disclosure provisions of FAS 123 and Accounting Principles Board's Opinion No.
28, "Interim Financial Reporting," to require disclosure in the summary of
significant accounting policies of the effects of an entity's accounting policy
with respect to stock-based employee compensation on reported net income and
earnings (loss) per share in annual and interim financial statements. FAS 148
does not require companies to account for employee stock options using the fair
value method of accounting (ie. the expensing of stock option grants in a
company's statement of operations). The Company adopted the disclosure
provisions of FAS 148 in the fiscal fourth quarter of its year ended March 31,
2003. FAS 148 has not had a material effect on the Company's operations,
financial position or cash flows as the Company will continue to account for
employee stock options using the intrinsic value method of accounting. However,
the Company will be required to provide additional disclosures with its interim
and annual financial statements regarding the impact of employee stock options
as if it had accounted for employee stock options using the fair value method of
accounting.
In December 2002, the FASB issued Interpretation No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others ("FIN 45")." FIN 45 elaborates on the
disclosures to be made by a guarantor in its interim and annual financial
statements about its obligations under certain guarantees that it has issued. It
also clarifies that a guarantor is required to recognize, at the inception of a
guarantee, a liability for the fair value of the obligation undertaken in
issuing the guarantee. The Company has adopted the disclosure requirements of
FIN 45 as of March 31, 2003. In addition, the Company adopted the initial
recognition and measurement of the fair value of the obligation undertaken in
issuing the guarantee on a prospective basis for all guarantees. The effect of
the adoption of FIN 45 on the Company's operations, financial position or cash
flows was not material.
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities ("FIN 46")." FIN 46 requires an investor with a
majority of the variable interests in a variable interest entity ("VIE") to
consolidate the entity and also requires majority and significant variable
interest investors to provide certain disclosures. A VIE is an entity in which
the equity investors do not have a controlling interest, or the equity
investment at risk is insufficient to finance the entity's activities without
receiving additional subordinated financial support from the other parties. For
arrangements entered into with VIEs created prior to January 31, 2003, the
provisions of FIN 46 are required to be adopted at the beginning of the first
interim or annual period beginning after June 15, 2003. The provisions of FIN 46
are effective immediately for all arrangements entered into with new VIEs
created after January 31, 2003. To date, the Company has not invested in any
VIE's and does not expect the adoption of FIN 46 to be material on its
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.
56
VIRAGE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued)
Lease Commitments and Lease Amendment
Operating Lease Commitment
The Company leases certain of its facilities under operating leases, some
of which have options to extend the lease period. Rent expense was $4,056,000,
$4,678,000 and $2,714,000 for the years ended March 31, 2003, 2002 and 2001,
respectively.
Future minimum lease payments under non-cancelable operating leases at
March 31, 2003 are as follows (in thousands):
Operating
Years Ending March 31, Leases
---------------------- ----------
2004............................ $ 2,694
2005............................ 1,651
2006............................ 1,414
2007............................ 707
----------
Total minimum payments......... $ 6,466
==========
The aforementioned amounts include estimates of expected fair market rental
rates in fiscal years ending March 31, 2004 to March 31, 2007 and the payments
of cash and forfeiture of other collateral of $1,000,000 for the year ending
March 31, 2004, respectively, pursuant to the Lease Amendment described below.
During the years ended March 31, 2003, 2002 and 2001, the Company was able
to sublease certain of its facilities. Rental payments received that relate to
the subleases were $124,000, $2,344,000 and $1,185,000 for the years ended March
31, 2003, 2002 and 2001, respectively (none for the year ended March 31, 2000).
Sublease income is recorded as contra-rent expense in the Company's statements
of operations. The sublease agreements remaining provide for payments to be
received by the Company of $66,000 during each of the years ended March 31, 2004
and 2005, respectively.
Operating Lease Amendment
In December 2002, the Company amended its lease for its headquarters (the
"Lease Amendment"). The Lease Amendment reduces, from December 2002 until
December 2003, the Company's rent rate to half of what the rent rate was under
the original operating lease agreement. In December 2003, and on each annual
anniversary thereafter through the Amendment's termination date of September
2006, the Company's rent rate will be adjusted to fair market value as to be
mutually determined by the Company and its landlord, subject to a minimum rate
that is equivalent to the Lease Amendment's initial reduced rate discussed above
(the "Minimum Rate").
In addition, the Company and its landlord will use best efforts to have the
landlord lease, to a third party, certain space that the Company abandoned in
March 2003. If the space is leased to a third party, the space will be excluded
from the Lease Amendment as of the date an agreement for the third party lease
is executed, subject to the Company guaranteeing its landlord the Minimum Rate
for the leased space. This guarantee will continue for a minimum of 24 months
after the date of execution for the leased space.
Furthermore, if the Company is acquired by an unrelated entity, the
acquirer may terminate the lease obligation for a termination fee equal to 67%
of the total minimum monthly rent payable for the remaining term of the lease
subsequent to such acquisition.
57
VIRAGE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued)
In consideration for the above, the Company issued its landlord a warrant
to purchase 200,000 shares of the Company's common stock at $0.57 per share (see
Note 3). In addition, the Company forfeited $1,250,000 of $2,000,000 of
restricted cash used to collateralize a letter of credit. The Company also
forgave approximately $240,000 of security deposits. The $2,000,000 of
restricted cash and $240,000 of security deposits were classified as other
assets on the Company's consolidated balance sheet at March 31, 2002.
The Company is obligated to forfeit $750,000 of restricted cash, which
collateralizes its obligation and is classified as other assets on the Company's
consolidated balance sheet, to its landlord if the landlord is able to lease the
Company's excess space. The Company estimates it will also incur approximately
$359,000 of other collateral forfeitures relating to certain provisions set
forth within the Lease Amendment.
In addition, the landlord, under certain limited conditions and exceptions
specified in the Lease Amendment, may have the option to extend the term of the
Lease Amendment for an additional five (5) years, with the base rent for the
renewal term based on fair market value.
The Company is amortizing the payments and other collateral described above
as rent expense over the life of the lease. In March 2003, the Company abandoned
approximately half of its headquarters facility to facilitate the leasing of the
excess space to a third party. As a result of this and the Company's adoption of
FAS 146 (see Note 1), the Company incurred charges of approximately $2,239,000
(including $89,000 of equipment write-downs) during the year ended March 31,
2003. The charges are related to the write-off of approximately half of the
unamortized portion of payments and other collateral forfeiture described above
and the accrual of approximately $1,026,000 relating to the expected leasing of
the excess space to a third party at a rate that is below the Minimum Rate
guarantee.
The Company has made a number of assumptions, such as length of time
required to engage a sublessee, and estimates, such as the assumed sublease
rate, in deriving the accounting for its lease amendment and excess facility
space. The Company's assumptions and estimates are based upon the best
information the Company has at the time any charges are derived. There are a
number of external factors outside of the Company's control that could
materially change the Company's assumptions and estimates and require the
Company to record additional charges in future periods. The Company monitors all
of these external factors and the impact on its assumptions and estimates as
part of its on-going financial reporting processes.
Technology Provider Royalty Commitments
The Company licenses technology from third parties, including software that
is integrated with internally developed software and used in the Company's
products to perform key functions. In consideration for this, the Company is
obligated to provide its third party technology partners with cash royalty
payments generally calculated as a fee per unit of product that the Company
sells that incorporates the third party's technology. In some instances, the
Company is obligated to pay a minimum royalty or fixed-fee to the vendor,
regardless of the quantities of products the Company actually sells. Royalty
expenses are included in the Company's cost of license revenues, which totaled
$738,000, $705,000 and $723,000 for the years ended March 31, 2003, 2002 and
2001, respectively.
58
VIRAGE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued)
Future minimum and fixed fee royalty payments under these agreements at
March 31, 2003 are as follows (in thousands):
Minimum
Years Ending March 31, Commitments
----------------------- -----------
2004............................ $ 340
2005............................ 300
2006............................ 300
2007............................ 350
----------
Total minimum payments....... $ 1,290
==========
It is the Company's best estimate as of March 31, 2003 that the Company
will recoup each period's commitment via future revenue streams generated by its
products. The Company has no loss-type contracts related to its technology
provider royalty commitments as of March 31, 2003.
Other Commitments
At March 31, 2003, the Company has other contractual and commercial
commitments not included on its balance sheet that it has entered into in the
ordinary course of business. Examples of these commitments include telecom
costs, marketing contracts, and other infrastructure requirements, all of which
are currently being used by the Company. Future full fiscal year commitments
remaining for these obligations are as follows: $154,000 in 2004, $21,000 in
2005, and $1,000 in 2006 ($176,000 in total other commitments as of March 31,
2003).
Guarantees
The Company generally provides a warranty for its software products and
services to its customers for a period of 90 days and accounts for its
warranties under the FASB's Statement of Financial Accounting Standards No. 5,
"Accounting for Contingencies." The Company's software products' media are
generally warranted to be free of defects in materials and workmanship under
normal use and the products are also generally warranted to substantially
perform as described in certain Company documentation. The Company's services
are generally warranted to be performed in a professional manner and to
materially conform to the specifications set forth in a customer's signed
contract. In the event there is a failure of such warranties, the Company
generally will correct or provide a reasonable work around or replacement
product. The Company's warranty accrual as of March 31, 2003 and 2002 was not
significant and, to date, the Company's product warranty expense has not been
significant.
The Company has two letters of credit that collateralize certain operating
lease obligations of the Company and total approximately $768,000 and $2,018,000
at March 31, 2003 and 2002, respectively. The Company collateralizes these
letters of credit with cash deposits made with certain of its financial
institutions and has classified these cash deposits as other assets on the
Company's balance sheet as of March 31, 2003 and 2002. The Company's landlords
are able to withdraw on each respective letter of credit in the event that the
Company is found to be in default of its obligations under each of its operating
leases.
The Company generally does not enter into indemnification agreements that
contingently require the Company to make payments directly to a party that is
indemnified by the Company (an "Indemnified Party"). The Company's
indemnification agreements generally defend and indemnify an Indemnified Party
against adverse situations such as, for example, defense against plaintiffs in a
lawsuit brought by a third party. In all such cases the Company would make
payments to such third party and/or attorneys if such a third party were
successful in such litigation. Historically, the expenses relating to or arising
from the Company's indemnification agreements have not been significant.
59
VIRAGE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued)
Restructuring
The Company accounted for its restructuring plans implemented during its
years ended March 31, 2003 and 2002 pursuant to EITF 94-3, until the fiscal
quarter ended December 31, 2002, at which point the Company early adopted the
provisions of FAS 146.
During the year ended March 31, 2003, the Company implemented additional
restructuring programs to better align operating expenses with anticipated
revenues. In each of the quarterly fiscal 2003 periods in which a plan was
implemented, appropriate levels of the Company's management had approved and
committed the Company to the specific actions for each of these programs. The
Company recorded a $3,215,000 restructuring charge, which consisted of
$2,150,000 of excess facility charges (recorded in the Company's fiscal fourth
quarter of the year ended March 31, 2003), $849,000 in employee severance costs
(the significant majority of which was recorded during the three months ended
June 30, 2002) and $216,000 in equipment write-downs across most of the expense
line items in the Company's consolidated statement of operations for the year
ended March 31, 2003. The restructuring programs resulted in a reduction in
force across all Company functions of approximately 50 employees. At March 31,
2003, the Company had $1,515,000 of accrued restructuring costs related to
monthly rent for excess facility capacity, and potential cash payments and
potential forfeiture of cash-based collateral in conjunction with the Lease
Amendment described above. The Company expects to pay out its excess facility
charges accrued as of March 31, 2003 over the life of the operating lease, which
runs through September 2006. The Company expects to forfeit its cash-based
collateral and pay out cash payments related to its Lease Amendment over the
course of the next twelve months.
During the year ended March 31, 2003, the Company made an adjustment of
$66,000 to its accrued excess facilities costs. The excess facility accrual was
originally recorded pursuant to EITF 94-3. The adjustment is a result of the
Company's re-occupying certain space in March 2003 that it had previously
written-off and had not intended to use until April 2003.
The following table depicts the restructuring activity during the year ended
March 31, 2003 (in thousands):
Balance at Expenditures Balance at
Category March 31, 2002 Additions Cash Non-cash Adjustments March 31, 2003
-------- -------------- --------- ------ -------- ----------- --------------
Excess facilities....... $ 460 $ 2,150 $ 1,029 $ -- $ 66 $ 1,515
Employee severance...... 259 849 1,108 -- -- --
Equipment write-downs... -- 216 -- 216 -- --
Other exit costs........ 44 -- 44 -- -- --
---------- --------- ------- ------- --------- --------------
Total................. $ 763 $ 3,215 $ 2,181 $ 216 $ 66 $ 1,515
========== ========= ======= ======= ========= ==============
During the year ended March 31, 2002, the Company implemented restructuring
programs to better align operating expenses with anticipated revenues. In each
of the quarterly fiscal 2002 periods in which a plan was implemented,
appropriate levels of the Company's management had approved and committed the
Company to the specific actions for each of these programs. The Company recorded
a $2,038,000 restructuring charge, which consists of $611,000 in facility exit
costs, $928,000 in employee severance costs, $455,000 in equipment write-downs,
and $44,000 in other exit costs across most of the expense line-items in the
Company's consolidated statement of operations for the year ended March 31,
2002. The restructuring programs resulted in a reduction in force across all
company functions of approximately 60 employees. At March 31, 2002, the Company
had $763,000 of accrued restructuring costs related to monthly rent for excess
facility capacity, employee severance payments and other exit costs. The Company
paid these accrued amounts during the year ended March 31, 2003.
60
VIRAGE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued)
The following table depicts the restructuring activity during the year
ended March 31, 2002 (in thousands):
Expenditures Balance at
Category Additions Cash Non-cash March 31, 2002
-------- --------- ---- -------- --------------
Excess facilities......... $ 611 $ 151 $ -- $ 460
Employee severance........ 928 669 -- 259
Equipment write-downs..... 455 -- 455 --
Other exit costs.......... 44 -- -- 44
--------- ----- -------- --------------
Total...................... $ 2,038 $ 820 $ 455 $ 763
========= ===== ======== ==============
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 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. On February 19, 2003, the Court issued a
ruling on the motions. The Court denied the motions to dismiss the claims under
the Securities Act of 1933. The Court granted the motions to dismiss the claims
under the Securities Exchange Act of 1934 with prejudice. The Company believes
it has meritorious defenses to these claims and intends to defend against 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's
consolidated financial position, results of operations or cash flows.
NASDAQ Listing 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.
61
VIRAGE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued)
The Company received a letter in March 2003 that stated the Company was not
in compliance with the minimum $1.00 per share listing requirement. NASDAQ
indicated that the Company has until April 29, 2003 to regain compliance. In May
2003, the Company received a subsequent letter from NASDAQ's compliance
department--see Note 9.
3. Stockholders' Equity
Preferred Stock
The Company's Certificate of Incorporation authorizes 2,000,000 shares of
preferred stock and the Board of Directors also adopted a preferred stock
purchase right plan intended to guard the Company against certain takeover
tactics. The Company's Board of Directors has the authority to fix or alter the
designation, powers, preferences and rights of the shares of each preferred
series and qualifications, limitations or restrictions to any unissued series of
preferred stock.
Initial Public Offering
In July 2000, the Company completed its initial public offering and issued
3,500,000 shares of its common stock to the public at a price of $11.00 per
share. The Company received net proceeds of $34,105,000 in cash after deducting
the underwriters' commissions and approximately $1,700,000 of offering costs.
The Company's underwriters also exercised their over-allotment option to
purchase an additional 525,000 shares of the Company's common stock at a price
of $11.00 per share resulting in an additional $5,371,000 of net proceeds to the
Company. All outstanding shares of redeemable convertible preferred stock were
converted into an aggregate of 10,369,451 shares of common stock at the closing
of the Company's public offering.
In addition, the Company's stockholders approved a 1-for-2 reverse stock
split of the Company's preferred and common stock and also authorized an
increase in the authorized number of common shares from 20,000,000 shares to
100,000,000 shares that became effective upon the consummation of the Company's
initial public offering. All share data has been restated to reflect the reverse
stock split.
Common Stock Purchase Agreement
In July 2000, the Company completed an $18,000,000 common stock purchase
agreement with certain private investors issuing 1,636,361 common shares at
$11.00 per share concurrent with its initial public offering.
Warrants
In September 1995 and October 1996, in connection with capital lease
agreements, the Company issued warrants to purchase 23,332 shares of common
stock at an exercise price of $0.75 per share, subject to certain adjustments.
Interest expense related to the fair value of the warrants was insignificant.
The fair value of the warrants was calculated using the Black-Scholes option
pricing model assuming a fair value of common stock of $0.75, risk-free interest
rate of 6.5%, volatility factor of 40%, and a life of 10 years. The warrants
were exercised during the year ended March 31, 2001 pursuant to a net exercise
provision in the warrant agreements resulting in the issuance of 22,221 common
shares.
62
VIRAGE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued)
In November 1999, the Company entered into a software development and
distribution agreement with SRI, International that provides the Company with a
non-exclusive license from SRI, International to embed and distribute SRI's
optical character recognition technology as a plug-in module to the Company's
VideoLogger product. The Company is required to pay SRI, International cash
royalty payments, subject to a minimum of $100,000 over the term of the
agreement, based upon annual license copy volumes as are defined within the
agreement. The Company also issued an immediately exercisable, nonforfeitable
warrant to purchase 19,055 shares of Series E preferred stock at an exercise
price of $6.56 per share, subject to certain adjustments. During the year ended
March 31, 2001, the warrant was exercised resulting in $125,000 of proceeds to
the Company. The Company determined the fair value of the warrants ($185,000)
using the Black-Scholes valuation model assuming a fair value of the Series E
preferred stock of $13.20, a risk-free interest rate of 5.9%, a volatility
factor of 90%, and a life of 3 years. The fair value of the warrants has been
recorded as a technology right and is being amortized to cost of goods sold over
the life of the agreement, which expires on December 31, 2004. Amortization
expense of $36,000, $35,000 and $35,000 was recorded during the years ended
March 31, 2003, 2002 and 2001, respectively.
In December 1999, the Company issued an immediately exercisable warrant to
purchase 75,435 shares of Series E preferred stock at $6.56 per share in
consideration for advertising provided by an Internet portal company. During the
year ended March 31, 2001, the warrant was net exercised by the holder resulting
in the issuance of 34,197 shares. The Company determined the fair value of the
warrant using the Black-Scholes valuation model assuming a fair value of the
Series E preferred stock of $13.20, risk-free interest rate of 6.1%, volatility
factor of 90%, and a life of 4 years. The fair value of the warrant ($781,000)
was recorded as deferred advertising costs and was amortized into sales and
marketing expense on a straight-line basis over 12 months, the term of the
advertising agreement, which commenced January 2000. Amortization expense of
$586,000 was recorded during the years ended March 31, 2001 (none for the years
ended March 31, 2003 and 2002).
In February 2000, the Company entered into a six-year operating lease
agreement on a new building. As part of the operating lease agreement, the
Company issued a warrant to the landlord in June 2000 to purchase 181,818 shares
of common stock at $11.00 per share which was exercised during the year ended
March 31, 2001 resulting in proceeds of $2,000,000 to the Company. The warrant
was issued concurrent with the pricing of the Company's IPO and if not
exercised, the warrant would have expired at the end of the first day that the
Company's stock began trading on NASDAQ. The Company estimated that the value of
the warrant is $72,000 using a Black-Scholes model with the following
assumptions: price of $11.00 as the deemed fair value, a risk-free interest rate
of 6.1%, a volatility factor of 90%, and an expected life of one day (based upon
the foregoing explanation of the warrant's short contractual life). The value of
the warrant is being amortized as rent expense over the term of the six-year
lease agreement and $35,000, $12,000 and $6,000 was recorded during the years
ended March 31, 2003, 2002 and 2001, respectively.
In December 2000, the Company entered into a services agreement with MLBAM
and issued an immediately exercisable, non-forfeitable warrant to purchase
200,000 shares of common stock at $5.50 per share. The warrant expires in
December 2003. The value of the warrant was estimated to be $648,000 and was
based upon a Black-Scholes valuation model with the following assumptions: risk
free interest rate of 7.0%, no dividend yield, volatility of 90%, expected life
of three years, exercise price of $5.50 and fair value of $5.38. The non-cash
amortization of the warrant's value was recorded against service revenues as
revenues from services were recognized over the one-year services agreement.
During the year ended March 31, 2002, the Company recorded a charge of $648,000
as contra-service revenues representing the amortization of the warrant's fair
value.
63
VIRAGE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued)
In December 2002, the Company entered into an amendment for its
headquarters' operating lease (see Note 2) and issued an immediately
exercisable, non-forfeitable warrant to purchase 200,000 shares of common stock
at $0.57 per share. The warrant expires in December 2005. The value of the
warrant was estimated to be $86,000 and was based upon a Black-Scholes valuation
model with the following assumptions: risk free interest rate of 1.9%, no
dividend yield, volatility of 130%, expected life of three years, and exercise
price of $0.57. The non-cash amortization of the warrant's value is being
recorded as rent expense over the life of the lease. During the year ended March
31, 2003, the Company recorded $44,000 as rent expense related to this warrant.
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 was required to grant its employees stock
options on August 7, 2002 at the closing market price as of that date. 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.
In addition, the Company had two employees that were eligible to
participate in this program that did not meet certain employee definitional
criteria pursuant to APB Opinion No. 25, as interpreted by the FASB's
Interpretation No. 44, "Accounting for Certain Transactions involving Stock
Compensation, an interpretation of APB Opinion No. 25 ("FIN 44")." Accordingly,
the Company had to account for the option grants to these two participants as
though they were non-employees pursuant to EITF Issue 96-18, resulting in the
Company recording non-cash, stock-based charges of $87,000 for the year ended
March 31, 2003.
Employee Stock Plans
In December 1997, the Company's stockholders agreed to terminate the
Virage, Inc. 1995 Stock Option Plan (the "1995 Plan") and to introduce the
Virage, Inc. 1997 Stock Option Plan (the "1997 Plan"). All options issued under
the 1995 Plan remained outstanding under that plan and did not become
outstanding under the 1997 Plan. The 1997 Plan provides for the granting of
incentive stock options and nonqualified stock options to employees, directors,
and consultants. Under the 1997 Plan, the Board of Directors (or any properly
appointed officer of the Company) determines the term of each award and the
award price. In the case of incentive stock options, the exercise price may be
established at an amount not less than the fair market value at the date of
grant, while nonstatutory options may have exercise prices not less than 85% of
the fair market value as of the date of grant. Options granted to any person
owning stock possessing more than 10% of the total combined voting power must
have exercise prices of at least 110% of the fair market value at the date of
grant. Options generally vest ratably over a four-year period commencing with
the grant date and expire no later than ten years from the date of grant. The
1997 Plan provides for the lesser of 1,000,000 shares or five percent of
outstanding shares to increase the number of shares outstanding on an annual
basis effective every April 1.
64
VIRAGE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued)
Options granted under the 1995 Plan are not exercisable until they are
fully vested. Options granted under the 1997 Plan are immediately exercisable,
but shares so purchased that are not yet vested may be repurchased by the
Company, at the Company's option, upon termination of employment at the exercise
price. All shares subject to options outstanding under the 1995 Plan that
expired or were terminated, canceled, or repurchased were added to the number of
shares authorized and reserved for issuance under the 1997 Plan.
In April 2001, the Company's Board of Directors agreed to establish the
Virage 2001 Nonstatutory Stock Option Plan (the "2001 Plan"). The 2001 Plan
provides for a maximum aggregate number of shares of stock that may be issued
under the Plan of 900,000 and provides for the granting of nonqualified stock
options to employees (excluding officers of the Company and any other person
whose eligibility to receive an option under the 2001 Plan at the time of grant
would require the approval of the Company's stockholders) and consultants. Under
the 2001 Plan, the Board of Directors (or any properly appointed officer of the
Company) determines the term of each award and the award price. Options
generally vest ratably over a four-year period commencing with the grant date
and expire no later than ten years from the date of grant.
A summary of all of the Company's stock option plans activity and related
information is set forth below:
Options Outstanding
-------------------
Shares Weighted
Available Number of Average
for Grant Shares Exercise Price
--------- --------- --------------
Balance at March 31, 2000......... 3,199,734 3,653,514 $ 6.00
Options granted................. (3,252,025) 3,252,025 $ 8.55
Options exercised............... -- (266,481) $ 2.20
Options canceled................ 345,056 (345,056) $ 8.69
Options repurchased............. 23,897 -- $ 2.07
----------- -----------
Balance at March 31, 2001......... 316,662 6,294,002 $ 7.34
Options authorized.............. 1,900,000 -- --
Options granted................. (2,422,525) 2,422,525 $ 3.08
Options exercised............... -- (206,787) $ 0.33
Options canceled................ 3,741,351 (3,741,351) $ 9.32
Options repurchased............. 80,050 -- $ 0.34
----------- -----------
Balance at March 31, 2002......... 3,615,538 4,768,389 $ 3.92
Options authorized.............. 1,000,000 -- --
Options granted................. (5,143,750) 5,143,750 $ 0.78
Options exercised............... -- (186,256) $ 0.53
Options canceled................ 2,059,058 (2,059,058) $ 3.72
----------- -----------
Balance at March 31, 2003......... 1,530,846 7,666,825 $ 1.94
=========== ===========
As of March 31, 2003, there were 522 shares of common stock exercised
pursuant to stock options that were not fully vested. These shares are subject
to repurchase solely at the option of the Company at the original grant price
upon an employee's termination.
65
VIRAGE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued)
The following table summarizes information about stock options outstanding
and exercisable at March 31, 2003:
Options Outstanding Options Exercisable
------------------------------------------- ---------------------------
Weighted-
Average
Remaining Weighted- Weighted-
Range of Number Contractual Average Number Average
Exercise Prices Outstanding Life Exercise Price Exercisable Exercise Price
--------------- ----------- ---- -------------- ----------- --------------
(in years)
$ 0.15-- $ 0.40 178,851 4.92 $ 0.31 178,851 $ 0.31
$ 0.41-- $ 0.60 2,090,325 9.35 $ 0.59 2,005,115 $ 0.59
$ 0.61-- $ 1.00 1,907,667 9.30 $ 0.77 1,733,478 $ 0.77
$ 1.01-- $ 2.50 1,371,995 8.55 $ 2.02 1,309,190 $ 2.03
$ 2.51-- $ 5.00 1,602,510 7.87 $ 3.72 1,387,034 $ 3.87
$ 5.01-- $ 12.00 515,477 6.76 $ 6.72 507,667 $ 6.72
---------- ----------
$ 0.15-- $ 12.00 7,666,825 8.61 $ 1.94 7,121,335 $ 1.97
========== ==== ====== ========== ======
In March 2000, the Company's stockholders approved the Virage, Inc. 2000
Employee Stock Purchase Plan (the "ESPP"), which is designed to allow eligible
employees of the Company to purchase shares of the Company's common stock at
semiannual intervals through periodic payroll deductions. An aggregate of
1,900,000 shares of common stock has been reserved for the ESPP, and 498,816
shares have been issued through March 31, 2003. The number of shares reserved is
increased cumulatively by the lesser of 400,000 shares or two percent of the
number of issued and outstanding shares of common stock on the immediately
preceding March 31 on each April 1 through April 1, 2010. The ESPP is
implemented in a series of successive offering periods, each with a maximum
duration of 24 months. Eligible employees can have up to 10% of their base
salary deducted that is to be used to purchase shares of the common stock on
specific dates determined by the board of directors (up to a maximum of $25,000
per year based upon the fair market value of the shares). The price of common
stock purchased under the ESPP will be equal to 85% of the lower of the fair
market value of the common stock on the commencement date of each offering
period or the specified purchase date.
Deferred Compensation & Option Vesting Acceleration
During the years ended March 31, 2003 and 2001, the Company recorded
aggregate deferred compensation of $69,000 and $71,000, respectively,
representing the difference between the exercise price of stock options granted
and the then deemed fair value of the Company's common stock (none for the year
ended March 31, 2002). The amortization of deferred compensation is charged to
operations over the vesting period of the options using the straight-line
method, which is typically four years. For the years ended March 31, 2003, 2002
and 2001, the Company amortized $1,306,000, $6,511,000 and $4,165,000,
respectively, of deferred compensation of which $1,306,000, $5,113,000 and
3,294,000, respectively, related to stock options issued to employees (presented
separately in the Company's statement of operations) and none, $1,398,000 and
$871,000, respectively, related to stock options issued to consultants.
During the year ended March 31, 2002, the Company accelerated the vesting
of stock options for certain employees upon their termination pursuant to
certain agreements entered into between the former employees and the Company.
Pursuant to the FIN 44, the fair value of the options of $123,000 was determined
based upon the intrinsic value of the accelerated shares as of the modification
date and was recorded as expense during the year ended March 31, 2002.
66
VIRAGE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued)
Options Issued to Consultants
As described above, the Company had two employees that were eligible to
participate in its Voluntary Stock Option Cancellation and Re-grant Program that
did not meet certain employee definitional criteria Accordingly, the Company had
to account for the option grants to these two participants as though they were
non-employees pursuant to FAS 123 and EITF 96-18, resulting in the Company
recording non-cash, stock-based charges of $87,000 for the year ended March 31,
2003 based upon the Black-Scholes valuation model and the following inputs:
exercise price of $0.59, fair market value of $0.59 on date of grant and other
prices based upon various remeasurement dates, expected lives of three to nine
months, volatility of 121%, interest rate of 2.5% and no dividend yield.
Through the year ended March 31, 2002, the Company had granted options to
purchase 295,523 shares of common stock to consultants at exercise prices
ranging from $1.00 to $12.00 per share. The options were granted in exchange for
consulting services to be rendered and vest over periods ranging from
immediately to four years. The Company valued these options at $2,846,000 being
their fair value estimated using a Black-Scholes valuation model assuming fair
values of common stock ranging from $1.52 to $11.00 per share, risk-free
interest rates ranging from 4.8% to 6.1%, a volatility factor of 90% and a life
of four years. The options issued to consultants were marked-to-market using the
estimate of fair value at the end of each accounting period pursuant to EITF
96-18. During the year ended March 31, 2001, the Company recorded additional
deferred compensation of $71,000 pursuant to this provision which was amortized
over the remaining vesting period. The Company recorded a non-cash, stock-based
charge to operations of $1,398,000 and $871,000 for the years ended March 31,
2002 and 2001, respectively, representing the amortization of deferred
compensation related to these options. The Company also reversed the unamortized
portion of deferred compensation of $29,000 related to these options during the
year ended March 31, 2002 due to the termination of service by these consultants
prior to the full-vesting of the options granted.
4. Shares Reserved
At March 31, 2003, common stock reserved for future issuance was as follows:
Number of Securities
to be Issued upon
Exercise of Weighted- Shares
Outstanding Options, Average Available
Warrants and Rights Exercise Price For Grant
------------------- -------------- ---------
Equity compensation plans approved
by stockholders................................... 6,866,805 $ 1.96 2,832,050
Equity compensation plans not approved
by stockholders................................... 1,200,020 $ 2.17 99,980
---------- ---------
Total.......................................... 8,066,825 $ 1.99 2,932,030
========== ========== =========
Included in the 2,832,050 shares available for grant for equity
compensation plans approved by stockholders are 1,401,184 shares reserved
pursuant to the Company's ESPP (see above).
5. Savings Plan
The Company maintains a savings plan under Section 401(k) of the Internal
Revenue Code. Under the plan, employees may defer certain amounts of their
pretax salaries but not more than statutory limits. The Company may make
discretionary contributions to the plan as determined by the Board of Directors.
The Company has not contributed to the plan through March 31, 2003.
67
VIRAGE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued)
6. Income Taxes
Due to operating losses and the Company's inability to recognize an income
tax benefit from current losses, there is no provision for income taxes for the
years ended March 31, 2003, 2002 or 2001.
The difference between the provision for income taxes and the amount
computed by applying the Federal statutory income tax rate to income before
taxes is explained below (in thousands):
March 31,
-------------------------------------
2003 2002 2001
---------- --------- ---------
Tax benefit at federal statutory rate (34%)..................... $ (6,161) $ (9,435) $ (9,817)
Loss for which no tax benefit is currently recognizable......... 5,678 6,985 8,664
Nondeductible stock compensation................................ 483 2,450 1,153
---------- --------- ---------
Total provision............................................... $ -- $ -- $ --
========== ========= =========
Significant components of the Company's deferred tax assets are as follows
(in thousands):
March 31,
------------------
2003 2002
------- --------
Deferred tax assets:
Net operating loss carryforwards.......... $ 28,800 $ 24,000
Tax credit carryforwards.................. 1,800 870
Other individually immaterial items....... (430) 2,170
--------- ---------
Total deferred tax assets.............. 29,550 27,040
Valuation allowance......................... (29,550) (27,040)
--------- ---------
Net deferred tax assets..................... $ -- $ --
========= =========
FASB Statement No. 109, "Accounting for Income Taxes," provides for the
recognition of deferred tax assets if realization of such assets is more likely
than not. Based upon the weight of available evidence, which includes the
Company's historical operating performance and the reported cumulative net
losses in all prior years, the Company has provided a full valuation allowance
against its net deferred tax assets. The valuation allowance increased by
$2,510,000 and $7,872,000 during the years ended March 31, 2003 and 2002,
respectively.
As of March 31, 2003, the Company had federal and state net operating loss
carryforwards of approximately $80,206,000 and $26,269,000, respectively. As of
March 31, 2003, the Company also had federal and state research and development
tax credit carryforwards of approximately $759,000 and $647,000, respectively.
The net operating loss and tax credit carryforwards will expire at various dates
beginning in 2003, if not utilized.
Utilization of the net operating loss and tax credit carryforwards may be
subject to substantial annual limitations due to the ownership change
limitations provided by the Internal Revenue Code and similar state provisions.
The annual limitation may result in the expiration of net operating losses and
tax credit carryforwards before utilization.
68
VIRAGE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued)
7. Segment Reporting
The Company has two reportable segments: the sale of software and related
software support services and the sale of its application and professional
services which includes set-up fees, professional services fees, video
processing fees, and hosting and distribution fees ("application and
professional services"). The Company's Chief Operating Decision Maker ("CODM")
is the Company's Chief Executive Officer who evaluates performance and allocates
resources based upon total revenues and gross profit (loss). Discreet financial
information for each segment's profit and loss and each segment's total assets
is not provided to the Company's CODM, nor is it tracked by the Company.
Information on the Company's reportable segments for the years ended March
31, 2003, 2002 and 2001 are as follows (certain prior year balances have been
reclassified to conform with current year presentation, in thousands):
Years Ended March 31,
-----------------------------------------
2003 2002 2001
------------- ------------- ------------
Software:
Total revenues................ $ 8,766 $ 10,068 $ 7,914
Total cost of revenues........ 1,589 1,307 1,199
----------- ----------- -----------
Gross profit.................. $ 7,177 $ 8,761 $ 6,715
=========== =========== ===========
Application and Professional
Services:
Total revenues................ $ 4,163 $ 6,677 $ 3,487
Total cost of revenues........ 3,750 8,158 7,054
----------- ----------- -----------
Gross profit (loss)........... $ 413 $ (1,481) $ (3,567)
=========== =========== ===========
Total revenues to customers located outside the United States were
approximately $3,285,000, $3,997,000, and $3,341,000 for the years ended March
31, 2003, 2002 and 2001, respectively. Virage Europe Ltd. and Virage GmbH, the
Company's European subsidiaries, accounted for approximately $1,539,000,
$2,114,000 and $2,020,000 of the Company's total revenues for the years ended
March 31, 2003, 2002 and 2001, respectively. The total combined assets of Virage
Europe Ltd. and Virage GmbH accounted for less than five percent of the
Company's total assets as of March 31, 2003 and 2002.
8. Quarterly Financial Data (Unaudited)
Three Months Ended
----------------------------------------------------------------------------------------------------
March 31, December 31, September 30, June 30, March 31, December 31, September 30, June 30,
2003 2002 2002 2002 2002 2001 2001 2001
---- ---- ---- ---- ---- ---- ---- ----
(in thousands)
Total revenues...... $ 3,103 $ 3,314 $ 3,277 $ 3,235 $ 3,221 $ 4,788 $ 4,746 $ 3,990
Gross profit........ 1,614 2,029 2,058 1,889 1,502 2,459 2,072 1,247
Net loss............ (4,614) (3,262) (4,743) (5,501) (8,966) (5,204) (6,369) (7,211)
Basic and diluted
net loss per share $ (0.22) $ (0.16) $ (0.23) $ (0.27) $ (0.44) $ (0.26) $ (0.31) $ (0.36)
69
VIRAGE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued)
9. Subsequent Events (Unaudited)
NASDAQ Listing Requirements
The Company received a NASDAQ letter on May 1, 2003 that stated the Company
was not in compliance with the NASDAQ's minimum bid price listing requirement
and that the Company had seven calendar days to do one of the following:
o Submit an application for transfer of the Company's securities for
trading to the NASDAQ SmallCap Market;
o Request a hearing to appeal the delisting notice; or
o Have the Company's securities delisted from the NASDAQ National
Market.
The Company initiated an appeal process with NASDAQ whereby it has
requested an in-person hearing with NASDAQ regulators to present relevant
measures the Company is taking in order to improve its operating results and, as
a result, bolster its stock price to levels required by NASDAQ. Should NASDAQ
dismiss the Company's appeal, the Company believes it will submit an application
for transfer to the NASDAQ SmallCap Market, where if accepted, the Company
believes it will have at least 180 days from the date of transfer to attempt to
regain compliance with NASDAQ's listing requirements. If the Company transfers
to the NASDAQ SmallCap Market, 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.
70
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
There were no matters to be reported under this item.
PART III
Item 10. Directors and Executive Officers of the Registrant
(a) Executive Officers
The information with respect to Executive Officers is included in Part I
hereof after Item 4.
(b) Directors
The information required by this item is included in the section
entitled "Election of Directors" in the Proxy Statement for the 2003
Annual Meeting of Stockholders ("Proxy Statement") and is incorporated
by reference herein. The information regarding compliance with section
16(a) of the Exchange Act is included in the section entitled "Section
16(a) Beneficial Ownership Reporting Compliance" in the Proxy Statement
and incorporated herein by reference.
Item 11. Executive Compensation
The information required by this item is included in the section entitled
"Executive Compensation" in the Proxy Statement and is incorporated herein by
reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management
The information required by this item is included in the section entitled
"Security Ownership of Certain Beneficial Owners and Management" in the Proxy
Statement and is incorporated herein by reference and is also included in Part
II, Item 5 and Note 4 of the Company's Consolidated Financial Statements and
Notes thereto included in Part II, Item 8, hereof.
Item 13. Certain Relationships and Related Transactions
The information required by this item is included in the section entitled
"Certain Transactions" in the Proxy Statement and is incorporated herein by
reference.
Item 14. Controls and Procedures
Within 90 days prior to the filing date of this Annual Report on Form 10-K,
we carried out an evaluation, under the supervision and with the participation
of our management, including our Chief Executive Officer ("CEO") and our Acting
Chief Financial Officer ("ACFO"), of the effectiveness of the design and
operation of our "disclosure controls and procedures" and "internal controls"
pursuant to Item 307 of Regulation S-K.
Disclosure controls and procedures are designed with the objective of
ensuring that (i) information required to be disclosed in our reports filed
under the Securities Exchange Act of 1934, is recorded, processed, summarized
and reported within the time periods specified in the Securities and Exchange
Commission's rules and forms, and (ii) information is accumulated and
communicated to management, including the CEO and ACFO, as appropriate to allow
timely decisions regarding required disclosure. Internal controls are procedures
designed with the objective of providing reasonable assurance that our
transactions are properly authorized; assets are safeguarded against
unauthorized or improper use; and transactions are properly recorded and
reported, all to permit the preparation of our consolidated financial statements
in conformity with generally accepted accounting principles.
71
The evaluation of our disclosure controls and procedures and internal
controls included a review of the objectives and processes, implementation by us
and effect on the information generated for use in this Annual Report on Form
10-K. In the course of this evaluation, we sought to identify any significant
deficiencies or material weaknesses in our controls, and whether we had
identified any acts of fraud involving personnel who have a significant role in
our internal controls, and to confirm that any necessary corrective action,
including process improvements, were being undertaken. This type of evaluation
will be done on a quarterly basis so that the conclusions concerning the
effectiveness of these controls can be reported in our Quarterly Reports on Form
10-Q and Annual Report on Form 10-K. Our internal controls are also evaluated on
an ongoing basis by our finance organization. The overall goals of these
evaluation activities are to monitor our disclosure and internal controls and to
make modifications as necessary. We intend to maintain these controls as
processes that may be appropriately modified as circumstances warrant.
Based on the evaluation described above and subject to the discussion
below, our CEO and ACFO concluded that our controls and procedures are effective
in timely alerting them to material information relating to us (including our
consolidated subsidiaries) required to be included in this Annual Report on Form
10-K. There have been no significant changes in our internal controls or in
other factors that could significantly affect those controls since the date of
their last evaluation.
However, a control system, no matter how well conceived and operated, can
provide only reasonable, not absolute, assurance that the objectives of the
control system are met. Management necessarily applied its judgment in assessing
the benefits of controls relative to their costs. Because of the inherent
limitations in all control systems, no evaluation of controls can provide
absolute assurance that all control issues and instances of fraud, if any,
within our company have been detected. The design of any system of controls is
based in part upon certain assumptions about the likelihood of future events,
and there can be no assurance that any design will succeed in achieving its
stated goals under all potential future conditions, regardless of how remote.
Because of the inherent limitations in a cost-effective control system,
misstatements due to error or fraud may occur and not be detected.
72
PART IV
Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K
(a) (1) Financial Statements
The consolidated financial statements of Virage as set forth under
Item 8 are filed as part of this Annual Report on Form 10-K.
(2) Financial Statement Schedule Virage, Inc.
Schedule II--Valuation and Qualifying Accounts
(in thousands)
Additions Balance
Balance at charged to at end
beginning costs and of
Description of period expenses Adjustments period
----------- --------- -------- ----------- ------
Fiscal year ended March 31, 2003
Allowance for doubtful accounts........ $1,153 $ -- $651 $ 502
Fiscal year ended March 31, 2002
Allowance for doubtful accounts........ $ 867 $ 286 $ -- $1,153
Fiscal year ended March 31, 2001
Allowance for doubtful accounts........ $ 591 $ 276 $ -- $ 867
All other schedules are omitted because they are not applicable or the amounts
are insignificant or the required information is presented in the Consolidated
Financial Statements and Notes thereto in Item 8 above.
(3) Exhibits
Exhibit
Number Description of Document
- ------ -----------------------
3.1+ Amended and Restated Certificate of Incorporation of the
Registrant
3.2+ Amended and Restated Bylaws of the Registrant
4.1+ Second Amended and Restated Rights Agreement, dated September
21, 1999, between Registrant and certain stockholders
4.2+ Specimen Stock Certificate
4.3+ Amendment No. 1 to Second Amended and Restated Rights
Agreement, dated September 21, 1999, between Registrant and
certain stockholders
4.5++ Warrant to Purchase Common Stock between Virage and MLB
Advanced Media, L.P., dated December 31, 2000
4.6++ Warrant to Purchase Common Stock between Registrant and JRT
Investment Company, a limited partnership wholly owned by Jim
Joseph Revocable Trust, dated December 23, 2002.
10.1+ Form of Indemnification Agreement between Registrant and
Registrant's directors and officers
10.2+ 1995 Stock Option Plan
10.3+ 1997 Stock Option Plan
10.4+ 2000 Employee Stock Purchase Plan
10.5+ Lease Agreement, dated January 17, 1996, as amended, between
Casiopea Venture Corporation and Registrant
10.6+ Lease Agreement, dated January 17, 1996, as amended, between
Casiopea Venture Corporation and Registrant
10.7+ License Agreement, dated September 27, 1999, between Office
Dynamics Limited, Protege Property and Registrant
10.8+ Security and Loan Agreement, dated November 2, 1998, as
amended, between Imperial Bank and Registrant
10.9+ Office Lease, dated February 17, 2000, between Jim Joseph,
Trustee, Jim Joseph Revocable Trust, dated January 19, 2000,
and Registrant
10.10+ Agreement, dated February 28, 2000, between Pinewood Studios
Limited and Registrant
10.11+++ 2001 Nonstatutory Stock Option Plan
10.12++ Severance Agreement with Michael H. Lock
10.13++ Retention Bonus and Severance Agreement with Scott Gawel
10.14++ Amendment to Office Lease, Dated December 23, 2002, between 411
Borel LLC and Registrant
23.1 Consent of Ernst & Young LLP, Independent Auditors
24.1 Power of Attorney (included on signature page)
99.1 Certifications under Section 906 of the Sarbanes-Oxley Act of
2002
+Incorporated by reference to the Registrant's Registration Statement on Form
S-1 (Registration No. 333-96315).
++ Incorporated by reference to the Registrant's Quarterly Reports filed on Form
10-Q on February 6, 2001, November 12, 2002 or February 14, 2003.
+++Incorporated by reference to the Registrant's Annual Report filed on Form
10-K on June 14, 2002.
(b) Reports on Form 8-K: No reports on Form 8-K were filed during the fourth
quarter ended March 31, 2003.
(c) See Item 14(a)(3) above.
(d) See Items 8 and 14(a)(2) above.
73
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized, on June 16, 2003.
Virage, Inc.
By: /s/ Paul G. Lego
-------------------------------------
Paul G. Lego
Chairman of the Board of Directors,
President and Chief Executive Officer
POWER OF ATTORNEY
Know all persons by these presents, that each person whose signature
appears below constitutes and appoints Paul G. Lego and Scott C. Gawel, jointly
and severally, his attorneys-in-fact, each with the power of substitution, for
him in any and all capacities, to sign any amendments to this Report on Form
10-K, and to file the same, with exhibits thereto and other documents in
connection therewith, with the Securities and Exchange Commission, hereby
ratifying and confirming all that each of said attorneys-in-fact, or his
substitute or substitutes, may do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
Signature Title Date
--------- ----- ----
/s/ Paul G. Lego Chairman, President and June 16, 2003
- ------------------------------------------- Chief Executive Officer
Paul G. Lego (Principal Executive Officer)
/s/ Scott C. Gawel Vice President, Finance and June 16, 2003
- ------------------------------------------- Acting Chief Financial Officer
Scott C. Gawel (Principal Financial and Accounting
Officer)
/s/ Alar E. Arras Director June 16, 2003
- -------------------------------------------
Alar E. Arras
/s/ Ronald E.F. Codd Director June 16, 2003
- -------------------------------------------
Ronald E.F. Codd
/s/ Philip W. Halperin Director June 16, 2003
- -------------------------------------------
Philip W. Halperin
/s/ Randall S. Livingston Director June 16, 2003
- -------------------------------------------
Randall S. Livingston
/s/ Standish H. O'Grady Director June 16, 2003
- -------------------------------------------
Standish H. O'Grady
/s/ William H. Younger, Jr. Director June 16, 2003
- -------------------------------------------
William H. Younger, Jr.
74
INDEX TO EXHIBITS
Exhibit
Number Description of Document
- ------ -----------------------
3.1+ Amended and Restated Certificate of Incorporation of the
Registrant
3.2+ Amended and Restated Bylaws of the Registrant
4.1+ Second Amended and Restated Rights Agreement, dated September
21, 1999, between Registrant and certain stockholders
4.2+ Specimen Stock Certificate
4.3+ Amendment No. 1 to Second Amended and Restated Rights
Agreement, dated September 21, 1999, between Registrant and
certain stockholders
4.5++ Warrant to Purchase Common Stock between Virage and MLB
Advanced Media, L.P., dated December 31, 2000
4.6++ Warrant to Purchase Common Stock between Registrant and JRT
Investment Company, a limited partnership wholly owned by Jim
Joseph Revocable Trust, dated December 23, 2002.
10.1+ Form of Indemnification Agreement between Registrant and
Registrant's directors and officers
10.2+ 1995 Stock Option Plan
10.3+ 1997 Stock Option Plan
10.4+ 2000 Employee Stock Purchase Plan
10.5+ Lease Agreement, dated January 17, 1996, as amended, between
Casiopea Venture Corporation and Registrant
10.6+ Lease Agreement, dated January 17, 1996, as amended, between
Casiopea Venture Corporation and Registrant
10.7+ License Agreement, dated September 27, 1999, between Office
Dynamics Limited, Protege Property and Registrant
10.8+ Security and Loan Agreement, dated November 2, 1998, as
amended, between Imperial Bank and Registrant
10.9+ Office Lease, dated February 17, 2000, between Jim Joseph,
Trustee, Jim Joseph Revocable Trust, dated January 19, 2000,
and Registrant
10.10+ Agreement, dated February 28, 2000, between Pinewood Studios
Limited and Registrant
10.11+++ 2001 Nonstatutory Stock Option Plan
10.12++ Severance Agreement with Michael H. Lock
10.13++ Retention Bonus and Severance Agreement with Scott Gawel
10.14++ Amendment to Office Lease, Dated December 23, 2002, between 411
Borel LLC and Registrant
23.1 Consent of Ernst & Young LLP, Independent Auditors
24.1 Power of Attorney (included on signature page)
99.1 Certifications under Section 906 of the Sarbanes-Oxley Act of
2002
+Incorporated by reference to the Registrant's Registration Statement on Form
S-1 (Registration No. 333-96315).
++ Incorporated by reference to the Registrant's Quarterly Reports filed on Form
10-Q on February 6, 2001, November 12, 2002 or February 14, 2003.
+++Incorporated by reference to the Registrant's Annual Report filed on Form
10-K on June 14, 2002.
75