UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended March 31, 2000
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _____ to _____
Commission file number 000-25687
===============================================================================
PHONE.COM, INC.
(Exact name of registrant as specified in its charter)
Delaware 94-3219054
(State or other jurisdiction of incorporation or (I.R.S. Employer Identification No.)
organization)
800 Chesapeake Drive
Redwood City, California 94063
(Address of principal executive offices, including zip code)
(650) 562-0200
(Registrant's telephone number, including area code)
===============================================================================
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.
Yes X No [_]
As of April 30, 2000, there were 78,711,840 shares of the registrant's
Common Stock outstanding.
1
INDEX
-----
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements.
Condensed consolidated balance sheets at March 31, 2000 and
June 30, 1999
Condensed consolidated statements of operations for the three
and nine month periods ended March 31, 2000 and 1999
Condensed consolidated statements of cash flows for the nine
month periods ended March 31, 2000 and 1999
Notes to condensed consolidated financial statements
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations.
Item 3. Quantitative and Qualitative Disclosures about Market Risk.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
Item 2. Changes in Securities and Use of Proceeds
Item 3. Defaults Upon Senior Securities
Item 4. Submission of Matters to a Vote of Security Holders
Item 5. Other Information
Item 6. Exhibits and Reports on Form 8-K.
SIGNATURES
2
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
PHONE.COM, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)
March 31, June 30,
2000 1999
------------ -----------
Assets
Current assets:
Cash and cash equivalents.................................... $ 123,782 $ 79,803
Short-term investments....................................... 373,157 33,283
Accounts receivable.......................................... 33,061 20,474
Prepaid expenses and other current assets.................... 4,888 865
----------- ------------
Total current assets................................ 534,888 134,425
Property and equipment, net....................................... 17,172 3,014
Deposits and other assets......................................... 3,153 1,494
Goodwill and intangible assets, net............................... 934,126 --
----------- ------------
$ 1,489,339 $ 138,933
=========== ============
Liabilities and Stockholders' Equity
Current liabilities:
Current portion of equipment loans
and capital lease obligations............................. $ 1,014 $ 424
Accounts payable............................................. 4,259 1,749
Accrued liabilities - acquisition related ................... 30,764 --
Other accrued liabilities.................................... 23,101 7,173
Deferred revenue............................................. 62,993 36,797
----------- ------------
Total current liabilities........................... 122,131 46,143
Equipment loans and capital lease obligations,
less current portion........................................... 1,766 498
----------- ------------
Total liabilities................................... 123,897 46,641
----------- ------------
Stockholders' equity:
Common stock................................................. 75 62
Additional paid-in capital................................... 1,515,199 136,178
Deferred stock-based compensation............................ (7,322) (1,318)
Treasury stock............................................... (196) (196)
Notes receivable from stockholders........................... (837) (484)
Accumulated deficit.......................................... (141,477) (41,950)
----------- ------------
Total stockholders' equity.......................... 1,365,442 92,292
----------- ------------
$ 1,489,339 $ 138,933
=========== ============
See accompanying notes to the condensed consolidated financial statements.
3
PHONE.COM, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
Three Months Ended Nine Months Ended
March 31, March 31,
-------------------------------- -------------------------------
2000 1999 2000 1999
--------------- --------------- -------------- --------------
Revenues:
License.................................... $11,833 $ 1,264 $ 24,751 $ 1,530
Maintenance and support services........... 3,939 1,454 9,448 3,786
Consulting services........................ 2,889 814 5,791 1,401
---------- ----------- ---------- ---------
Total revenues....................... 18,661 3,532 39,990 6,717
---------- ----------- ---------- ---------
Cost of revenues:
License.................................... 567 84 1,086 172
Maintenance and support services........... 2,613 767 6,862 1,876
Consulting services........................ 1,689 511 3,433 646
---------- ----------- ---------- ---------
Total cost of revenues............... 4,869 1,362 11,381 2,694
---------- ----------- ---------- ---------
Gross profit......................... 13,792 2,170 28,609 4,023
---------- ----------- ---------- ---------
Operating expenses:
Research and development................... 11,351 3,468 25,051 8,406
Sales and marketing........................ 11,418 2,629 21,958 6,504
General and administrative................. 3,400 1,092 8,113 2,731
Stock-based compensation................... 1,861 280 3,581 784
Amortization of goodwill and
Intangible assets....................... 49,297 -- 62,939 --
In-process research and development........ 18,080 -- 18,190 --
---------- ----------- ---------- ---------
Total operating expenses............. 95,407 7,469 139,832 18,425
---------- ----------- ---------- ---------
Operating loss....................... (81,615) (5,299) (111,223) (14,402)
Interest and other income, net.................. 7,199 359 12,791 1,139
---------- ----------- ---------- ---------
Loss before income taxes............. (74,416) (4,940) (98,432) (13,263)
Income taxes.................................... 170 710 1,095 710
---------- ----------- ---------- ---------
Net loss............................. ($74,586) ($5,650) ($99,527) ($13,973)
========== =========== ========== =========
Basic and diluted net loss per share............ ($1.05) ($0.50) ($1.51) ($1.24)
========== =========== ========== =========
Shares used in computing basic and
diluted net loss per share................. 71,003 11,398 66,051 11,236
========== =========== ========== =========
See accompanying notes to the condensed consolidated financial statements.
4
PHONE.COM, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
Nine Months Ended
March 31,
---------------------------------
2000 1999
--------------- --------------
Cash flows from operating activities:
Net loss................................................................ ($99,527) ($13,973)
Adjustments to reconcile net loss to net cash
(used for) provided by operating activities:
Depreciation and amortization...................................... 65,960 699
Amortization of deferred stock-based compensation.................. 3,581 784
In-process research and development................................ 18,190 --
Changes in operating assets and liabilities:
Accounts receivable............................................ (7,543) (2,737)
Prepaid expenses and other assets.............................. (3,571) (698)
Accounts payable............................................... (407) 153
Accrued liabilities............................................ 10,567 2,980
Deferred revenue............................................... 24,181 11,746
------------- -------------
Net cash provided by (used for) operating
activities................................................ 11,431 (1,046)
------------- -------------
Cash flows from investing activities:
Purchases of property and equipment, net................................ (13,050) (1,073)
Businesses acquired, net of cash received............................... (8,908) --
Purchases of short-term investments..................................... (459,384) (30,735)
Proceeds from sales and maturities
Of short-term investments............................................ 119,510 23,921
------------- -------------
Net cash used for investing activities....................... (361,832) (7,887)
------------- -------------
Cash flows from financing activities:
Issuance of common stock................................................ 394,804 83
Net proceeds from sale of convertible preferred stock................... -- 16,700
Repayment of notes receivable from stockholders......................... -- 11
Repayment of equipment loans and capital lease
Obligations.......................................................... (424) (308)
------------- -------------
Net cash provided by financing activities.................... 394,380 16,486
------------- -------------
Net increase in cash and cash equivalents.................................... 43,979 7,553
Cash and cash equivalents at beginning of period............................. 79,803 12,677
------------- -------------
Cash and cash equivalents at end of period................................... $ 123,782 $ 20,230
============= =============
Supplemental disclosures of cash flow information:
Acquisition-related accrued liabilities................................. $ 30,764 $ --
============= =============
Common stock issued to officers and employees for
Notes receivable..................................................... $ -- $ 223
============= =============
Deferred stock-based compensation....................................... $ 9,585 $ 543
============= =============
Common stock issued and options assumed in acquisitions................. $ 974,645 $ --
============= =============
See accompanying notes to the condensed consolidated financial statements.
5
PHONE.COM, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2000
NOTE 1 - Basis of Presentation
The accompanying unaudited condensed consolidated financial statements have
been prepared in accordance with generally accepted accounting principles for
interim financial information, the instructions to Form 10-Q and Article 10 of
Regulation S-X. Accordingly, they do not contain all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, the accompanying unaudited
condensed consolidated financial statements include all adjustments, consisting
only of normal recurring adjustments, necessary for the fair presentation of the
Company's financial position as of March 31, 2000, and the results of its
operations and cash flows for the three and nine month periods ended March 31,
2000 and 1999. These financial statements should be read in conjunction with the
Company's audited financial statements as of June 30, 1999 and 1998 and for each
of the years in the three-year period ended June 30, 1999, including notes
thereto, included in the Company's 1999 Annual Report on Form 10-K. Operating
results for the three and nine month periods ended March 31, 2000, are not
necessarily indicative of the results that may be expected for the year ending
June 30, 2000.
On November 15, 1999, the Company completed a two-for-one stock split of its
common stock for stockholders of record as of October 29, 1999. The accompanying
unaudited condensed consolidated financial statements have been retroactively
restated to give effect to the stock split.
NOTE 2 - Revenue Recognition
Effective July 1, 1998, the Company adopted SOP 97-2, Software Revenue
Recognition, as amended by SOP 98-4 and SOP 98-9. SOP 97-2, as amended,
generally requires revenue earned on software arrangements involving multiple
elements to be allocated to each element based on the relative fair value of the
elements.
The Company licenses its UP.Link Server Suite and related server-based
software products to network operators through its direct sales force and
indirectly through its channel partners. The Company's license agreements do not
provide for a right of return. Allowances for future estimated warranty costs
are provided at the time revenue is recognized. Licenses can be purchased under
a perpetual license model either on an as-deployed basis or on a prepaid basis,
or alternatively under a quarterly time-based license model under which no
perpetual license is acquired. For licenses purchased on an as-deployed basis,
license revenue is generally recognized quarterly as subscribers are activated
to use the services that are based on the Company's UP.Link Server Suite and
related server-based software products. For licenses purchased on a prepaid
basis, prepaid license fees are recognized under either subscription accounting
due to the Company's commitment to provide standards-compliant products for each
license covered by the prepaid arrangement or ratably over the period that
maintenance and support services are expected to be provided. For customers that
license the Company's products under the quarterly time-based license model,
revenues are recognized over the respective quarterly term based on the number
of the customer's subscribers using the services that are based on the Company's
products. Subscriptions are recognized ratably over the contractual term of the
prepaid arrangement (i.e., the date the prepaid licenses expire if not used),
generally 12 to 30 months, commencing at the beginning of the month delivery and
acceptance occur by the network operator. The Company recognizes its other
prepaid licenses, including the related maintenance and support services
provided to network operators, ratably over the lesser of the estimated life of
the software or the contractual term of the arrangement, generally 12 to 30
months, commencing at the beginning of the month delivery and acceptance occur
by the network operator. Revenues from consulting services provided to network
operators are recognized as the services are performed.
The Company recognizes revenues from UP.Browser agreements with wireless
telephone manufacturers ratably over the period during which the services are
performed, generally one year. The Company provides its wireless telephone
manufacturer customers with support associated with their efforts to port its
UP.Browser software to their wireless telephones, software error corrections,
and new releases as they become commercially available.
NOTE 3 - Comprehensive Income
The Company has no material components of other comprehensive income (loss)
for all periods presented.
NOTE 4 - Net Loss Per Share
7
Basic net loss per share is computed using the weighted-average number of
outstanding shares of common stock excluding shares of restricted stock subject
to repurchase summarized below. Diluted net loss per share is computed using the
weighted-average number of shares of common stock outstanding and, when
dilutive, potential shares of restricted common stock subject to repurchase,
common stock from exercise of options and warrants to purchase common stock,
using the treasury stock method, and from convertible securities on an "as if
converted" basis. The following potential shares of common stock have been
excluded from the computation of diluted net loss per share for all periods
presented because the effect would have been antidilutive (in thousands):
Three and Nine Months Ended
March 31,
--------------------------------
2000 1999
--------------- ---------------
Shares issuable under stock options 11,075 6,642
Shares of restricted stock subject
to repurchase.................. 465 1,094
Shares issuable pursuant to
warrants to purchase common stock 18 62
Shares of convertible preferred
stock on an "as if converted"
basis.......................... - 40,348
The weighted-average exercise price of stock options outstanding was $29.77
and $0.94 as of March 31, 2000 and 1999, respectively. The weighted-average
purchase price of restricted stock subject to repurchase was $0.91 and $0.24 as
of March 31, 2000 and 1999, respectively. The weighted-average exercise price of
outstanding warrants was $8.92 and $1.91 as of March 31, 2000 and 1999,
respectively. In June 1999, all outstanding shares of the Company's convertible
preferred stock were automatically converted into common stock upon completion
of the Company's initial public offering.
NOTE 5 - Recent Accounting Pronouncements
In June 1998, the FASB issued Statement of Financial Accounting Standard
(SFAS) No. 133, Accounting for Derivative Instruments and Hedging Activities.
SFAS No. 133, as amended by SFAS No. 137, establishes accounting and reporting
standards for derivative financial instruments and hedging activities related to
those instruments, as well as other hedging activities. Because the Company does
not currently hold any derivative instruments and does not engage in hedging
activities, the Company expects that the adoption of SFAS No. 133, as amended,
will not have a material impact on its consolidated financial position, results
of operations, or cash flows. The Company will be required to adopt SFAS No. 133
in fiscal 2001.
In December 1999, the Securities and Exchange Commission (SEC) issued Staff
Accounting Bulletin No. 101 (SAB 101), Revenue Recognition in Financial
Statements, as amended by SAB 101A which provides guidance on the recognition,
presentation, and disclosure of revenue in financial statements filed with the
SEC. SAB 101 outlines the basic criteria that must be met to recognize revenue
and provides guidance for disclosures related to revenue recognition policies.
The company does not expect the adoption of SAB 101 to have a material effect on
its consolidated financial position or results of operations.
In March 2000, the EITF published their consensus on EITF Issue No. 00-2,
Accounting for Web Site Development Costs, which outlines the accounting
criteria for costs related to the development of web sites. The Company will be
required to adopt EITF Issue No. 00-2 in fiscal quarters beginning after
June 30, 2000. The Company is in the process of assessing any impact that the
adoption of EITF Issue No. 00-2 will have on its consolidated financial position
or results of operations.
In March 2000, the EITF published their consensus on EITF Issue No. 00-3,
Application of AICPA Statement of Position 97-2, Software Revenue Recognition,
to Arrangements That Include the Right to Use Software Stored on Another
Entity's Hardware. EITF Issue No. 00-3 outlines the accounting criteria for
hosting arrangements. The Company does not expect the adoption of EITF Issue No.
00-3 to have material effect on its consolidated financial position or results
of operations.
In March 2000, The FASB issued Interpretation No. 44, Accounting for Certain
Transactions involving Stock Compensation, an interpretation of APB Opinion No.
25. This Interpretation clarifies the application of Opinion 25 for certain
issues: (a) the definition of employee for purposes of applying Opinion 25, (b)
the criteria for determining whether a plan qualifies as a noncompensatory plan,
(c) the accounting consequence of various modifications to the terms of a
previously fixed stock option or award, and (d) the accounting for an exchange
of stock compensation awards in a business combination. Generally, this
Interpretation is effective July 1, 2000. The Company does not expect the
adoption of Interpretation No. 44 to have a material effect on its consolidated
financial position or results of operations.
NOTE 6 - Geographic, Segment, and Significant Customer Information
During 1999, the Company adopted the provisions of SFAS No. 131, Disclosures
about Segments of an Enterprise and Related Information. SFAS No. 131
establishes standards for the reporting by public business enterprises of
information about operating segments, products and services, geographic areas,
and major customers. The method for determining what information to report is
based on the way that management organizes the operating segments within the
Company for making operational decisions and assessments of financial
performance.
The Company's chief operating decision maker is considered to be the
Company's Chief Executive Officer (CEO). The CEO reviews financial information
presented on a consolidated basis accompanied by disaggregated information about
revenues by geographic region and by product for purposes of making operating
decisions and assessing financial performance. Therefore, the Company operates
in a single operating segment: software that enables the delivery of
Internet-based services to mass-market wireless telephones and related
8
services. The disaggregated information reviewed on a product basis by the CEO
is as follows (in thousands):
Three Months Ended Nine Months Ended
March 31, March 31,
-------------------------------- -------------------------------
2000 1999 2000 1999
--------------- --------------- -------------- --------------
Revenue:
UP.Link Server Suite and
related server-based
products..................... $ 12,439 $ 1,424 $ 26,360 $ 2,382
UP.Browser.................... 3,346 1,294 7,852 2,934
Consulting services........... 2,876 814 5,778 1,401
--------------- --------------- -------------- --------------
Total revenues............ $ 18,661 $ 3,532 $ 39,990 $ 6,717
=============== =============== ============== ==============
The Company markets its products primarily from its operations in the United
States. International sales are primarily to customers in Asia Pacific and
Europe. Information regarding the Company's revenues in different geographic
regions is as follows (in thousands):
Three Months Ended Nine Months Ended
March 31, March 31,
-------------------------------- -------------------------------
2000 1999 2000 1999
--------------- --------------- -------------- --------------
Revenue:
North America................. $ 5,190 $ 1,355 $ 11,904 $ 2,425
Europe........................ 4,253 1,069 8,777 2,221
Asia Pacific.................. 9,218 1,108 19,309 2,071
--------------- --------------- -------------- --------------
Total revenues............ $ 18,661 $ 3,532 $ 39,990 $ 6,717
=============== =============== ============== ==============
Significant customer information is as follows:
% of Total Revenue % of Total
-------------------------------------------------------- Accounts
Three Months Ended Nine Months Ended Receivable
March 31, March 31, -------------------
--------------------------- -------------------------- March 31,
2000 1999 2000 1999 2000
------------ ------------ ------------ ----------- -------------------
Customer A 2% 22% 7% 14% 2%
Customer B 24% 1% 25% 1% 3%
Customer C 1% 10% 1% 13% -
Customer D - 15% 4% 11% -
Note 7 - Acquisitions
On October 26, 1999, the Company acquired all of the outstanding capital
stock of APiON Telecom Limited ("APiON") in exchange for 2,393,026 shares of its
common stock. In addition, the Company also agreed to issue cash and common
stock with an aggregate value of up to approximately $14,100,000 to current and
former employees of APiON. APiON is a provider of WAP software products to GSM
network operators in Europe and has expertise in GSM Intelligent Networks,
wireless data and WAP technology. Former employees of APiON will receive
consideration totaling up to approximately $6.5 million of which one third was
paid in cash (approximately $2.2 million) upon the closing of the Company's
secondary offering
9
in November 1999 and two thirds is payable in common stock of the Company on the
one year anniversary of the closing of the acquisition of APiON and is subject
to forfeiture upon the occurrence of certain events. Current employees of APiON
will receive consideration totaling up to approximately $7.6 million of which
one third was paid in cash upon the closing of the Company's secondary offering
and one third is payable in common stock of the Company on each of the first two
anniversaries of the closing of the acquisition of APiON contingent upon
continued employment. The actual number of Phone.com shares to be issued to
current and former employees of APiON will depend upon the fair value of
Phone.com common stock on the distribution date.
Common stock issued to former shareholders and cash paid to current and
former employees of APiON at the closing of the acquisition was included in the
purchase price. Contingent common stock issuable in the future to former
employees of APiON has been treated as contingent consideration. The then fair
value of the common stock that is issued to the former employees of APiON upon
the satisfaction of certain future events will be added to goodwill and
amortized over the remaining useful life. Common stock issuable in the future to
current employees of APiON has been recorded as deferred stock-based
compensation.
Total consideration given, including direct acquisition costs, aggregated
approximately $245.9 million. The acquisition was accounted for as a purchase
with the results of APiON included from the acquisition date. The excess of the
purchase price over the fair value of tangible net assets acquired amounted to
approximately $243.6 million, with $241.6 million attributable to goodwill, $1.7
million attributable to assembled workforce, $170,000 attributable to developed
technology and $110,000 attributable to in-process research and development. The
in-process research and development has been expensed on the acquisition date,
and the intangible assets are being amortized on a straight-line basis over an
estimated life of 3 years. In connection with the acquisition, the Company
recorded deferred stock-based compensation in the amount of $5.1 million, which
is being amortized on an accelerated basis over the vesting period of 24 months,
consistent with the method described in FASB Interpretation No. 28.
On October 27, 1999, the Company acquired substantially all of the assets of
Angelica Wireless ApS ("Angelica"), including all software technology,
intellectual property and certain customer agreements, and excluding the
assumption of liabilities. Angelica is a developer of WAP software products
complementary to the Company's MyPhone mobile internet portal software, targeted
for customers in Europe. Total consideration paid, including direct acquisition
costs, aggregated $2.0 million. In addition, the Company also agreed to issue
16,000 shares of common stock with an aggregate value of approximately $1.7
million to employees of Angelica, subject to certain forfeiture conditions
dependent on continued employment. The acquisition was accounted for as a
purchase with the results of Angelica included from the acquisition date. The
excess of the purchase price over the fair value of tangible net assets acquired
in the amount of $2.0 million has been attributed to goodwill and is being
amortized on a straight-line basis over an estimated life of 3 years. In
connection with the acquisition, the Company recorded deferred stock-based
compensation in the amount of $1.7 million, which is being amortized on an
accelerated basis over the vesting period of 36 months, consistent with the
method described in FASB Interpretation No. 28.
On February 8, 2000, the Company acquired all of the outstanding common and
redeemable convertible preferred stock of AtMotion, Inc. ("AtMotion"), in
exchange for 2,280,287 shares of its common stock. The Company also assumed all
of the outstanding options and warrants of AtMotion. At the time of the
acquisition, 12.1% of the shares issued by the Company were placed in escrow.
Most of the escrow shares will remain in escrow for a period of at least one
year from the date of the acquisition and will be released upon the occurrence
of certain events. AtMotion is a provider of Voice Portal technology. Total
consideration given aggregated approximately $287.2 million. The acquisition was
accounted for as a purchase with the results of AtMotion included from the
acquisition date. The excess of the purchase price over the fair value of
tangible net assets acquired amounted to approximately the entire purchase price
of $286.6 million, with $243.4 million attributable to goodwill, $42.5 million
attributable to developed technology and $655,000 attributable to assembled
workforce. The intangible assets are being amortized on a straight-line basis
over an estimated life of 3 years.
On March 4, 2000, the Company acquired all of the outstanding common and
preferred stock of Paragon Software (Holdings) Limited, a private limited
company incorporated in England and Wales, in exchange for 3,015,015 shares of
Phone.com common stock and assumed all of the outstanding options of Paragon for
up to 397,672 shares of Phone.com common stock. Paragon is a provider of
synchronization technology allowing PC-based personal information to be
10
easily transferred to mobile devices. Total consideration given aggregated
approximately $453.7 million in Company common stock as well as a cash payment
at closing of $3.6 million. An additional $17 million will be paid within one
year, payable in approximately 142,950 common shares of the Phone.com common
stock at the election of the shareholder or in cash with the consent of
Phone.com as well as additional cash payments of $3.9 million to be allocated
among certain employees of Paragon. There were also transaction costs in
connection with the purchase of approximately $11.6 million. The acquisition
was accounted for as a purchase with the results of Paragon included from the
acquisition date. The excess of the purchase price over the fair value of
tangible net assets acquired amounted to $483.0 million, with $454.5 million
attributable to goodwill, $18.1 million attributable to in-process research
and development, $7.2 million attributable to developed technology, $2.3
million attributable to non-compete agreements and $980,000 attributable to
assembled workforce. The in-process research and development has been expensed
on the acquisition date, and the intangible assets are being amortized on a
straight-line basis over and estimated life of 3 years.
The following summary, prepared on an unaudited pro forma basis, reflects the
condensed consolidated results of operations for the three and nine month
periods ended March 31, 2000 and 1999 assuming APiON, Angelica, AtMotion and
Paragon had been acquired on July 1, 1998 (in thousands, except per share data):
Three Months Ended Nine Months Ended
March 31, March 31,
-------------------------------- -------------------------------
2000 1999 2000 1999
--------------- --------------- -------------- --------------
Revenues............................ $19,032 $4,396 $42,444 $8,127
Net loss............................ ($91,871) ($93,487) ($281,158) ($275,540)
Basic and diluted net loss per share ($1.24) ($4.89) ($3.92) ($14.55)
Shares used in pro forma per share
computation...................... 74,258 19,102 71,707 18,940
On February 14, 2000, the Company signed a definitive agreement to acquire
Onebox.com, Inc. ("Onebox"), a communications application service provider. In
connection with the acquisition, which was completed on April 14, 2000, the
Company agreed to a valuation for Onebox of approximately $800 million, to be
associated with the issuance of approximately 6.5 million shares of the
Company's common stock in exchange for all of the outstanding common stock and
preferred stock of Onebox, and the assumption of options and warrants. The
Company expects to incur approximately $20 million for transaction costs
relating to the acquisition. The stock-for-stock transaction will be accounted
for using purchase accounting.
Note 8 - Subsequent Events
On May 3, 2000, the Company's Board of Directors approved the 2000 Non-
Executive Stock Option Plan (the "Plan") reserving up to 2,000,000 shares of
the Company's common stock for issuance upon the exercise of nonstatutory
stock options at a price no less than 85% of the fair market value of the
Company's common stock on the date of the grant.
In April 2000, the Company filed a lawsuit against Geoworks Corporation in
the U.S. District Court in San Francisco, California, alleging, and seeking a
court order declaring, that U.S. Patent No. 5,327,529, assigned to Geoworks is
not infringed by the Company and that the patent is also invalid and
unenforceable. The Company took this action in response to Geoworks' attempt to
require industry participants to obtain licenses under the Geoworks patent. We
cannot assure you that Geoworks will not bring an action against us claiming
infringement by us of the Geoworks patent. While we intend to pursue our
position vigorously, the outcome of any litigation is uncertain, and we may not
prevail. Should we be found to infringe the Geoworks patent, we may be liable
for potential monetary damages, and could be required to obtain a license from
Geoworks. If we were unable to obtain a license on commercially reasonable
terms, we may not be able to proceed with development and sale of some of our
products.
11
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
This Management's Discussion and Analysis of Financial Condition and Results
of Operations and other parts of this Form 10-Q contain forward-looking
statements that involve risks and uncertainties. Words such as "anticipates,"
"expects," "intends," "plans," "believes," "seeks," "estimates," and similar
expressions identify such forward-looking statements. These statements are not
guarantees of future performance and are subject to certain risks and
uncertainties that could cause actual results to differ materially from those
expressed or forecasted. Factors that might cause such a difference include, but
are not limited to, those discussed in the section entitled "Factors That May
Affect Future Results" and those appearing elsewhere in this Form 10-Q. Readers
are cautioned not to place undue reliance on these forward-looking statements,
which reflect management's analysis only as of the date hereof. The Company
assumes no obligation to update these forward-looking statements to reflect
actual results or changes in factors or assumptions affecting such
forward-looking statements.
Overview
We were incorporated in December 1994 and, from inception until June 1996,
our operations consisted primarily of various start-up activities, including
development of technologies central to our business, recruiting personnel and
raising capital. In 1995, we developed our initial technology, which enables the
delivery of Internet-based services to wireless telephones. In 1996, we
introduced and deployed our first products based on this technology. We first
recognized license revenues in August 1996, and generated license revenues of
approximately $80,000, $522,000 and $5.2 million for the fiscal years ended June
30, 1997, 1998 and 1999, respectively, and $24.8 million for the nine months
ended March 31, 2000. We incurred net losses of approximately $99.5 million for
the nine months ended March 31, 2000 and $8.0 million, $10.6 million and $20.8
million for the fiscal years ended June 30, 1997, 1998 and 1999, respectively.
As of March 31, 2000, we had an accumulated deficit of approximately $141.5
million.
To provide a worldwide standard for the delivery of Internet-based services
over mass-market wireless telephones, we formed the WAP Forum in close
cooperation with Ericsson, Motorola and Nokia, the world's three largest
manufacturers of wireless telephones. In February 1998, the WAP Forum published
technical specifications for application development and product
interoperability based substantially on Phone.com's technology and on Internet
standards. Leading network operators, telecommunications device and equipment
manufacturers and software companies worldwide have sanctioned the
specifications promulgated by the WAP Forum.
We generate revenues from licenses, maintenance and support services and
consulting services. We receive license revenues primarily from licensing our
UP.Link Server Suite and related server-based software products directly to
network operators and indirectly through value-added resellers. Maintenance and
support services revenues also include engineering and support services provided
to wireless telephone manufacturers. Consulting services revenues are derived
from consulting services provided to network operator customers either directly
by us or indirectly through resellers.
In September 1999, we introduced MyPhone, our mobile Internet portal
platform. We continue to expect to incur significant additional expenses in
developing and commercializing our MyPhone wireless Internet portal framework
software and our related communications applications as well as sales and
marketing and research and development expenses. We expect to incur these costs
and expenses in advance of generating revenues from this service and cannot be
certain that our business model for the MyPhone service will result in
sufficient revenues to achieve profitability.
In October 1999, we completed the acquisition of the outstanding share
capital of APiON Telecoms Ltd. ("APiON"), a company based in Belfast, Northern
Ireland. APiON is a provider of WAP software products to GSM network operators
in Europe and has expertise in GSM Intelligent Networks, wireless data and WAP
technology. In connection with this transaction, we acquired all of the
outstanding shares of capital stock of APiON in exchange for an aggregate of
approximately 2,393,026 shares of our common stock. A portion of these shares
are held in escrow for a period of one year to indemnify us against potential
liabilities of APiON and its former shareholders.
12
In addition, we also agreed to issue cash and common stock to current and
former employees of APiON. Current employees of APiON received cash in the
aggregate amount of approximately $2.5 million, less applicable withholdings for
taxes and insurance, upon the closing of the Company's secondary offering in
November 1999, and will receive shares of common stock equal in value to
approximately $2.5 million, less applicable withholdings for taxes and
insurance, on each of the first two anniversaries of the closing of the APiON
acquisition, subject to their continued employment. Former employees of APiON
who were engaged in APiON's services business, which we did not acquire in the
transaction, received cash in the aggregate amount of approximately $2.2
million, less applicable withholdings for taxes and insurance, upon the closing
of the Company's secondary offering in November 1999, and will receive shares of
common stock equal in value to approximately $4.3 million, less applicable
withholdings for taxes and insurance, on the anniversary of the closing of the
APiON acquisition, subject to forfeiture upon the occurrence of certain events.
In connection with the APiON acquisition, we recorded goodwill and other
intangible assets of approximately $243.6 million and deferred stock-based
compensation of approximately $5.1 million, to be amortized over a three-year
period and a two-year period, respectively, which will significantly increase
our net loss for the foreseeable future. We also recorded expense of $110,000
relating to in-process research and development in connection with the
acquisition. In addition, we expect that operating expenses will increase as a
result of the acquisition, due primarily to the additional personnel and the
costs of operating a European subsidiary. For example, as a result of the
addition of APiON's technical, sales and customer engineering personnel, we
expect that research and development expenses and sales and marketing expenses
may increase by as much as $5 million in the aggregate for the fiscal year ended
June 30, 2000.
In October 1999 we also acquired substantially all of the assets of Angelica
Wireless ApS ("Angelica"), including all software technology, intellectual
property and certain customer agreements, and excluding the assumption of
liabilities. Angelica is a developer of WAP software products targeted for
customers in Europe which are complementary to our MyPhone mobile internet
portal software. Total consideration paid, including direct acquisition costs,
aggregated $2.0 million. In addition, we also agreed to issue 16,000 shares of
common stock with an aggregate value of approximately $1.7 million to employees
of Angelica, subject to certain forfeiture conditions dependent on continued
employment. The acquisition was accounted for as a purchase with the results of
Angelica included from the acquisition date. The excess of the purchase price
over the fair value of tangible net assets acquired in the amount of $2.0
million has been attributed to goodwill and is being amortized on a
straight-line basis over 3 years. In connection with the acquisition, the
Company recorded deferred stock-based compensation in the amount of $1.7
million, which is being amortized on an accelerated basis over the vesting
period of 36 months, consistent with the method described in FASB Interpretation
No. 28.
On February 8, 2000, we acquired AtMotion Inc. ("AtMotion"), an emerging
provider of Voice Portal technology. Our intention is to integrate AtMotion's
technology to voice-enable both our MyPhone mobile portal and our UP.Link
Server Suite. In connection with the acquisition, we acquired all of the
outstanding common and redeemable convertible preferred stock of AtMotion in
exchange for 2,280,287 common shares. We also assumed all of the outstanding
options and warrants of AtMotion. Total consideration given aggregated
approximately $287.2 million. The stock-for-stock transaction was accounted
for using purchase accounting. The excess of the purchase price over the fair
value of tangible net assets acquired amounted to approximately $286.6
million, with $243.4 million attributable to goodwill, $42.5 million
attributable to developed technology and $655,000 attributable to assembled
workforce. The intangible assets are being amortized on a straight-line basis
over an estimated useful life of 3 years. Amortization of goodwill and other
intangible assets is expected to significantly increase our net loss for the
foreseeable future. We expect to incur significant additional expenses in
developing, integrating and commercializing the acquired technology, as well
as sales and marketing and research and development expenses. We expect to
incur these costs and expenses in advance of generating revenues and cannot be
certain that our business model for the incorporation of the AtMotion
technology will result in significant revenues or profitability.
On March 4, 2000, we acquired Paragon Software Ltd ("Paragon"), a leading
provider of synchronization technology allowing PC-based personal information
to be easily transferred to mobile devices. We plan to extend the Paragon
technology to WAP-based over-the-air synchronization to meet phone users needs
for simpler synchronization of information between the mobile phone, PC
applications, and Internet information services, whether or not the phone
users are on-line.
In connection with the acquisition, we acquired all of the outstanding
common and preferred stock of Paragon in exchange for 3,015,015 shares of
Phone.com common stock and assumed all of the outstanding options of Paragon
for up to 397,672 shares of Phone.com common stock. Total consideration given
aggregated approximately $453.7 million in Company common stock as well as a
cash payment of $3.6 million. An additional $17 million will be paid within
one year, payable in approximately 142,950 common shares of the Phone.com
common stock at the election of the shareholder or in cash with the consent of
Phone.com as well as additional cash payments of $3.9 million to be allocated
among certain employees of Paragon. There were also transaction costs in
connection with the purchase of approximately $11.6 million. The acquisition
was accounted for as a purchase with the results of Paragon included from the
acquisition date. The excess of the purchase price over the fair value of
tangible net assets acquired amounted to $483.0 million, with $454.5 million
attributable to goodwill, $18.1 million attributable to in-process research
and development, $7.2 million attributable to developed technology, $2.3
million attributable to non-compete agreements and $980,000 attributable to
assembled workforce. The in-process research and development has been expensed
on the acquisition date since the in-process technology has not yet reached
technological feasibility and had no alternative future uses. The goodwill and
the intangible assets are being amortized on a straight-line basis over an
estimated life of 3 years. Amortization of goodwill and other intangible
assets is expected to significantly increase our net loss for the foreseeable
future. We expect to incur significant additional expenses in developing,
integrating and commercializing the acquired technology, as well as sales and
marketing and research and development expenses. We expect to incur these
costs and expenses in advance of generating revenues and cannot be certain
that our business model from the incorporation of the Paragon technology will
result in significant revenues or profitability.
The in-process research and development expensed in our acquisition of
Paragon represented the estimated fair value based on risk-adjusted cash flows
related to the incomplete research and development project. At the time of the
acquisition, the project was considered to be 40% complete. The estimated fair
value of the in-process research and development was arrived at by an
independent valuation which forecasted total in-process project revenues
expected from sales of the first generation of the in-process product and
removed 9% of those revenues to account for core technology to be leveraged by
the in-process product to arrive at net total in-process project revenues. Net
total in-process project revenues were then reduced by 60% for the incomplete
portion of the product to arrive at net in-process revenues. Net in-process
revenues were then adjusted by deducting operating expenses, cash flow
adjustments and other items to arrive at forecasted net returns based on the
completed portion of the in-process technology. The net returns thus arrived at
were then discounted to a present value at a discount rate of 25%. We expect to
complete development of this project during fiscal 2001, at a total cost to
complete of approximately $395,000. Though the Company currently expects that
the acquired in-process technology will be successfully developed, there can be
no assurance that commercial or technical viability of this product will be
achieved. Furthermore, future industry developments, changes in other product
offerings or other developments may cause the Company to alter or abandon these
plans.
On February 14, 2000, we entered into a definitive agreement to acquire
Onebox.com, Inc. ("Onebox"), a communications application service provider
offering users unified email, voicemail, fax, and wireless-enabled communication
applications. In connection with the acquisition, which was completed April 14,
2000, we agreed to the issuance of up to approximately 6.5 million shares of
the Company's common stock associated with a value of approximately $800 million
in exchange for all of the outstanding common stock and preferred stock of
Onebox, and the assumption of options and warrants. We expect to incur
approximately $20 million for transaction costs relating to the acquisition.
The stock-for-stock transaction will be accounted for using purchase accounting
and is subject to customary closing conditions. Amortization of goodwill and
other intangible assets is expected to significantly increase our net loss for
the forseeable future. We expect to incur significant additional expenses in
developing, integrating and commercializing the acquired technology, as well as
sales and marketing and research and development expenses. We expect to incur
these costs and expenses in advance of generating revenues and cannot be certain
that our business model for the incorporation of the Onebox technology will
result in significant revenues or profitability.
13
Our future success depends on our ability to increase revenues from sales of
products and services to new and existing network operator customers. If the
market for Internet-based services via wireless telephones develops more slowly
than expected, then our business would be materially and adversely affected. In
addition, because there is a relatively small number of network operators
worldwide, any failure to sell our products to network operator customers
successfully could result in a shortfall in revenues that could not be readily
offset by other revenue sources.
Our business strategy also relies to a significant extent on the widespread
propagation of UP.Browser-enabled telephones through our relationships with
network operators and wireless telephone manufacturers. In order to encourage
adoption of UP.Browser-enabled wireless telephones, we license our UP.Browser
software to wireless telephone manufacturers free of per-unit royalties and
other license fees and provide maintenance and support services for an annual
flat fee.
Effective July, 1 1998, the Company adopted SOP 97-2, Software Revenue
Recognition, as amended by SOP 98-4 and SOP 98-9. SOP 97-2, as amended,
generally requires revenue earned on software arrangements involving multiple
elements to be allocated to each element based on the relative fair value of the
elements.
The Company licenses its UP.Link Server Suite and related server-based
software products to network operators through its direct sales force and
indirectly through its channel partners. The Company's license agreements do not
provide for a right of return. Allowances for future estimated warranty costs
are provided at the time revenue is recognized. Licenses can be purchased under
a perpetual license model either on an as-deployed basis or on a prepaid basis,
or alternatively under a quarterly time-based license model under which no
perpetual license is acquired. For licenses purchased on an as-deployed basis,
license revenue is generally recognized quarterly as subscribers are activated
to use the services that are based on the Company's UP.Link Server Suite and
related server-based software products. For license purchased on a prepaid
basis, prepaid license fees are recognized under either subscription accounting
due to the Company's commitment to provide standards-compliant products for each
license covered by the prepaid arrangement or ratably over the period that
maintenance and support services are expected to be provided. For customers that
license the Company's products under the quarterly time-based license model,
revenues are recognized over the respective quarterly term based on the number
of the customer's subscribers using the services that are based on the Company's
products. Subscriptions are recognized ratably over the contractual term of the
prepaid arrangement ( i.e. the date the prepaid license expire if not used),
generally 12 to 30 months, commencing at the beginning of the month delivery and
acceptance occur by the network operator. The Company recognizes its other
prepaid licenses, including the related maintenance and support services
provided to network operators, ratably over the lesser of the estimated life of
the software or the contractual term of the arrangement, generally 12 to 30
months, commencing at the beginning of the month delivery and acceptance occur
by the network operator. Revenues from consulting services provided to network
operators are recognized as the services are performed.
The Company recognizes revenues from UP.Browser agreements with wireless
telephone manufacturing ratably over the period during which the services are
performed, generally one year. The Company provides its wireless telephone
manufacturer customers with support associated with their efforts to port its UP
Browser software to their wireless telephones, software error corrections, and
new releases as they become commercially available.
Deferred revenue was $63.0 million as of March 31, 2000, comprised of $57.1
million in prepaid fees charged to wireless network operators and $5.9 million
in prepaid maintenance and other service fees charged to wireless telephone
manufacturers. Although deferred revenues increased from $46.6 million as of
December 31, 1999, we expect that deferred revenue will decline in the long term
as network operators deploy services based on our products. Deferred revenues
relating to prepayments by wireless network operators as of March 31, 2000 in
the amount of approximately $39 million will be recognized over the next
fifteen months. The remainder of deferred revenues relating to wireless network
operators will generally be recognized over the next twelve to thirty months.
14
We expect that our gross profit on revenues derived from sales through
indirect channel partners will be less than the gross profit on revenues from
direct sales. Our success, in particular in international markets, depends in
part on our ability to increase sales of our products and services through
value-added resellers and to expand our indirect distribution channels. In
addition, our agreements with our distribution partners generally do not
restrict the sale of products that are competitive with our products and
services, and each of our partners can cease marketing our products and services
at their option.
International sales of products and services accounted for 72% and 62% of our
total revenues for the quarters ended March 31, 2000 and 1999, respectively. We
expect international sales to continue to account for a significant portion of
our revenues, although the percentage of our total revenues derived from
international sales may vary. Risks inherent in our international business
activities include:
. failure by us and/or third parties to develop localized content and
applications that are used with our products;
. costs of localizing our products for foreign markets;
. difficulties in staffing and managing foreign operations;
. longer accounts receivable collection time;
. political and economic instability;
. fluctuations in foreign currency exchange rates;
. reduced protection of intellectual property rights in some foreign
countries;
. contractual provisions governed by foreign laws;
. export restrictions on encryption and other technologies;
. potentially adverse tax consequences; and
. the burden of complying with complex and changing regulatory requirements.
Since early 1997, we have invested substantially in research and development,
marketing, domestic and international sales channels, professional services and
our general and administrative infrastructure. These investments have
significantly increased our operating expenses, contributing to net losses in
each fiscal quarter since our inception. Our limited operating history makes it
difficult to forecast future operating results. Although our revenues have grown
in recent quarters, our revenues may not increase at a rate sufficient to
achieve and maintain profitability, if at all. We anticipate that our operating
expenses will increase substantially in absolute dollars for the foreseeable
future as we expand our product development, sales and marketing, professional
services and administrative staff. Even if we were to achieve profitability in
any period, we may not sustain or increase profitability on a quarterly or
annual basis.
RESULTS OF OPERATIONS
License Revenues
License revenues increased from $1.3 million for the three months ended March
31, 1999 to $11.8 million for the three months ended March 31, 2000, and
increased from $1.5 million for the nine months ended March 31, 1999 to $24.8
million for the nine months ended March 31, 2000. The increase in license
revenues was primarily due to the recognition of revenues associated with the
licensing of our products to AT&T Wireless Services and Sprint in the United
States, DDI and IDO in Japan, Shinsegi Telecom in Korea, Cegetel/SFR in France
and other recently licensed network operators in Europe, Korea and Hong Kong.
Maintenance and Support Services Revenues
Maintenance and support services revenues increased from $1.5 million for the
three months ended March 31, 1999 to $3.9 million for the three months ended
March 31, 2000, and increased from $3.8 million for the nine months ended March
31, 1999 to $9.4 million for the nine months ended March 31, 2000. The increase
in maintenance and support services revenues was attributable primarily to
increased demand for maintenance and engineering support services by an
increased number of wireless telephone manufacturers, and to a lesser extent
from increased maintenance and support services provided to wireless network
operators.
Consulting Services Revenues
15
Consulting services revenues increased from $814,000 for the three months
ended March 31, 1999 to $2.9 million for the three months ended March 31, 2000,
and increased from $1.4 million for the nine months ended March 31, 1999 to $5.8
million for the nine months ended March 31, 2000. The increase in consulting
services revenues was primarily due to the increased number of wireless network
operators who have licensed our technology and engaged us to perform integration
services relating to their commercial launches of our technology.
Cost of License Revenues
Cost of license revenues consists primarily of third-party license and
support fees. Cost of license revenues increased from $84,000 for the three
months ended March 31, 1999 to $567,000 for the three months ended March 31,
2000, and increased from $172,000 for the nine months ended March 31, 1999 to
$1.1 million for the nine months ended March 31, 2000. The growth in cost of
license revenues was attributable primarily to the increase in license revenues.
As a percentage of license revenues, cost of license revenues for the three
months ended March 31, 1999 and 2000 was 7% and 5%, respectively. Cost of
license revenues as a percentage of license revenues for the nine months ended
March 31, 1999 and 2000 was 11% and 4%, respectively. The decrease as a
percentage of license revenues was attributable primarily to higher license
revenues for the three and nine months ended March 31, 2000 and to the
amortization of fixed maintenance fees relating to third party software
licenses. We expect that cost of license revenues will increase as a percentage
of license revenues stemming from the acquisition of Onebox and the inclusion of
its costs associated with the operation of its data center in cost of license
revenues.
Cost of Maintenance and Support Services Revenues
Cost of maintenance and support services revenues consists of compensation
and related overhead costs for personnel engaged in the delivery of
installation, training and support services to network operators, and
engineering and support services to wireless telephone manufacturers. The
engineering and support services performed for wireless telephone manufacturers
includes assistance relating to integrating our UP.Browser software into the
manufacturers' wireless telephones. Cost of maintenance and support services
revenues increased from $767,000 for the three months ended March 31, 1999 to
$2.6 million for the three months ended March 31, 2000, and from $1.9 million
for the nine months ended March 31, 1999 to $6.9 million for the nine months
ended March 31, 2000. As a percentage of maintenance and support service
revenues, cost of maintenance and support services revenues for the three months
ended March 31, 1999 and 2000 was 53% and 66%, respectively. Cost of maintenance
and support services revenues as a percentage of the related revenues for the
nine months ended March 31, 1999 and 2000 was 50% and 73%, respectively. The
margin decreases associated with the growth in cost of maintenance and support
services revenues were attributable primarily to an increase in personnel
dedicated to support a larger number of wireless telephone manufacturer
customers and to increased staffing in anticipation of growth in the number of
network operator customers. We anticipate that the cost of maintenance and
support services revenues will increase in absolute dollars in future operating
periods.
Cost of Consulting Services Revenues
Cost of consulting services revenues consists of compensation and independent
consultant costs for personnel engaged in our consulting services operations and
related overhead. Cost of consulting services revenues increased from $511,000
for the three months ended March 31, 1999 to $1.7 million for the three months
ended March 31, 2000, and increased from $646,000 for the nine months ended
March 31, 1999 to $3.4 million for the nine months ended March 31, 2000. As a
percentage of consulting services revenues, cost of consulting services revenues
for the three months ended March 31, 1999 and 2000 was 63% and 58%,
respectively. Cost of consulting services revenues as a percentage of the
related revenues for the nine months ended March 31, 1999 and 2000 was 46% and
59%, respectively. For the comparative three-months periods, the increase in
margins reflects a higher mix of consulting services performed on a time and
materials basis, while the decrease in margins for the comparative nine-month
periods reflects a higher mix of consulting services under fixed contractual
arrangements. Gross profit on consulting services revenues is impacted by the
mix of company personnel and independent consultants assigned to projects. The
gross profit we achieve is also impacted by the contractual terms of the
consulting assignments we undertake, and the gross profit on fixed price
contracts typically is more susceptible to fluctuation than contracts
performed on a time-and-materials basis. We anticipate that the cost of
consulting services revenues will
16
increase in absolute dollars as we continue to invest in the growth of our
consulting services operations.
Research and Development Expenses
Research and development expenses consist primarily of compensation and
related costs for research and development personnel. Research and development
expenses increased 227% from $3.5 million, or 98% of revenues, for the three
months ended March 31, 1999, to $11.4 million, or 61% of revenues, for the three
months ended March 31, 2000. Research and development expenses increased 198%
from $8.4 million, or 125% of revenues, for the nine months ended March 31,
1999, to $25.1 million, or 63% of revenues, for the nine months ended March 31,
2000. These increases were attributable primarily to the addition of personnel
in our research and development organization associated with product
development. We expect to continue to make substantial investments in research
and development and anticipate that research expenses will continue to increase
in absolute dollars. In particular, we anticipate that research and development
expenses will increase significantly due to product development efforts for the
MyPhone service and the addition of research and development personnel in
connection with the acquisitions of APiON, AtMotion, Paragon and Onebox.
Sales and Marketing Expenses
Sales and marketing expenses consist primarily of compensation and related
costs for sales and marketing personnel, sales commissions, marketing programs,
public relations, promotional materials, travel expenses and trade show exhibit
expenses. Sales and marketing expenses increased 334% from $2.6 million, or 74%
of revenues, for the three months ended March 31, 1999, to $11.4 million, or 61%
of revenues, for the three months ended March 31, 2000. Sales and marketing
expenses increased 238% from $6.5 million, or 97% of revenues, for the nine
months ended March 31, 1999, to $22.0 million, or 55% of revenues, for the nine
months ended March 31, 2000. These increases resulted from the addition of
personnel in our sales and marketing organizations, reflecting our increased
selling effort to develop market awareness of our products and services. We
anticipate that sales and marketing expenses will increase in absolute dollars
as we increase our investment in these areas. In addition, we expect that sales
and marketing expenses will increase as a result of the addition of sales and
marketing personnel in connection with the acquisitions of APiON, AtMotion,
Paragon and Onebox.
General and Administrative Expenses
General and administrative expenses consist primarily of salaries and related
expenses, accounting, legal and administrative expenses, professional service
fees and other general corporate expenses. General and administrative expenses
increased 211% from $1.1 million, or 31% of revenues, for the three months ended
March 31, 1999, to $3.4 million, or 18% of revenues, for the three months ended
March 31, 2000. General and administrative expenses increased 197% from $2.7
million, or 41% of revenues, for the nine months ended March 31, 1999, to $8.1
million, or 20% of revenues, for the nine months ended March 31, 2000. These
increases were due primarily to the addition of personnel performing general and
administrative functions, additional expenses in connection with our operation
as a public company and, to a lesser extent, legal expenses associated with
increased product licensing and patent activity. We expect general and
administrative expenses to increase in absolute dollars as we add personnel and
incur additional expenses related to the anticipated growth of our business, the
management of our international operations and our operation as a public
company.
Stock-Based Compensation
Stock-based compensation expense totaled $280,000 and $1.9 million for the
three months ended March 31, 1999 and 2000, respectively, and totaled $784,000
and $3.6 million for the nine months ended March 31, 1999 and 2000,
respectively. Some stock options granted and restricted stock sold during the
fiscal years ended June 30, 1998 and June 30, 1999 have been deemed to be
compensatory. Total deferred stock-based compensation associated with these
equity arrangements amounted to $2.4 million related to stock options granted
and restricted stock issued from October 1997 through March 2000. These amounts
are being amortized over the respective vesting periods of these equity
arrangements in a manner consistent with Financial Accounting Standards Board
Interpretation No. 28. The amortization of deferred stock-based compensation for
these equity arrangements was $280,000 and $138,000 for the three months ended
March 31, 1999 and 2000, respectively, and
17
$784,000 and $562,000 for the nine months ended March 31, 1999 and 2000,
respectively. We expect amortization in the remainder of fiscal 2000 of
approximately $0.1 million and $0.4 million, $0.2 million and $0.1 million in
the fiscal years ending June 30, 2001, 2002 and 2003, respectively, relating to
the amortization of the deferred stock-based compensation associated with stock
options granted and restricted stock issued from October 1997 through March
2000. In connection with our acquisition of APiON in October 1999, we recorded
additional deferred stock-based compensation of approximately $5.1 million,
which is being amortized over two years in a manner consistent with Financial
Accounting Standards Board Interpretation No. 28. For the three and nine months
ended March 31, 2000, we recognized stock-based compensation expense related to
APiON in the amount of $955,000 and $1.6 million, respectively, and we expect
amortization in the remainder of fiscal 2000 of approximately $1.0 million,
and $2.1 million and $0.4 million in the fiscal years ending June 30, 2001 and
2002, respectively. In connection with our acquisition of Angelica in October
1999, we recorded additional deferred stock-based compensation of
approximately $1.7 million, which is being amortized over three years in a
manner consistent with Financial Accounting Standards Board Interpretation No.
28. For the three months and nine months ended March 31, 2000, we recognized
stock-based compensation expense related to Angelica in the amount of $307,000
and $511,000, respectively, and we expect amortization in the remainder of
fiscal 2000 of approximately $0.3 million, and $0.7 million and $0.2 million
in the fiscal years ending June 30, 2001 and 2002, respectively. In November
1999 a stock option award was made to a new employee at a price discounted
from the then-current fair market value of our stock, giving rise to deferred
stock-based compensation in the amount of $2.8 million, which is being
amortized over four years in a manner consistent with Financial Accounting
Standards Board Interpretation No. 28. For the three and nine months ended
March 31, 2000 we recognized stock-based compensation expense related to this
award in the amount of $457,000 and $912,000, respectively, and we expect
amortization in the remainder of fiscal 2000 of approximately $0.3 million,
and $0.9 million, $0.4 million and $0.2 million in the fiscal years ending
June 30, 2001, 2002 and 2003, respectively.
Amortization of Goodwill and Intangible Assets and In-Process Research and
Development
Amortization of goodwill and intangible assets relating to our October 1999
acquisitions of APiON and Angelica and our acquisitions of AtMotion in February
2000 and Paragon in March 2000 aggregated $49.3 million for the three-month
period ended March 31, 2000 and $62.9 million for the nine-month period ended
March 31, 2000. In connection with the APiON acquisition, we recorded goodwill
and other intangible assets of approximately $243.6 million which is being
amortized on a straight-line basis over a three-year period. We also recorded an
immediate expense of $110,000 relating to in-process research and development in
connection with the APiON acquisition. In connection with the Angelica
acquisition, we recorded goodwill of $2.0 million, which is being amortized on a
straight-line basis over a three-year period. In connection with the AtMotion
acquisition, we recorded goodwill and other intangible assets of approximately
$286.6 million which is being amortized on a straight-line basis over a
three-year period. In connection with the Paragon acquisition, we recorded
goodwill and other intangible assets of approximately $464.9 million which is
being amortized on a straight-line basis over a three-year period. We also
recorded an immediate expense of $18.1 relating to in-process research and
development in connection with the Paragon acquisition. We anticipate that the
amortization of goodwill and intangible assets will increase significantly due
to the acquisition of Onebox, which was completed April 14, 2000.
Interest and Other Income, Net
18
Net interest and other income is comprised primarily of interest earned on
cash and cash equivalents and short-term investments, offset by interest expense
related to obligations under capital leases and our equipment loan. Net interest
and other income increased from $359,000 to $7.2 million for the three months
ended March 31, 1999 and 2000, respectively, and increased from $1.1 million to
$12.8 million for the nine months ended March 31, 1999 and 2000, respectively.
The increases were due primarily to increased cash balances as a result of our
secondary public offering in November 1999, our initial public offering in June
1999 and our private placement financing in March 1999.
Income Taxes
Income tax expense was $710,000 and $170,000 for the three months ended March
31, 1999 and 2000, respectively, and $710,000 and $1.1 million for the nine
months ended March 31, 1999 and 2000, respectively. Income tax expense for the
three and nine months ended March 31, 2000 consisted primarily of foreign
withholding taxes.
Liquidity and Capital Resources
Since inception, we have financed our operations primarily through private
sales of convertible preferred stock which totaled $66.0 million in aggregate
net proceeds through March 31, 1999, through our initial public offering in June
1999 which generated net proceeds of $66.8 million, and through our secondary
public offering in November 1999 which generated net proceeds of approximately
$390 million. As of March 31, 2000, we had $496.9 million of cash, cash
equivalents and short-term investments and working capital of $412.8 million.
Net cash provided by operating activities was $11.4 million for the nine
months ended March 31, 2000. The net cash provided was attributable primarily to
increases in deferred revenue and accrued liabilities of $24.2 million and $10.6
million, respectively, offset in part by the net loss of $99.5 million and after
consideration of non-cash amortization expenses principally relating to
goodwill, in-process research and development, and other intangibles as a result
of the acquisitions of Paragon, AtMotion, APiON and Angelica.
Net cash used for investing activities was $361.8 million for the nine months
ended March 31, 2000, primarily reflecting net purchases of short-term
investments, purchases of property and equipment and cash paid for acquisitions.
Net cash provided by financing activities was $394.4 million for the nine
months ended March 31, 2000, primarily reflecting the net proceeds from our
secondary public offering in November 1999.
As of March 31, 2000, our principal commitments consisted of obligations
outstanding under operating leases and our equipment loans and capital lease
obligations. On March 30, 2000, we entered into a lease for approximately
280,000 square feet of office space in Redwood City, California that is under
construction and is expected to be completed in the year 2001. Lease terms
require a base rent of $3.25 per square foot as provided by the lease agreement
and will increase by 3.5% annually on the anniversary of the initial month of
the commencement of the lease. The lease term is for a period of twelve years
from the commencement date of the lease. The agreement requires that we will
provide a letter of credit in the amount of $16.5 million. The lease further
requires that we pay leasehold improvements which are expected to be at least
$15 million over the next year. We also expect to increase capital expenditures
and lease commitments consistent with our anticipated growth in operations,
infrastructure and personnel in international markets.
We believe that our current cash, cash equivalents and short-term
investments, will be sufficient to meet our anticipated cash needs for working
capital and capital expenditures for at least the next twelve months. If cash
generated from operations is insufficient to satisfy our liquidity requirements,
we may seek to sell additional equity or debt securities or to obtain a credit
facility. If additional funds are raised through the issuance of debt
securities, these securities could have rights, preferences and privileges
senior to holders of common stock, and terms of any debt could impose
restrictions on our operations. The sale of additional equity or convertible
debt securities could result in additional dilution to our stockholders, and
additional financing may not be available in amounts or on terms acceptable to
us, if at all. If we are unable to obtain this additional financing, we may be
required to reduce the scope of our planned product development and marketing
efforts, which could harm our business, financial condition and operating
results.
19
Year 2000 Readiness Disclosure
With the changeover to the year 2000, the Company did not experience any
disruption to its operations, as a result of the issues associated with the
limitations of the programming code in many existing computer systems, whereby
the computer systems may not properly recognize or process date-sensitive
information. Systems that do not properly recognize such information could
generate erroneous data or cause a system to fail. There can be no assurance
that there will not be future complications arising from Year 2000 issues.
The Company's program for addressing Year 2000 concerns included an
assessment and evaluation of internal systems, which resulted in testing and
remediation efforts for Year 2000 compliance. In addition, the Company evaluated
its customers, vendors and service providers to determine the extent to which
the Company was vulnerable to any failure by these third-party providers and to
ascertain their readiness for the Year 2000.
The total estimated cost of assessing Year 2000 issues is difficult to
determine with accuracy, but total costs did not have a material adverse impact
on the Company's operating results or financial condition. Although the Company
believes that it has successfully addressed any significant disruption from Year
2000, it will continue to monitor all critical systems for the appearance of
delayed complications or disruptions, as well as continue to monitor its
suppliers and customers.
Factors That May Affect Future Results
In addition to the other information in this report, the following factors
should be considered carefully in evaluating the Company's business and
prospects.
Our future profitability is uncertain because we have a limited operating
history.
Because we commenced operations in December 1994 and commercially released
our first products in June 1996, we only have a limited operating history on
which you can base your evaluation of our business. We may not continue to grow
or achieve profitability. We face a number of risks encountered by early stage
companies in the wireless telecommunications and Internet software industries,
including:
. our need for network operators to launch and maintain commercial services
utilizing our products;
. the uncertainty of market acceptance of commercial services utilizing our
products;
. our substantial dependence on products with only limited market
acceptance to date;
. our need to introduce reliable and robust products that meet the demanding
needs of network operators and wireless telephone manufacturers;
. our need to expand our marketing, sales, consulting and support
organizations, as well as our distribution channels;
. our ability to anticipate and respond to market competition;
. our need to manage expanding operations; and
. our dependence upon key personnel.
Our business strategy may not be successful, and we may not successfully
address these risks. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Overview."
We may not achieve or sustain our revenue or profit goals.
Because we expect to continue to incur significant product development, sales
and marketing, and administrative expenses, we will need to generate significant
revenues to become profitable and sustain profitability on a quarterly or annual
basis. We may not achieve or sustain our revenue or profit goals, and our
ability to do so depends on a number of factors outside of our control,
including the extent to which:
. there is market acceptance of commercial services utilizing our products;
. our competitors announce and develop, or lower the prices of, competing
products; and
20
. our strategic partners dedicate resources to selling our products and
services.
As a result, we may not be able to increase revenue or achieve profitability
on a quarterly or annual basis. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations--Overview."
Our quarterly operating results are subject to significant fluctuations, and our
stock price may decline if we do not meet expectations of investors and
analysts.
Our quarterly revenues and operating results are difficult to predict and may
fluctuate significantly from quarter to quarter due to a number of factors, some
of which are outside of our control. These factors include, but are not limited
to:
. delays in market acceptance or implementation by our customers of our
products and services;
. changes in demand by our customers for additional products and services;
. our lengthy sales cycle, our concentrated target market and the potentially
substantial effect on total revenues that may result from the gain or loss
of business from each incremental network operator customer;
. introduction of new products or services by us or our competitors;
. delays in developing and introducing new products and services;
. changes in our pricing policies or those of our competitors or customers;
. changes in our mix of domestic and international sales;
. risks inherent in international operations;
. changes in our mix of license, consulting and maintenance and support
services revenues; and
. changes in accounting standards, including standards relating to revenue
recognition, business combinations and stock-based compensation.
Our sales cycle, which is lengthy--typically between six and twelve
months--contributes to fluctuations in our quarterly operating results. Many
factors outside our control add to the lengthy education and customer approval
process for our products. For example, many of our prospective customers have
neither budgeted expenses for the provision of Internet-based services to
wireless subscribers nor specifically dedicated personnel for the procurement
and implementation of our products and services. Further, the emerging and
evolving nature of the market for Internet-based services via wireless
telephones may lead prospective customers to postpone their purchasing
decisions.
Most of our expenses, such as employee compensation and lease payments for
facilities and equipment, are relatively fixed. In addition, our expense levels
are based, in part, on our expectations regarding future revenues. As a result,
any shortfall in revenues relative to our expectations could cause significant
changes in our operating results from quarter to quarter. Due to the foregoing
factors, we believe period to period comparisons of our revenue levels and
operating results are not meaningful. You should not rely on our quarterly
revenues and operating results to predict our future performance.
We may be unable to successfully integrate AtMotion,Paragon or Onebox into our
business or achieve the expected benefits of the acquisitions.
Our acquisitions of AtMotion and Paragon, which were completed in February
2000 and March 2000, respectively, and our acquisition of Onebox, which was
completed in April 2000, will require integrating the products, business and
operations of these companies with our company. We may not be able to
successfully assimilate the personnel, operations and customers of these
companies into our business. Additionally, we may fail to achieve the
anticipated synergies from the acquisitions, including product integration,
marketing, product development, distribution and other operational synergies.
The integration process may further strain our existing financial and
managerial controls and reporting systems and procedures. This may result in the
diversion of management and financial resources from our core business
objectives. In addition, we are not experienced in managing significant
facilities or operations in geographically distant areas. Finally, we cannot be
certain that we will be able to retain these companies' key employees.
Any future acquisitions of companies or technologies may result in disruptions
to our business and/or the distraction of our management.
21
To date we have completed acquisitions of five companies, APiON, Angelica
Wireless, AtMotion, Paragon and Onebox. We may acquire or make investments in
other complementary businesses and technologies in the future. We may not be
able to identify other future suitable acquisition or investment candidates, and
even if we do identify suitable candidates, we may not be able to make these
acquisitions or investments on commercially acceptable terms, or at all. If we
do acquire or invest in other companies, we may not be able to realize the
benefits we expected to achieve at the time of entering into the transaction. In
any future acquisitions we will likely face the same risks as discussed above
with respect to the integration of the businesses of AtMotion, Paragon and
Onebox. Further, we may have to incur debt or issue equity securities to pay for
any future acquisitions or investments, the issuance of which could be dilutive
to our existing stockholders.
Our sales cycle is long, and our stock price could decline if sales are delayed
or cancelled.
Quarterly fluctuations in our operating performance are exacerbated by our
sales cycle, which is lengthy, typically between six and twelve months, and
unpredictable. Because our products represent a significant capital investment
for our customers, we spend a substantial amount of time educating customers
regarding the use and benefits of our products and they in turn spend a
substantial amount of time performing internal reviews and obtaining capital
expenditure approvals before purchasing our products. Any delay in sales of our
products could cause our quarterly operating results to vary significantly from
projected results, which could cause our stock price to decline.
Our success depends on acceptance of our products and services by network
operators and their subscribers.
From inception through March 31, 2000, we have generated a significant
portion of our total cumulative revenues from fees paid to us by wireless
telephone manufacturers that embed our browser in their wireless telephones.
However, our future success depends on our ability to increase revenues from
sales of our UP.Link Server Suite and related server-based software and services
to new and existing network operator customers and on market acceptance of new
products and services, including our MyPhone wireless Internet portal framework
and related server-based communications applications software products, and we
may not be able to achieve widespread adoption by these customers. This
dependence is exacerbated by the relatively small number of network operators
worldwide. To date, we currently have only a limited number of network operator
customers that have implemented and deployed services based on our products. We
cannot assure you that network operators will widely deploy or successfully
market services based on our products, or that large numbers of subscribers will
use these services. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Overview."
The market for the delivery of Internet-based services through wireless
telephones is rapidly evolving, and we may not be able to adequately address
this market.
The market for the delivery of Internet-based services through wireless
telephones is rapidly evolving and is characterized by an increasing number of
market entrants that have introduced or developed, or are in the process of
introducing or developing, products that facilitate the delivery of
Internet-based services through wireless telephones. As a result, the life cycle
of our products is difficult to estimate. We may not be able to develop and
introduce new products, services and enhancements that respond to technological
changes or evolving industry standards on a timely basis, in which case our
business would suffer. In addition, we cannot predict the rate of adoption by
wireless subscribers of these services or the price they will be willing to pay
for these services. As a result, it is extremely difficult to predict the
pricing of these services and the future size and growth rate of this market.
Our network operator customers face implementation and support challenges in
introducing Internet-based services via wireless telephones, which may slow
their rate of adoption or implementation of the services our products enable.
Historically, network operators have been relatively slow to implement new
complex services such as Internet-based services. In addition, network operators
may encounter greater customer service demands to support Internet-based
services via wireless telephones than they do for their traditional voice
services. We have limited or no control over the pace at which network operators
implement these new services. The failure of network operators to introduce and
support services
22
utilizing our products in a timely and effective manner could harm our business.
See "Management's Discussion and Analysis of Financial Condition and Results of
Operations--Overview."
To date, we have relied on sales to a small number of customers, and the failure
to retain these customers or add new customers may harm our business.
To date, a significant portion of our revenues in any particular period has
been attributable to a limited number of customers, comprised primarily of
network operators and wireless telephone manufacturers. We believe that we will
continue to depend upon a limited number of customers for a significant portion
of our revenues for each quarter for the foreseeable future. Any failure by us
to capture a significant share of those customers could materially harm our
business. For example, during the fiscal year ended June 30, 1999, AT&T Wireless
Services accounted for approximately 17% of our total revenues, and DDI
Corporation accounted for approximately 14% of our total revenues. For the nine
months ended March 31, 2000, DDI Corporation and AT&T Wireless Services
accounted for 21% and 7%, respectively, of our total revenues. The foregoing
calculations are based on revenues derived from direct and indirect sales to
these customers.
If wireless telephones are not widely adopted for mobile delivery of
Internet-based services, our business could suffer.
We have focused our efforts on mass-market wireless telephones as the
principal means of delivery of Internet-based services using our products. If
wireless telephones are not widely adopted for mobile delivery of Internet-based
services, our business would suffer materially. Mobile individuals currently use
many competing products, such as portable computers, to remotely access the
Internet and email. These products generally are designed for the visual
presentation of data, while wireless telephones historically have been limited
in this regard. If mobile individuals do not adopt wireless telephones as a
means of accessing Internet-based services, our business would suffer. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--Overview."
If widespread integration of browser technology does not occur in wireless
telephones, our business could suffer.
Because our current UP.Link Server Suite and related server-based software
offers enhanced features and functionality that are not currently covered by the
specifications promulgated by the WAP Forum, subscribers currently must use
UP.Browser-enabled wireless telephones in order to fully utilize these features
and functionality. Additionally, we expect that future versions of our UP.Link
Server Suite and related server-based software will offer features and
functionality that are compatible with the specifications promulgated by the WAP
Forum. Our business could suffer materially if widespread integration of
UP.Browser or WAP-compliant third party browser software in wireless telephones
does not occur. All of our agreements with wireless telephone manufacturers are
nonexclusive, so they may choose to embed a browser other than ours in their
wireless telephones. We may not succeed in maintaining and developing
relationships with telephone manufacturers, and any arrangements may be
terminated early or not renewed at expiration. In addition, wireless telephone
manufacturers may not produce products using UP.Browser in a timely manner and
in sufficient quantities, if at all. See "Management's Discussion and Analysis
of Financial Condition and Results of Operations--Overview."
Our strategy for the MyPhone service is subject to uncertainties, and we may not
be able to generate sufficient revenues to achieve profitability.
In September 1999, we announced our MyPhone service. We offer MyPhone as an
OEM service to enable network operators to create branded mobile Internet
portals for their subscribers, and we do not currently intend to develop our
own branded portal site. We have limited experience in developing mobile
Internet portals, and we may not be successful in executing our business
strategy for the MyPhone service. The success of MyPhone will depend on a
number of factors, including the adoption of MyPhone by network operators, our
ability to establish strong relationships with content and information service
providers, our ability to provide compelling applications and services through
MyPhone and the acceptance by
23
wireless subscribers of the MyPhone service. Developing these capabilities and
commercializing this service will require us to incur significant additional
expenses, including costs relating to operating the portal, as well as sales and
marketing and research and development expenses. We expect to incur these costs
and expenses in advance of generating revenues from this service. Furthermore,
our business model for MyPhone is new and evolving. Even if we are successful in
executing this strategy, we cannot be certain that our business model for the
MyPhone service will result in sufficient revenues to achieve profitability.
The market for our products and services is highly competitive.
The market for our products and services is becoming increasingly
competitive. The widespread adoption of open industry standards such as the WAP
specifications may make it easier for new market entrants and existing
competitors to introduce products that compete with our software products. In
addition, a number of our competitors, including Nokia, have announced or are
expected to announce enhanced features and functionality as proprietary
extensions to the WAP protocol. Furthermore, some of our competitors, such as
NTT, have introduced or may introduce services based on proprietary wireless
protocols that are not compliant with the WAP specifications.
We expect that we will compete primarily on the basis of price, time to
market, functionality, quality and breadth of product and service offerings. Our
current and potential competitors include the following:
. Wireless equipment manufacturers, such as Ericsson and Nokia;
. Microsoft;
. Wireless Knowledge, a joint venture of Microsoft and Qualcomm as well as a
similar European joint venture of Microsoft and Ericsson;
. Systems integrators, such as CMG plc, and software companies, such as
Oracle Corporation;
. Wireless network operators, such as NTT DoCoMo; and
. Providers of Internet software applications and content, electronic
messaging applications and personal information management software
solutions.
In particular, Microsoft Corporation has announced its intention to introduce
products and services that may compete directly with our UP.Link, UP.Browser and
UP.Application products. In addition, Microsoft has announced that it intends to
enable its Windows CE operating system to run on wireless handheld devices,
including wireless telephones. Microsoft has announced its own browser, called
Mobile Explorer, for these devices. Furthermore, Nokia is marketing a WAP server
to corporate customers and content providers. This WAP server is designed to
enable wireless telephone subscribers to directly access applications and
services provided by these customers, rather than through gateways provided by
network operators' WAP servers. If Nokia's WAP server is widely adopted by
corporate customers and content providers, it could undermine the need for
network operators to purchase WAP servers. Many of our existing competitors, as
well as potential competitors, have substantially greater financial, technical,
marketing and distribution resources than we do.
As we enter new markets and introduce new services, such as the MyPhone
service, we will face additional competitors. As we enter the Unified Messaging
market, we will face competition from established voicemail providers such as
Comverse, and Internet-based unified messaging providers such as Critical Path.
In the Portal Framework market, a number of companies have introduced products
and services relating to mobile portals that compete with our MyPhone service.
These existing and potential competitors may include telecommunications
companies such as Lucent Technologies, traditional Internet portals such as AOL,
InfoSpace, Microsoft and Yahoo!, Internet infrastructure software companies and
several private mobile Internet portal companies. Our Fonesync synchronization
product will face competition from Motorola's TrueSync product, and product from
Puma, as well as from emerging synchronization companies such as Fusion One.
Our software products may contain defects or errors, and shipments of our
software may be delayed.
The software we develop is complex and must meet the stringent technical
requirements of our customers. We must develop our products quickly to keep pace
with the rapidly changing Internet software and telecommunications markets.
Software products and services as complex as ours are likely to contain
undetected errors or defects, especially when first introduced or when new
versions are released. We have in the past experienced delays in releasing some
versions of our products until software problems were corrected. Our products
may not be free from errors or defects after commercial shipments have begun,
which could result in the rejection of our products and damage to our
reputation, as well
24
as lost revenues, diverted development resources, and increased service and
warranty costs, any of which could harm our business.
We depend on recruiting and retaining key management and technical personnel
with telecommunications and Internet software experience.
Because of the technical nature of our products and the dynamic market in
which we compete, our performance depends on attracting and retaining key
employees. In particular, our future success depends in part on the continued
services of each of our current executive officers. We currently maintain key
person life insurance policies for Alain Rossmann, our Chief Executive Officer,
and Charles Parrish, our Executive Vice President. Competition for qualified
personnel in the telecommunications and Internet software industries is intense,
and finding qualified personnel with experience in both industries is even more
difficult. We believe that there are only a limited number of persons with the
requisite skills to serve in many key positions, and it is becoming increasingly
difficult to hire and retain these persons. Competitors and others have in the
past, and may in the future, attempt to recruit our employees.
We may fail to support our anticipated growth in operations.
To succeed in the implementation of our business strategy, we must rapidly
execute our sales strategy and further develop products and expand service
capabilities, while managing anticipated growth by implementing effective
planning and operating processes. If we fail to manage our growth effectively,
our business could suffer materially. To manage anticipated growth, we must:
. continue to implement and improve our operational, financial and management
information systems; for example, we are currently in the process of
implementing Oracle financial software;
. hire, train and retain additional qualified personnel;
. continue to expand and upgrade core technologies; and
. effectively manage multiple relationships with various network operators,
wireless telephone manufacturers, content providers, applications developers
and other third parties.
Our systems, procedures and controls may not be adequate to support our
operations, and our management may not be able to achieve the rapid execution
necessary to exploit the market for our products and services.
Our success, particularly in international markets, depends in part on our
ability to maintain and expand our distribution channels.
Our success depends in part on our ability to increase sales of our products
and services through value-added resellers and systems integrators and to expand
our indirect distribution channels. If we are unable to maintain the
relationships that we have with our existing distribution partners, increase
revenues derived from sales through our indirect distribution channels, or
increase the number of distribution partners with whom we have relationships,
then we may not be able to increase our revenues or achieve profitability.
We expect that many network operators in international markets will require
that our products and support services be supplied through value-added resellers
and systems integrators. Thus, we expect that a significant portion of
international sales will be made through value-added resellers and systems
integrators, and the success of our international operations will depend on our
ability to maintain productive relationships with value-added resellers and
systems integrators.
In addition, our agreements with our distribution partners do not restrict
the sale by them of products and services that are competitive with our products
and services, and each of our partners generally can cease marketing our
products and services at their option and, in some circumstances, with little
notice and with little or no penalty.
We depend on others to provide content and develop applications for wireless
telephones.
In order to increase the value to customers of our product platform and
encourage subscriber demand for Internet-based services via wireless telephones,
we must successfully promote the development of Internet-based applications and
content for this market. If content providers and application developers fail to
create sufficient applications and
25
content for Internet-based services via wireless telephones, our business could
suffer materially. Our success in motivating content providers and application
developers to create and support content and applications that subscribers find
useful and compelling will depend, in part, on our ability to develop a customer
base of network operators and wireless telephone manufacturers large enough to
justify significant and continued investments in these endeavors.
If we are unable to integrate our products with third-party technology, such as
network operators' systems, our business may suffer.
Our products are integrated with network operators' systems and wireless
telephones. If we are unable to integrate our platform products with these
third-party technologies, our business could suffer materially. For example, if,
as a result of technology enhancements or upgrades of these systems or
telephones, we are unable to integrate our products with these systems or
telephones, we could be required to redesign our software products. Moreover,
many network operators use legacy, or custom-made, systems for their general
network management software. Legacy systems are typically very difficult to
integrate with new server software such as our UP.Link Server Suite. We may not
be able to redesign our products or develop redesigned products that achieve
market acceptance.
An interruption in the supply of software that we license from third parties
could cause a decline in product sales.
We license technology that is incorporated into our products from third
parties, such as RSA Data Security, Inc. and other companies. Any significant
interruption in the supply of any licensed software could cause a decline in
product sales, unless and until we are able to replace the functionality
provided by this licensed software. We also depend on these third parties to
deliver and support reliable products, enhance their current products, develop
new products on a timely and cost-effective basis, and respond to emerging
industry standards and other technological changes. The failure of these third
parties to meet these criteria could materially harm our business.
We may be unable to adequately protect our proprietary rights.
Our success depends significantly on our ability to protect our proprietary
rights to the technologies used in our products. If we are not adequately
protected, our competitors could use the intellectual property that we have
developed to enhance their products and services, which could harm our business.
We rely on patent protection, as well as a combination of copyright and
trademark laws, trade secrets, confidentiality provisions and other contractual
provisions, to protect our proprietary rights, but these legal means afford only
limited protection.
We may be sued by third parties for infringement of their proprietary rights.
The telecommunications and Internet software industries are characterized by
the existence of a large number of patents and frequent litigation based on
allegations of patent infringement or other violations of intellectual property
rights. As the number of entrants into our market increases, the possibility of
an intellectual property claim against us grows. Any intellectual property
claims, with or without merit, could be time-consuming and expensive to litigate
or settle and could divert management attention from administering our core
business.
In April 2000, we filed a lawsuit against Geoworks Corporation in the U.S.
District Court in San Francisco, California, alleging, and seeking a court
order declaring, that U.S. Patent No. 5,327,529, assigned to Geoworks is not
infringed by Phone.com and that the patent is also invalid and unenforceable.
We took this action in response to Geoworks' attempt to require industry
participants to obtain licenses under the Geoworks patent. We cannot assure
you that Geoworks will not bring an action against us claiming infringement by
us of the Geoworks patent. While we intend to pursue our position vigorously,
the outcome of any litigation is uncertain, and we may not prevail. Should we
be found to infringe the Geoworks patent, we may be liable for potential
monetary damages, and could be required to obtain a license from Geoworks. If
we were unable to obtain a license on commercially reasonable terms, we may
not be able to proceed with development and sale of some of our products.
International sales of products is an important part of our strategy, and this
expansion carries specific risks.
International sales of products and services accounted for 72% and 70% of our
total revenues for the three and nine month periods ended March 31, 2000,
respectively. We expect international sales to continue to account for a
significant portion of our revenues, although the percentage of our total
revenues derived from international sales may vary. Risks inherent in our
international business activities include business risks, economic and political
risks, and legal risks. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Overview".
Uncorrected year 2000 problems could harm our business.
Even though the date is now past January 1, 2000 and we have not experienced
any immediate adverse impact from the transition to the Year 2000, we cannot
provide assurance
26
that our suppliers and customers have not been affected in a manner that is not
yet apparent. In addition, certain computer programs that were date sensitive to
the Year 2000 may not process the Year 2000 as a leap year and any negative
consequential effects remain unknown. As a result, we will continue to monitor
our Year 2000 compliance and the Year 2000 compliance of our suppliers and
customers. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations--Year 2000 Readiness Disclosure."
We may acquire technologies or companies in the future, and these acquisitions
could result in the dilution of our stockholders and disruption of our business.
We may acquire technologies or companies in the future. Entering into an
acquisition entails many risks, any of which could materially harm our business,
including:
. diversion of management's attention from other business concerns;
. failure to assimilate the acquired company with our pre-existing
business;
. potential loss of key employees from either our pre-existing business or
the acquired business;
. dilution of our existing stockholders as a result of issuing equity
securities; and
. assumption of liabilities of the acquired company.
Our stock price, like that of many companies in the Internet and
telecommunications software industries, may be volatile.
Since our initial public offering in June 1999, our stock price has
experienced significant volatility. We expect that the market price of our
common stock also will fluctuate in the future as a result of variations in our
quarterly operating results. These fluctuations may be exaggerated if the
trading volume of our common stock is low. In addition, due to the
technology-intensive and emerging nature of our business, the market price of
our common stock may rise and fall in response to:
. announcements of technological or competitive developments;
. acquisitions or strategic alliances by us or our competitors;
. the gain or loss of a significant customer or order; and
. changes in estimates of our financial performance or changes in
recommendations by securities analysts.
Our executive officers and directors own a large percentage of our voting stock
and could exert significant influence over matters requiring stockholder
approval.
Our executive officers and directors and their respective affiliates,
currently own a significant portion of our outstanding common stock.
Accordingly, these stockholders may, as a practical matter, be able to exert
significant influence over matters requiring approval by our stockholders,
including the election of directors and the approval of mergers or other
business combinations. This concentration could have the effect of delaying or
preventing a change in control.
Our certificate of incorporation and bylaws and Delaware law contain provisions
that could discourage a takeover.
Provisions of our certificate of incorporation and bylaws and Delaware law
may discourage, delay or prevent a merger or acquisition that a stockholder may
consider favorable. These provisions include the following:
. establishing a classified board in which only a portion of the total board
members will be elected at each annual meeting;
. authorizing the board to issue preferred stock;
. prohibiting cumulative voting in the election of directors;
. limiting the persons who may call special meetings of stockholders;
. prohibiting stockholder action by written consent; and
. establishing advance notice requirements for nominations for election of
the board of directors or for proposing matters that can be acted on by
stockholders at stockholder meetings.
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Item 3. Quantitative and Qualitative Disclosures About Market Risk.
Foreign Currency Hedging Instruments
We transact business in various foreign currencies and, accordingly, we are
subject to exposure from adverse movements in foreign currency exchange rates.
To date, the effect of changes in foreign currency exchange rates on revenues
and operating expenses have not been material. Substantially all of our revenues
are earned in U.S. dollars. Operating expenses incurred by our U.K., Danish and
Japanese subsidiaries are denominated primarily in U.K. pounds sterling, Danish
kroner and Japanese yen, respectively.
We currently do not use financial instruments to hedge operating expenses in
the U.K., Denmark or Japan denominated in their respective local currency. We
intend to assess the need to utilize financial instruments to hedge currency
exposures on an ongoing basis.
We do not use derivative financial instruments for speculative trading
purposes, nor do we currently hedge our foreign currency exposure to offset the
effects of changes in foreign exchange rates.
Fixed Income Investments
Our exposure to market risks for changes in interest rates relates primarily
to corporate debt securities. We place our investments with high credit quality
issuers and, by policy, limit the amount of the credit exposure to any one
issuer.
Our general policy is to limit the risk of principal loss and ensure the
safety of invested funds by limiting market and credit risk. All highly liquid
investments with a maturity of less than three months at the date of purchase
are considered to be cash equivalents; all investments with maturities of three
months or greater are classified as available-for-sale and considered to be
short-term investments.
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PART II. OTHER INFORMATION
Item 1. Legal Proceedings
In April 2000, we filed a lawsuit against Geoworks Corporation in the U.S.
District Court in San Francisco, California, alleging, and seeking a court order
declaring, that U.S. Patent No. 5,327,529, assigned to Geoworks is not infringed
by Phone.com and that the patent is also invalid and unenforceable. We took this
action in response to Geoworks' attempt to require industry participants to
obtain licenses under the Geoworks patent. We cannot assure you that Geoworks
will not bring an action against us claiming infringement by us of the Geoworks
patent. While we intend to pursue our position vigorously, the outcome of any
litigation is uncertain, and we may not prevail. Should we be found to infringe
the Geoworks patent, we may be liable for potential monetary damages, and could
be required to obtain a license from Geoworks. If we were unable to obtain a
license on commercially reasonable terms, we may not be able to proceed with
development and sale of some of our products.
Item 2. Changes in Securities and Use of Proceeds.
In June 1999, in connection with the Company's initial public offering, a
Registration Statement on Form S-1 (No. 333-75219) was declared effective by the
Securities and Exchange Commission, pursuant to which 9,200,000 shares of the
Company's Common Stock were offered and sold for the account of the Company at a
price of $8.00 per share, generating gross offering proceeds of $73.6 million.
The managing underwriters were Credit Suisse First Boston Corporation,
BancBoston Robertson Stephens Inc., Hambrecht & Quist LLC and U.S. Bancorp Piper
Jaffray Inc. After deducting approximately $5.2 million in underwriting
discounts and $1.4 million in other related expenses, the net proceeds of the
offering were approximately $67 million.
In November 1999, in connection with the Company's secondary public offering,
a Registration Statement on Form S-1 (No. 333-89879) was declared effective by
the Securities and Exchange Commission, pursuant to which 3,041,500 shares of
the Company's Common Stock were offered and sold for the account of the Company
at a price of $135.00 per share, generating gross offering proceeds of
$410,602,500. The managing underwriters were Credit Suisse First Boston
Corporation, Goldman, Sachs & Co., Hambrecht & Quist, BancBoston Robertson
Stephens Inc., U.S. Bancorp Piper Jaffray Inc., and Bank of America Securities
LLC. After deducting approximately $19.2 million in underwriting discounts and
$974,000 in other related expenses, the net proceeds of the offering were
approximately $390 million.
The Company has not yet used the funds from the initial or secondary public
offerings, and the net proceeds have been invested in investment grade, interest
bearing securities. The Company intends to use such remaining proceeds for
capital expenditures, including the acquisition of computer and communication
systems, and for general corporate purposes, including working capital to fund
increased accounts receivable and inventory levels.
Item 3. Defaults Upon Senior Securities - Not Applicable.
Item 4. Submission of Matters to a Vote of Security Holders - Not Applicable
Item 5. Other Information - Not Applicable.
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits
Ex-10.19 Lease Agreement dated February 4, 2000 for
offices at Pacific Shores Center by and between
Registrant and Pacific Shores Center, LLC.
Ex-27.1 Financial Data Schedule
(b) Reports on Form 8-K
(1) On February 24, 2000, Phone.com, Inc. filed a report on
Form 8-K to report that it had consummated its
acquisition of AtMotion, Inc.
(2) On March 17, 2000, Phone.com, Inc. filed a report on
Form 8-K to report that it had consummated its
acquisition of Paragon Software (Holdings) Limited, a
private limited company incorporated in England and
Wales.
(3) On April 24, 2000, Phone.com, Inc. filed a report on
Form 8-K/A to provide certain financial information as
required in conjunction with its acquisition of
AtMotion, Inc.
(4) On May 12, 2000, Phone.com, Inc. filed a report on Form
8-K/A to provide certain financial information as
required in conjunction with its acquisition of Paragon
Software (Holdings) Limited.
(5) On May 15, 2000, Phone.com, Inc. filed a report on Form
8-K to report that it had consummated its acquisition
of Onebox, Inc.
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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Phone.com, Inc.
By: /s/ ALAN BLACK
--------------------------------------------
Alan Black
Vice President of Finance and
Administration, Chief Financial Officer and
Treasurer (Principal Financial and
Accounting Officer)
Date: May 15, 2000
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