Exhibit 99.2
REPORT OF INDEPENDENT ACCOUNTANTS
To the Stockholders and Board of Directors of
Prime Response, Inc.:
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations, stockholders' equity (deficit) and cash
flows present fairly, in all material respects, the financial position of Prime
Response, Inc. and its subsidiaries at December 31, 2000 and 1999, and the
results of their operations and their cash flows for each of the three years in
the period ended December 31, 2000 in conformity with accounting principles
generally accepted in the United States of America. These financial statements
are the responsibility of the Company's management; our responsibility is to
express an opinion on these financial statements based on our audits. We
conducted our audits of these statements in accordance with auditing standards
generally accepted in the United States of America, which require that we plan
and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, assessing the accounting principles used and
significant estimates made by management, and evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
/s/ PricewaterhouseCoopers LLP
February 20, 2001
F-38
1
PRIME RESPONSE, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands)
December 31,
-------------------
1999 2000
-------- ---------
ASSETS
Current assets:
Cash and cash equivalents............................... $ 3,999 $ 27,139
Accounts receivable, net of allowance for doubtful
accounts of $147 and $1,198, respectively.............. 9,057 10,616
Prepaid and other current assets........................ 2,595 3,046
-------- ---------
Total current assets................................... 15,651 40,801
Property and equipment, net............................... 2,602 3,390
Goodwill, intangible and other long-term assets, net...... 7,262 6,891
-------- ---------
Total assets........................................... $ 25,515 $ 51,082
======== =========
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable........................................ $ 3,920 $ 5,154
Short-term debt and capital lease obligations........... 2,289 78
Accrued expenses and other liabilities.................. 4,472 6,299
Accrued interest income................................. 176 176
Deferred revenue........................................ 6,074 6,312
-------- ---------
Total current liabilities.............................. 16,931 18,019
Long-term debt and capital lease obligations.............. 311 --
Long-term accrued interest income......................... 1,398 1,222
Commitments and contingencies (Note 8)
Redeemable common stock, $0.01 par value: 1,677 shares
issued and outstanding at December 31, 1999 and 0 shares
issued and outstanding at December 31, 2000.............. 8,295 --
Series A redeemable convertible preferred stock, $0.01 par
value, 1,155 shares authorized; 1,155 shares issued and
outstanding at December 31, 1999, and 0 shares issued and
outstanding at December 31, 2000......................... 27,842 --
Series B redeemable convertible preferred stock, $0.01 par
value; 1,700 shares authorized; 1,700 shares issued and
outstanding at December 31, 1999, and 0 shares issued and
outstanding at December 31, 2000......................... 10,343 --
Series C redeemable convertible preferred stock, $0.01 par
value, 3,000 shares authorized; 1,833 shares issued and
outstanding at December 31, 1999, and 0 shares issued and
outstanding at December 31, 2000......................... 4,891 --
Stockholders' equity (deficit):
Common stock, $0.01 par value: 60,000 shares authorized;
6,454 issued and outstanding at December 31, 1999, and
20,482 shares issued and outstanding at December 31,
2000................................................... 65 205
Additional paid-in capital.............................. 6,520 155,355
Treasury stock, 1,249 shares at cost.................... -- (4,273)
Accumulated other comprehensive income.................. (12) 61
Accumulated deficit..................................... (46,127) (114,965)
Note receivable from shareholder........................ (2,545) (2,545)
Deferred compensation................................... (2,397) (1,997)
-------- ---------
Total stockholders' equity (deficit)................... (44,496) 31,841
-------- ---------
Total liabilities and stockholders' equity (deficit)... $ 25,515 $ 51,082
======== =========
The accompanying notes are an integral part of these consolidated financial
statements.
F-39
2
PRIME RESPONSE, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
Year Ended December 31,
----------------------------
1998 1999 2000
-------- -------- --------
Revenues:
Software licenses.................................. $ 8,495 $ 10,134 $ 15,750
Services and support............................... 4,214 6,519 9,906
Applications hosting............................... 3,827 3,869 3,207
-------- -------- --------
Total revenues.................................. 16,536 20,522 28,863
-------- -------- --------
Cost of revenues:
Software licenses.................................. 152 -- 79
Services and support............................... 6,477 4,522 8,046
Applications hosting............................... 2,477 2,776 3,314
Non-cash cost of revenues.......................... -- 113 116
-------- -------- --------
Total cost of revenues.......................... 9,106 7,411 11,555
-------- -------- --------
Gross profit........................................ 7,430 13,111 17,308
-------- -------- --------
Operating expenses:
Sales and marketing................................ 9,459 13,285 26,301
Non-cash sales and marketing....................... -- 266 2,701
Research and development........................... 6,289 10,185 10,464
Non-cash research and development.................. -- 63 126
General and administrative......................... 4,843 4,112 7,002
Non-cash general and administrative................ -- 1,732 119
Amortization of goodwill and other intangible
assets............................................ 1,279 1,245 --
-------- -------- --------
Total operating expenses........................ 21,870 30,888 46,713
-------- -------- --------
Loss from operations................................ (14,440) (17,777) (29,405)
Other expense (income):
Interest income.................................... (219) (115) (2,054)
Interest expense................................... 294 184 318
Interest expense related to beneficial conversion
feature........................................... -- 2,500 --
Loss on foreign exchange........................... 88 58 (5)
-------- -------- --------
Loss before income taxes............................ (14,603) (20,404) (27,664)
Provision for income taxes.......................... -- 15 (74)
-------- -------- --------
Net loss ........................................... (14,603) (20,419) (27,590)
Preferred stock dividends and recognition of
beneficial conversion feature on preferred stock... 2,015 5,034 41,234
-------- -------- --------
Net loss attributable to common stockholders........ $(16,618) $(25,453) (68,824)
======== ======== ========
Net loss per share--basic and diluted............... $ (2.36) $ (3.44) $ (3.77)
======== ======== ========
Weighted average shares used in computing basic and
diluted net loss per share......................... 7,035 7,405 18,237
======== ======== ========
The accompanying notes are an integral part of these consolidated financial
statements.
F-40
3
PRIME RESPONSE, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
(in thousands, except share data)
Accumulated Retained Total
Common Stock Additional Other Earnings Stockholders'
------------------ Treasury Paid-in Comprehensive (Accumulated Note Deferred Equity
Shares Amount Stock Capital Income Deficit) Receivable Compensation (Deficit)
---------- ------ -------- ---------- ------------- ------------ ---------- ------------ -------------
Balance, December
31, 1997......... 5,785,500 $ 58 -- $(12,232) $ 6 $ (4,059) -- -- $(16,227)
Net loss........ -- -- -- -- -- (14,603) -- -- (14,603)
Foreign currency
translation
adjustments..... -- -- -- -- (18) -- -- -- (18)
--------
Total
comprehensive
income.......... (14,621)
Accrual of
dividends on
redeemable
convertible
preferred stock
and accretion to
redemption
value........... -- -- -- -- -- (2,012) -- -- (2,012)
---------- ---- ------- -------- ---- --------- ------- ------- --------
Balance, December
31, 1998......... 5,785,500 58 -- (12,232) (12) (20,674) -- -- (32,860)
Net loss and
total
comprehensive
income.......... -- -- -- -- -- (20,419) -- -- (20,419)
Issuance of
common stock and
warrants........ -- -- -- 8,467 -- -- -- -- 8,467
Recognition of
beneficial
conversion
feature on
preferred
stock........... -- -- -- 2,391 -- (2,391) -- -- --
Recognition of
beneficial
conversion
feature on
convertible
debt............ -- -- -- 2,500 -- -- -- -- 2,500
Accrual of
dividends on
redeemable
convertible
preferred stock
and accretion to
redemption
value........... -- -- -- -- -- (2,643) -- -- (2,643)
Exercise of
stock options... 31,781 1 -- 109 -- -- -- -- 110
Exercise of
stock options in
exchange for
notes
receivable...... 636,225 6 -- 2,539 -- -- $(2,545) -- --
Compensation
related to
grants of stock
options......... -- -- -- 2,746 -- -- -- $(2,602) 144
Amortization of
deferred
compensation.... -- -- -- -- -- -- -- 205 205
---------- ---- ------- -------- ---- --------- ------- ------- --------
Balance, December
31, 1999......... 6,453,506 65 -- 6,520 (12) (46,127) (2,545) (2,397) (44,496)
---------- ---- ------- -------- ---- --------- ------- ------- --------
Net Loss........ -- -- -- -- -- (27,590) -- -- (27,590)
Foreign currency
translation
adjustments..... -- -- -- -- 73 (14) -- -- 59
Accrual of
dividends on
redeemable,
convertible
preferred stock
and accretion to
redemption
value........... -- -- -- -- -- (505) -- -- (505)
Dividends paid
in common
stock........... 381,482 4 -- 4,574 -- -- -- -- 4,578
Accretion of
discount on
preferred
stock........... -- -- -- -- -- (1,329) -- -- (1,329)
Conversion of
Series A, B and
C preferred
stock........... 6,323,867 63 -- 39,342 -- -- -- -- 39,405
Initial Public
Offering........ 4,025,000 40 -- 65,338 -- -- -- -- 65,378
Participation
payments upon
IPO............. 2,490,257 25 -- 29,858 -- (39,400) -- -- (9,517)
Reclass
redeemable
common stock.... 1,677,307 17 -- 8,278 -- -- -- -- 8,295
Purchase of
treasury stock
at cost......... (1,249,500) (12) $(4,273) 12 -- -- -- -- (4,273)
Compensation
related to
vesting of
warrants........ -- -- -- 452 -- -- -- -- 452
Compensation
related to
grants of stock
options......... -- -- -- 421 -- -- -- (326) 95
Amortization of
deferred
compensation.... -- -- -- -- -- -- -- 726 726
Exercise of
stock options
and warrants.... 379,686 3 -- 560 -- -- -- -- 563
---------- ---- ------- -------- ---- --------- ------- ------- --------
Balance, December
31, 2000......... 20,481,605 $205 $(4,273) $155,355 $ 61 $(114,965) $(2,545) $(1,997) $ 31,841
========== ==== ======= ======== ==== ========= ======= ======= ========
The accompanying notes are an integral part of these financial statements.
F-41
4
PRIME RESPONSE, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
Year Ended December 31,
----------------------------
1998 1999 2000
-------- -------- --------
Cash flows used in operating activities:
Net loss........................................ $(14,603) $(20,419) $(27,590)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation of property and equipment.......... 654 1,032 1,439
Amortization of goodwill and intangibles........ 1,279 1,394 2,027
Gain on sale of fixed assets.................... (12) -- --
Compensation expense related to stock options... -- 2,025 1,273
Interest expense related to beneficial
conversion feature............................. -- 2,500 --
Changes in assets and liabilities:
Accounts receivable............................ (1,739) (4,313) (2,159)
Prepaid and other current assets............... (560) (1,448) (602)
Other long term assets......................... -- -- (1,750)
Accounts payable............................... (98) 2,258 1,392
Accrued expenses and other liabilities......... 1,426 1,329 2,256
Deferred revenue............................... (94) 4,492 660
-------- -------- --------
Net cash used in operating activities......... (13,747) (11,150) (23,054)
-------- -------- --------
Cash flows used in investing activities:
Purchase of property and equipment.............. (1,086) (1,428) (2,372)
Proceeds from sale of fixed assets.............. 20 -- --
Payment for acquired business................... (2,812) -- --
-------- -------- --------
Net cash used in investing activities......... (3,878) (1,428) (2,372)
-------- -------- --------
Cash flows provided by (used in) financing
activities:
Proceeds of initial public offering, net of
issuance costs................................. -- -- 65,378
Proceeds from issuance of redeemable common
stock and warrants............................. -- 4,000 --
Proceeds from issuance of preferred stock
(Series A, B and C) and warrants, net of
issuance costs................................. 5,199 8,001 --
Proceeds from exercise of stock options and
warrants....................................... -- 110 557
Repayment of bank loans......................... (275) (162) --
Proceeds from credit facility................... -- 2,000 --
Repayment of credit facility.................... -- -- (2,000)
Payment of participation payment................ -- -- (9,517)
Purchase of treasury stock...................... -- -- (4,274)
Repayment of capital lease...................... (197) (329) (503)
Repayment of directors' loans................... (8,113) -- --
Decrease in line of credit...................... (561) -- --
Dividends paid.................................. -- -- (934)
Proceeds from shareholder loans................. -- 2,500 --
-------- -------- --------
Net cash provided by (used in) financing
activities................................... (3,947) 16,120 48,707
-------- -------- --------
Effect of exchange rate on cash.................. (4) (73) (141)
-------- -------- --------
Net increase (decrease) in cash and cash
equivalents..................................... (21,576) 3,469 23,140
Cash and cash equivalents, beginning of year..... 22,106 530 3,999
-------- -------- --------
Cash and cash equivalents, end of year........... $ 530 $ 3,999 $ 27,139
======== ======== ========
Supplemental disclosure of non-cash transactions:
Assets acquired under capital leases............ $ 710 $ 132 --
======== ======== ========
Issuance of restricted common stock in exchange
for note receivable from shareholder........... -- $ 2,545 --
======== ======== ========
Conversion of shareholder loan to Series C
preferred stock................................ -- $ 2,500 --
======== ======== ========
Conversion of series A, B and C preferred stock
to common stock................................ -- -- $ 39,405
======== ======== ========
Payment of dividends in common stock............ -- -- $ 4,578
======== ======== ========
Participation payment paid in common stock...... -- -- $ 29,886
======== ======== ========
Supplemental cash flow disclosure:
Interest paid................................... $ 294 $ 147 $ 307
======== ======== ========
Income taxes paid............................... -- $ 15 $ 32
======== ======== ========
The accompanying notes are an integral part of these consolidated financial
statements.
F-42
5
PRIME RESPONSE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Nature of Business and Summary of Significant Accounting Policies
The Company
Prime Response, Inc. ("PRI") together with its consolidated subsidiaries
("Prime Response") is a leading provider of integrated relationship marketing
software solutions that enable businesses with large customer bases to create,
manage and execute highly targeted Internet, wireless and traditional marketing
campaigns to build more loyal and profitable customer relationships. Prime
Response's customers consist primarily of Fortune 1000 businesses as well
leading e-commerce businesses primarily based in the United States and Europe.
Prime Response sells its products through multiple distribution channels
including direct sales and resellers.
Basis of Presentation
The financial statements have been prepared in accordance with generally
accepted accounting principles in the United States.
These financial statements represent the consolidated results of PRI and its
predecessor, Prime Response Limited ("PRL"). PRI was formed as a holding
company on September 26, 1997 and acquired 100% of the outstanding ordinary
shares of PRL (a company incorporated in the United Kingdom in 1987) on October
23, 1997. Refer to Note 6 for discussion of the reorganization of Prime
Response.
Prime Response declared a 0.75 for 1 reverse common stock split on February
2, 2000. All share and per share amounts presented relating to common stock
have been restated to reflect the common stock split.
Prime Response is subject to risks and uncertainties common to growing
technology-based companies, including rapid technological developments,
reliance on continued development and acceptance of the internet, intense
competition and a limited operating history. In 1995, Prime Response began to
transition from a marketing database service bureau to a software company.
Since that time, Prime Response has incurred substantial operating losses.
Prime Response cannot be certain if or when it will become profitable. During
January 2001, Prime Response signed a definitive merger agreement with
Chordiant Software, Inc. Under the terms of the agreement, each share of Prime
Response common stock will convert into 0.60 of a share of Chordiant common
stock. The acquisition is expected to be accounted for as a purchase and is
subject to stockholder and regulatory approvals.
Prime Response believes that its existing balance of cash and cash
equivalents will be sufficient to meet its working capital and anticipated
capital expenditure needs for at least the next 12 months. In the event that
the impending merger with Chordiant Software, Inc., does not close, Prime
Response may require additional sources of funds to continue to support its
business. There can be no assurance that such capital, if needed, will be
available or will be available on terms which Prime Response finds acceptable.
Prime Response has evaluated its cost structure and plans to streamline its
operations in an effort to restructure costs associated with its business in
order to improve operating margins and reduce overall expenses. This
restructuring included limited reductions in employee headcount during January
2001 and is expected to include the closing of sales offices in San Francisco,
California and Minneapolis, Minnesota. Prime Response will continue to evaluate
its business and take limited actions designed to align its cost structure with
anticipated future revenue levels. In connection with the restructuring, Prime
Response has committed to pay severance payments in the amount of approximately
$2.0 million during 2001.
F-43
6
PRIME RESPONSE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Initial Public Offering:
On March 3, 2000, Prime Response completed an initial public offering (the
"IPO") of 3,500,000 shares of its common stock. On April 3, 2000, the
underwriters of the initial public offering exercised the over allotment option
to purchase an additional 525,000 shares. All 4,025,000 shares covered by Prime
Response's Registration Statement on Form S-1, were sold by Prime Response at a
price of $18.00 per share, less an underwriting commission of $1.26 per share.
Net proceeds to the Company, after deducting underwriting commissions and
offering expenses, were approximately $65.4 million. Upon the consummation of
Prime Response's initial public offering on March 3, 2000, all of the then
outstanding Series A, B and C Preferred Stock automatically converted into
common stock (see Note 5).
Principles of Consolidation
The consolidated financial statements include the accounts of PRI and its
wholly-owned domestic and foreign subsidiaries. All intercompany accounts and
transactions have been eliminated.
Use of Estimates
The preparation of the consolidated financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amount of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Concentration of Credit Risk
Prime Response's financial instruments that are exposed to concentrations of
credit risk consist primarily of cash, cash equivalents, and accounts
receivable. Prime Response's accounts receivable result from operations and
reflect a broad customer base both in North America, Europe and Asia Pacific.
Prime Response does not require collateral for its receivables.
Fair Value of Financial Instruments
Prime Response's financial instruments consist of cash, cash equivalents and
debt instruments. The carrying amounts of these instruments at December 31,
2000 approximate their fair values.
Cash and Cash Equivalents
Prime Response considers all highly liquid investments which have an
original maturity of three months or less when acquired to be cash equivalents.
The carrying amount of cash and cash equivalents approximates fair value.
Software Development Costs
Software development costs are included in research and development expenses
and are expensed as incurred. Statement of Financial Accounting Standards No.
86, "Accounting for the Cost of Computer Software to be Sold, Leased, or
Otherwise Marketed" (SFAS 86) requires the capitalization of certain software
development costs once technological feasibility is established. The
capitalized cost is then amortized on a straight-line basis over the estimated
product life, or on the ratio of current revenues to total projected product
revenues, whichever is greater. To date, the period between achieving
technological feasibility, which Prime
F-44
7
PRIME RESPONSE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Response has defined as the establishment of a working model, and the general
availability of such software has been short and software development costs
qualifying for capitalization have not been material. Accordingly, Prime
Response has not capitalized any software development costs.
Property and Equipment
Property and equipment is stated at cost. Depreciation is provided using the
straight line method over the assets' estimated useful lives, based on the
following asset lives:
Motor vehicles..................................................... 4 years
Computer equipment................................................. 3 years
Furniture and equipment............................................ 6 years
The cost of significant additions and improvements is capitalized and
depreciated while expenditures for maintenance and repairs are charged to
expense as incurred. Upon retirement or sale, the cost and related accumulated
depreciation of the assets are removed from the accounts and any resulting gain
or loss is reflected in the determination of net income or loss.
Intangible Assets
Prime Response amortizes intangible assets over estimated useful lives.
Prime Response performs impairment reviews whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be
recoverable. In performing the review for recoverability Prime Response
estimates the future cash flows expected to result from the use of the asset.
If the sum of the expected future cash flows (undiscounted and without interest
charges) is less than the carrying amount of the asset, an impairment loss is
recognized.
Revenue Recognition
Prime Response sells software licenses under master license agreements and
recognizes revenue when the agreement has been signed, the software has been
shipped (or software has been electronically delivered), the license fee is
fixed or determinable, and collection of the resulting receivable is probable.
For license agreements which require customer acceptance, license revenues are
recognized only when obligations under the license agreement are completed and
the software has been accepted by the customer. For license agreements in which
Prime Response participates in financing arrangements, the fee is not
considered to be fixed or determinable and revenue is recognized as payments
become due. Prime Response provides professional services to customers under
service contracts and recognizes revenue on a time and materials basis as the
services are performed, provided that amounts due from customers are fixed or
determinable and collection of the resulting receivable is probable. These
services are not essential to the functionality of the software and are often
performed by other parties. Support revenues, including those bundled with the
initial license fee, are deferred and recognized ratably over the support
period. In the event that a contract contains multiple elements, Prime Response
allocates the aggregate of the contract value to each element based on relative
fair values as established by vendor specific objective evidence. Vendor
specific objective evidence is based on recent sales prices. Prime Response
provides applications hosting services to customers and recognizes revenue as
the services are performed.
Prime Response typically does not grant to its customers a contractual right
to return software products. When approved by management, however, Prime
Response has accepted returns of certain software products and has provided an
allowance for those specific products. Prime Response also provides reserves
for customer receivable balances which are considered potentially
uncollectible. Prime Response's allowances amounted to approximately $43,000,
$147,000 and $1,198,000 as of December 31, 1998, 1999 and 2000 respectively.
The
F-45
8
PRIME RESPONSE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
provision charged to the statement of operations was $147,000, $104,000 and
$1,380,000 in 1998, 1999 and 2000 respectively, and write-offs against the
allowances were $216,000, $0 and $329,000 in 1998, 1999 and 2000 respectively.
Cost of Revenues
All costs associated with software license production and distribution,
primarily preparation and translation of user manuals, are recorded as cost of
revenues for license fees. Additionally, royalties paid in connection with OEM
agreements that Prime Response has entered into are recorded as a cost of
license revenue. All costs associated with the services and support, comprising
mainly labor and overhead costs, are recorded as cost of revenues for services
and support. Services and support cost of revenues include any unbillable time
related to the personnel associated with the professional services group. All
costs associated with applications hosting, comprising mainly labor, equipment
and overhead costs, are recorded as cost of revenues for applications hosting.
Non-cash cost of revenues represents the amortization of stock compensation
expense in the connection with the granting of stock options. The expense
results from the difference between the estimated fair market value of the
common stock on the measurement date and the exercise price of the option,
which is being recognized over the vesting period.
Foreign Currency Translation
Prime Response has determined that the functional currency of each foreign
operation is the respective local currency. Transactions in a foreign currency
are recorded at the rate of exchange on the date of the transaction. Assets and
liabilities at year end are translated at the rate of exchange in effect at the
period end. Revenues and expenses are translated at average rates of exchange
in effect during the year. Translation gains or losses are included as a
component of accumulated other comprehensive income in stockholders' equity.
Transaction gains or losses that arise from exchange rate fluctuations on
transactions denominated in a currency other than the functional currency are
included in results of operations as incurred.
Income Taxes
Prime Response recognizes deferred tax assets and liabilities for the
expected future tax consequences of events that have been included in the
consolidated financial statements or tax returns. Deferred tax assets and
liabilities are determined on the basis of the difference between the income
tax basis of assets and liabilities and their respective financial reporting
amounts at tax rates in effect for the periods in which the differences are
expected to reverse. Prime Response provides a valuation allowance for deferred
tax assets when it is more likely than not, based on available evidence, that
some portion or all of the deferred tax assets will not be realized.
Net Loss per Share
Basic net loss per share is computed by dividing the net loss for the period
by the weighted average number of common shares outstanding during the period.
Diluted net loss per share does not differ from basic net loss per share since
potential common shares from conversion of preferred stock and exercise of
stock options and warrants are antidilutive for all periods presented. Net loss
per share for years ended December 31, 1998, 1999 and 2000 is computed using
the weighted average number of common shares outstanding. Net loss available to
common stockholders includes preferred stock dividends of none, $4.4 million
and $1.8 million for the years ended December 31, 1998, 1999 and 2000,
respectively, as well as participation payments in the cash and stock totaling
$39.4 million for the year ended December 31, 2000, in connection with the
Series A, B and C preferred stock.
F-46
9
PRIME RESPONSE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Options to purchase 737,000, 1,358,000 and 2,194,000 shares of common stock
at exercise prices ranging from $2.91 to $29.06 per share, respectively, and
warrants to purchase none, 1,246,000 and 1,750,000 shares of common stock at
exercise prices ranging from $0.01 to $9.35 per share, respectively, have been
excluded from the computation of diluted net loss per share for the years ended
December 31, 1998, 1999 and 2000, respectively.
Stock Based Compensation
Prime Response accounts for stock-based employee compensation arrangements
in accordance with provisions of Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees," and complies with the disclosure
provisions of Statement of Financial Accounting Standards No. 123, "Accounting
for Stock-Based Compensation."
Segment Information
Prime Response has adopted Statement of Financial Accounting Standards No.
131, "Disclosure about Segments of an Enterprise and Related Information,"
which requires companies to report selected information about operating
segments, as well as enterprise-wide disclosures about products, services,
geographic areas, and major customers. Operating segments are determined based
on the way management organizes its business for making operating decisions and
assessing performance. Prime Response has determined that it conducts its
operations in three business segments, software licenses, applications hosting
and services and support.
Comprehensive Income
Comprehensive income is comprised of net income and other comprehensive
income. Other comprehensive income includes certain changes in equity that are
excluded from net income. During the periods presented, comprehensive income
consisted solely of translation adjustments.
Recent Accounting Pronouncements
In December 1999, the SEC issued Staff Accounting Bulletin No. 101, commonly
referred to as SAB 101, "Revenue Recognition in Financial Statements." SAB 101
summarizes the SEC's view in applying U.S. generally accepted accounting
principles to selected revenue recognition issues. The application of the
guidance in SAB 101 (as amended by SAB 101A and SAB 101B) was required in the
fourth quarter of the fiscal year 2000. Adoption of SAB 101 did not have a
material affect on the financial statements of the Company.
2. Balance Sheet Components
December 31,
----------------
1999 2000
------- -------
Property and equipment (in thousands):
Furniture and equipment................................. $ 621 $ 1,158
Furniture and equipment under capital lease............. 560 56
Computer equipment and software......................... 3,698 6,434
Computer equipment under capital lease.................. 760 76
Motor vehicles under capital lease...................... 94 --
------- -------
5,733 7,724
Accumulated depreciation on owned assets.................. (2,561) (4,268)
Accumulated amortization on assets under capital lease.... (570) (66)
------- -------
$ 2,602 $ 3,390
======= =======
F-47
10
PRIME RESPONSE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Depreciation expense for the years ended December 31, 1998, 1999 and 2000
was $439,000, $724,000 and $1,439,000, respectively.
Amortization expense for the years ended December 31, 1998, 1999 and 2000
was $215,000, $308,000 and $111,000, respectively.
December 31,
-------------
1999 2000
------ ------
Accrued expenses and other liabilities (in thousands):
Accrued compensation and related payroll taxes.............. $1,917 $3,005
VAT payable................................................. 276 287
Amounts due to customer..................................... 500 --
Accrued professional fees................................... 117 569
Accrued sales taxes......................................... -- 528
Other creditors and accruals................................ 1,662 1,910
------ ------
$4,472 $6,299
====== ======
3. Other Assets
During March 2000, Prime Response entered into an OEM software license
agreement with a provider of customer optimization technology. Prime Response
will pay royalties for all licenses sold that integrate the customer
optimization technology. Prime Response paid $1,000,000 as an initial non-
refundable prepayment of these royalties. In addition, Prime Response received
a warrant to purchase 40,000 shares of common stock with an exercise price of
$9.73 per share and a five-year term. Prime Response has calculated the fair
value of the shares underlying the warrant to be $276,000 using the Black
Scholes model. The $1,000,000 paid has been recorded as a long term asset on
the balance sheet with $276,000 being allocated to the warrants and the
remainder will be recorded as royalty expense in cost of revenues as license
sales are recognized. During the year ended December 31, 2000, $79,000 was
recognized and recorded as a cost of license sale.
During July 2000, Prime Response entered into an OEM software license
agreement with a third party provider of enterprise portal software. Prime
Response will pay royalties for all licenses sold that integrate this
enterprise portal software. Prime Response paid $750,000 as an initial non-
refundable prepayment of these royalties. This $750,000 has been recorded as a
long-term asset at December 31, 2000 and will be recognized as a cost of
revenues as license sales are recognized.
4. Debt and Capital Leases
Debt and capital leases consists of the following (in thousands):
December 31,
-------------
1999 2000
------- ----
Capital Leases.............................................. $ 600 $ 78
Term loans.................................................. 2,000 --
------- ----
Total debt and capital leases............................... 2,600 78
------- ----
Less: short-term debt and current maturities of long-term
debt and capital leases.................................... (2,289) (78)
------- ----
Long-term debt and capital leases........................... $ 311 $ --
======= ====
F-48
11
PRIME RESPONSE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Term Loans
On October 28, 1999, Prime Response entered into an agreement with Greyrock
Capital which provided for a term loan of $2,000,000 which was received by
Prime Response upon execution of the agreement. This term loan was payable in
quarterly installments for one year beginning on February 28, 2000. Interest
accrued at prime plus 2.00% (10.50% at December 31, 1999) and was payable
monthly. The agreement also allowed Prime Response to borrow against
outstanding receivable balances up to $3,000,000. This agreement was repaid in
full with the proceeds of the IPO and subsequently terminated in June 2000.
During January 2000, Prime Response entered into an agreement with Kite
Limited evidenced by a promissory note in the amount of $4.3 million for the
repurchase of 1,249,500 shares of redeemable common stock from a former
shareholder at $3.42 per share. Prime Response repaid the note in full during
March 2000, and recorded the shares as treasury stock.
5. Redeemable Convertible Preferred Stock
Issuance
The following table sets forth the redeemable convertible preferred stock
("preferred stock") activity (in thousands):
Series A Series B Series C Total
---------------- ---------------- ---------------- ----------------
Carrying Carrying Carrying Carrying
Shares Value Shares Value Shares Value Shares Value
------ -------- ------ -------- ------ -------- ------ --------
Issuance October 1997... 1,155 $23,446 -- $ -- -- $ -- 1,155 $23,446
Accrual of cumulative
dividends and accretion
to Redemption value.... -- 604 -- -- -- -- -- 604
------ ------- ------ ------- ------ ------ ------ -------
Balance December 31,
1997................... 1,155 24,050 -- -- -- -- 1,155 24,050
Issuance September
1998................... -- -- 867 5,199 -- -- 867 5,199
Accrual of cumulative
dividends and accretion
to Redemption value.... -- 1,896 -- 116 -- -- -- 2,012
------ ------- ------ ------- ------ ------ ------ -------
Balance December 31,
1998................... 1,155 25,946 867 5,315 -- -- 2,022 31,261
Issuance March 1999..... -- -- 833 4,281 -- -- 833 4,281
Issuance July 1999...... -- -- -- -- 1,000 2,391 1,000 2,391
Issuance October 1999... -- -- -- -- 833 2,500 833 2,500
Accrual of cumulative
dividends and accretion
to redemption value.... -- 1,896 -- 747 -- -- -- 2,643
------ ------- ------ ------- ------ ------ ------ -------
Balance December 31,
1999................... 1,155 $27,842 1,700 $10,343 1,833 $4,891 4,688 $43,076
Accrual of cumulative
dividends and accretion
to redemption value.... -- 357 -- 875 -- 609 -- 1,841
Payment of dividends in
cash upon IPO.......... -- -- -- (934) -- -- -- (934)
Payment of dividends in
common stock upon IPO.. -- (4,498) -- (80) -- -- -- (4,578)
Conversion of preferred
stock to common stock
upon IPO............... (1,155) (23,701) (1,700) (10,204) (1,833) (5,500) (4,688) (39,405)
------ ------- ------ ------- ------ ------ ------ -------
Balance December 31,
2000................... -- -- -- -- -- -- -- --
====== ======= ====== ======= ====== ====== ====== =======
F-49
12
PRIME RESPONSE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Redemption
The holders of Series A, B and C preferred stock were entitled to receive a
payment of $20.52, $6.00 and $3.00, respectively, to be paid in cash or, at the
option of Prime Response in securities of Prime Response or other consideration
received by the holders of shares of common stock in the event of a merger.
Prime Response was required to reserve and keep available for issuance upon
the conversion of the Series A, B and C preferred stock, such number of its
authorized but unissued shares of common stock to be sufficient to permit the
conversion of all outstanding shares of Series A, B and C preferred stock, and
was required to take all action to increase the authorized number of share of
common stock if at anytime there was insufficient authorized but unissued share
of common stock to permit such reservation or to permit the conversion of all
outstanding share of Series A, B and C preferred stock.
These contractual terms made the Series A, B and C preferred stock
redeemable.
When issued, each share of Series C preferred stock in the July 1999
issuance was convertible into 0.75 shares of common stock, which represented a
discount from the fair value of common stock on the date of the Series C
issuance. The value attributable to this conversion feature represents an
incremental yield, or a beneficial conversion feature, which was recognized as
a return to the preferred stockholders. This amount, equal to the net proceeds
from the Series C offering of approximately $2,391,000, has been recorded as
accretion of preferred stock to redemption value in the consolidated statement
of operations in the year ended December 31, 1999, and represents a non-cash
charge in the determination of net loss attributable to common stockholders.
In August and September 1999, Prime Response obtained loans of $1,000,000
and $1,500,000, respectively, from a shareholder which were converted into
833,000 shares of Series C preferred stock in October 1999. When issued, both
the August and September loans were immediately convertible into Series C
preferred stock at the option of the holder. The number of shares of Series C
preferred stock to be issued is calculated by dividing the principal amount of
the notes by $3.00, which represents a discount from the fair value of common
stock on the date of issuance. The values attributable to the conversion
feature on each loan represent an incremental yield, or a beneficial conversion
feature, which was recognized as additional interest on the loans. These
amounts, equal to the proceeds from each loan of $1,000,000 and $1,500,000,
respectively, have been charged to interest expense in the consolidated
statement of operations in the year ended December 31, 1999, reflecting a non-
cash expense.
Conversion
Upon the consummation of the IPO, the Series A, B and C preferred shares
were converted into a total of 6,324,000 shares of common stock. Each share of
Series A, B and C preferred stock converted into 3.1282, 0.7858 and 0.75
shares, respectively, of common stock.
Dividends
Upon the consummation of the IPO, the holders of Series A and B preferred
stock received cumulative dividends in the amount of $3.59 and $0.51 per share,
respectively. Cumulative dividends on the Series A and B preferred stock were
$4,500,000 and $1,000,000, respectively. All of the Series A dividends were
paid in 374,821 shares of common stock. Series B dividends were paid $934,000
in cash and 6,661 in shares of common stock. The holders of Series C preferred
stock were not entitled to dividends.
F-50
13
PRIME RESPONSE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Participation Payment
Upon the consummation of the IPO, the holders of Series A and C preferred
stock received, in addition to accrued dividends and the common stock
conversion feature, $20.52 and $3.00 per share, respectively, paid in 2,433,382
shares of common stock. The holders of Series B preferred stock received, in
addition to accrued dividends and the conversion feature, $6.00 per share which
was paid with $9,500,000 in cash and 56,875 in shares of common stock.
Voting
Prior to the IPO, the holders of preferred stock shares were entitled to
vote, together with holders of common stock on all matters submitted to
stockholders for vote. Each preferred stock holder was entitled to a number of
votes equal to the number of shares of common stock into which each preferred
stock share was convertible at the time of such vote.
6. Common Stock
Reorganization
Prime Response Group Inc. was incorporated on September 26, 1997. In October
1997 Prime Response Group Inc. affected a reorganization involving an exchange
of common stock in Prime Response Group Inc. and a Promissory Note ("Note") for
all of the outstanding ordinary shares of PRL. Additionally certain subsidiary
companies of PRL became direct subsidiaries of Prime Response Group Inc. Prior
to this reorganization, Prime Response Group Inc. had no operating activities
of its own, all operations were conducted by PRL and its subsidiaries.
In order to effect this reorganization, on October 23, 1997 Prime Response
Group Inc. issued 7,035,000 shares of common stock and a Note for $7,899,000 to
the former shareholders of PRL, a company incorporated in the United Kingdom in
1987 and PRI's principal operating subsidiary. The Note was repaid in July
1998. In exchange, the former shareholders of PRL transferred their shares in
that company to Prime Response Group Inc. and issued an option to Prime
Response Group Inc. to repurchase 1,249,500 of these shares at an exercise
price of $3.42 per share. Prime Response repurchased these shares subsequent to
the IPO.
In 1999, the Company changed its name from Prime Response Group Inc. to
Prime Response, Inc. The shares in PRL are held by Prime Response, Inc. as an
investment in that subsidiary and are eliminated in consolidation. The exchange
of shares in PRL for those in Prime Response Group Inc. represents various
equity and debt transactions executed to facilitate investment by a U.S.
venture capitalist and to allow an existing investor to liquidate a portion of
his interest and therefore no change in control was recorded. In October 1997,
in connection with the reorganization described above, Prime Response Group
Inc. sold 1,155,000 shares of Series A convertible preferred stock for $20.52
per share, for an aggregate purchase price of $23,697,000, General Atlantic
Partners 42, L.P. purchased 909,858 shares and GAP Coinvestment Partners, L.P.
purchased 245,142 shares.
Holders of PRI's common stock are entitled to one vote per share.
Redeemable Common Stock
Accenture or its affiliate had the right to require Prime Response to
repurchase the 428,000 shares it purchased in December 1999 for $4,000,000. The
put right terminated upon the IPO and accordingly these shares were
reclassified from redeemable common stock to common stock upon the IPO. In
addition, during the
F-51
14
PRIME RESPONSE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
year ended December 31, 2000, Prime Response repurchased 1,249,500 shares of
common stock from a former shareholder that had the right to put these shares
to Prime Response prior to September 30, 2000. These shares were previously
recorded as redeemable common stock at December 31, 1999 and are classified as
treasury stock at December 31, 2000.
Employee Stock Option Plan
In April 1998 Prime Response's Board of Directors adopted, and the
stockholders subsequently approved the 1998 Stock Option/Stock Issuance's Plan
(the "1998 Plan"). The 1998 Plan serves as the successor equity incentive
program to the Company's 1997 Employee Stock Option Plan under which no options
were issued.
The 1998 Plan is divided into two separate components: (i) the Discretionary
Option Grant Program; and (ii) the Stock Issuance Program. The 1998 Plan will
terminate on April 21, 2008 unless terminated earlier by the Board. The number
of shares authorized in the 1998 Plan document of 1,250,000 was increased to
1,512,000 on September 30, 1998 and further increased to 2,148,000 on July 10,
1999. In October, 1999, Prime Response's Board of Directors authorized an
increase in the number of shares authorized for grant to 2,898,000 and in
November 1999, the Board of Directors further increased the number of shares
authorized to 3,273,000.
Options for common stock granted under the 1998 Plan are for exercise within
periods not to exceed ten years and must be issued at prices not less than 100%
and 85%, for incentive and non-qualified stock options, respectively, of the
fair value of the stock on the date of grant, unless a lower value is approved
by the Board of Directors. Incentive stock options granted to stockholders who
own greater than 10% of the outstanding stock are for periods not to exceed
five years and must be issued at prices not less than 110% of the fair market
value of the stock on the date of grant.
Options granted under the 1998 Plan vest in steps over a four-year period,
from commencement date, with the first 25% vesting after one year, and the
remainder vesting in 36 equal monthly installments.
Prime Response accounts for stock options granted to employees in accordance
with the provisions of Accounting Principles Board Opinion No. 25. In
connection with the grant of certain stock options to employees during the
period from commencement of the 1998 Plan (April 1998) to December 31, 1998 and
during the years ended December 31, 1999 and 2000, Prime Response recorded
deferred stock compensation of none, $2,602,000 and $327,000 respectively,
representing the difference between the estimated fair market value of the
common stock on measurement date and the exercise price. Compensation related
to options which vest over time was recorded as a component of stockholders'
deficit and is being amortized over the vesting periods of the related options.
Prime Response recorded compensation expense of none, $205,000 and $822,000 in
1998, 1999 and 2000, respectively relating to the amortization of deferred
compensation recorded during the years ended December 31, 1999 and 2000, and
the acceleration of a former employees' options. Compensation expense related
to restricted shares was recorded on grant date. Prime Response recorded
compensation expense of none, $1,677,000 and none in 1998, 1999 and 2000,
respectively, in relation to these restricted shares. Compensation expense
related to remeasurement of stock options due to extensions of exercise periods
was recognized on the remeasurement date. Prime Response recorded compensation
expense of none, $143,000 and none in 1998, 1999 and 2000, respectively, in
relation to these options. Compensation expense is disclosed as a non-cash
expense in the related Statement of Operations line items.
In November 1999, the 1999 Employee Stock Purchase Plan was adopted by its
board of directors, and approved by its stockholders in January 2000. The 1999
plan authorizes the issuance of up to a total of 300,000 shares of common stock
to participating employees. The purchase plan permits participants to purchase
common stock through payroll deductions. Under the terms of the 1999 Plan, the
option price is an amount equal to 85% of the average market price (as defined)
per share of the common stock on either the first day or
F-52
15
PRIME RESPONSE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
the last day of the offering period. As of December 31, 2000, no shares of
common stock had been issued under this plan.
Prime Response's 1999 Outside Director Stock Option Plan was adopted by its
board of directors in November 1999 and approved by its stockholders in January
2000. Under the terms of the Director Plan, directors who are not employees of
Prime Response or its subsidiaries receive nonstatutory options to purchase
shares of its common stock. A total of 200,000 shares of Prime Response common
stock may be issued upon exercise of options granted under the Director Plan.
As of December 31, 2000, options to purchase an aggregate of 80,000 shares of
common stock were outstanding under the 1999 Outside Directors Stock Option
Plan. As of December 31, 2000, no shares of common stock had been issued upon
exercise of options outstanding under this plan.
During the year ended December 31, 2000, Prime Response issued 40,000 stock
options to members of its newly formed Marketing Advisory Board. The options
were immediately vested. In connection with this grant, Prime Response recorded
a non-cash compensation expense of $313,000 using the Black Scholes model.
Valuation of Stock Options
Had compensation expense for the Plans been determined based upon the
estimated grant date fair value pursuant to SFAS 123, Prime Response's net loss
for years ended December 31, 1999 and 2000 would have been as follows:
Year Ended Year Ended Year Ended
December 31, December 31, December 31,
1998 1999 2000
------------ ------------ ------------
Net loss (in thousands):
As reported....................... $(14,603) $(20,419) $(27,590)
Pro forma......................... $(14,710) $(20,574) $(29,474)
Net loss per share attributable to
common stockholders--basic and
diluted:
As reported....................... $ (2.36) $ (3.44) $ (3.77)
Pro forma......................... $ (2.38) $ (3.46) $ (3.88)
As additional option grants are expected to be made subsequent to December
31, 2000 and most options vest over several years, the above pro forma effects
are not necessarily indicative of the pro forma effects on future years.
The fair value of these stock awards at the date of grant was estimated
using the minimum value method for the year ended December 31, 1999. The
determination of the fair value of all options granted during the year ended
December 31, 2000 included an expected volatility factor. The following table
summarized these assumptions:
Year Ended Year Ended Year Ended
December 31, December 31, December 31,
1998 1999 2000
------------ ------------ ------------
Risk free interest rate............... 5.24% 5.43% 6.34%
Dividend yield........................ 0% 0% 0%
Expected volatility................... 0% 0% 120%
Expected life......................... 10 years 10 years 4.4 years
F-53
16
PRIME RESPONSE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Summary of Stock Options
A summary of the status of Prime Response's options as of December 31, 1999
and 2000 and changes during the periods then ended are presented below.
Year Ended Year Ended Year Ended
December 31, 1998 December 31, 1999 December 31, 2000
------------------ -------------------- --------------------
Weighted- Weighted- Weighted-
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
------- --------- --------- --------- --------- ---------
Outstanding at beginning
of period.............. -- -- 736,538 $3.41 1,358,279 $ 4.91
Granted............... 783,600 $3.41 1,613,144 5.98 1,387,263 10.33
Exercised............. -- -- (668,006) 6.52 (128,245) 4.30
Cancelled............. (47,062) 3.41 (323,397) 3.49 (423,762) 10.73
------- ----- --------- ----- --------- ------
Outstanding at end of
period................. 736,538 $3.41 1,358,279 $4.91 2,193,535 $ 7.25
======= ===== ========= ===== ========= ======
Options available for
grant at end of
period................. 775,462 1,246,937 483,443
======= ========= =========
Options granted at fair
value:
Weighted average
exercise price....... $ 3.41 $ 4.31 $ 10.33
======= ========= =========
Weighted average fair
value................ $ 1.42 $ 1.72 $ 5.50
======= ========= =========
Options granted below
fair value:
Weighted average
exercise price....... $ 3.41 $ 6.09 $ --
======= ========= =========
Weighted average fair
value................ $ 1.82 $ 7.45 $ --
======= ========= =========
The following table summarizes information about stock options outstanding
at December 31, 2000:
Weighted- Vested and Exercisable
Weighted Average ------------------------
Average Remaining Number
Range of Exercise Number Contractual of Weighted-Average
Exercise Prices Price Outstanding Life (in Years) Shares Exercise Price
--------------- -------- ----------- --------------- ------ ----------------
$2.91-$4.31 $ 3.71 815,737 8.2 427,782 $ 3.66
5.88-8.00 7.23 724,719 9.1 149,134 6.89
9.38-12.00 10.21 532,829 9.3 42,961 9.80
14.88-18.00 16.16 100,250 9.2 40,000 18.00
29.06 29.06 20,000 9.2 20,000 29.06
------ --------- --- ------- ------
$ 7.25 2,193,535 8.8 679,877 $ 6.35
====== ========= === ======= ======
Issuance of Warrants
During 1999, Prime Response issued warrants to purchase up to 313,000 and
251,000 shares of Prime Response's Common Stock at an exercise price of $3.41
and $.01 per share, respectively, in conjunction with the Series B and Series C
preferred stock issuance, respectively. The warrants have terms of five years
and seven years, respectively. The fair value of these warrants was determined
to be $2.69 and $11.84 per share, respectively, using the Black-Scholes option
pricing model, based on the following assumptions: 85.00% volatility, a term of
five and seven years, respectively, and interest rates of 5.87% and 6.07%,
respectively. The value of the warrants have been recorded as $720,000 and
$609,000, respectively, and have been included in
F-54
17
PRIME RESPONSE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
additional paid in capital. During the year ended December 31, 2000, the
warrants to purchase 251,000 shares of Common Stock for $0.01 per share were
exercised.
During 1999, Prime Response issued 682,000 warrants to Accenture to purchase
682,000 shares of common stock. During 2000, Prime Response issued warrants to
purchase 31,500 shares of common stock to Accenture. See details of these
warrant issuances in Note 7.
Shareholder Note Receivable and Restricted Stock
At December 31, 2000, Prime Response held a note receivable in the amount of
$2,545,000 from an employee shareholder in consideration for the issuance of
restricted stock. The note is non-interest bearing and is due on January 31,
2009. Imputed interest of $1,678,000 had been recorded for this note and will
be amortized as income over the life of the loan. Compensation expense of
$1,678,000 for the discount from fair value due to imputed interest was
recognized during 1999 at the time the shares were issued. Shares vest and
restrictions lapse in accordance with the terms of the 1998 Stock Option/Stock
Issuance Plan. In the event employment is terminated, Prime Response can elect
to repurchase, and the employee is obligated to sell, any of the vested shares
for fair market value and any unvested shares for the original purchase price.
In the event of a change of control, all of the restrictions on this stock will
terminate. During 1999, 636,000 shares of common stock were issued subject to
such time-based restrictions and 345,000 remain unvested at December 31, 2000.
7. Accenture (formerly Andersen Consulting) Relationship
On December 6, 1999, Prime Response and Accenture entered into a joint
marketing agreement and, along with an affiliate of Accenture, a stock and
warrant purchase agreement. Pursuant to the stock and warrant purchase
agreement, Accenture purchased 428,000 shares of common stock and Accenture
received a warrant to purchase 682,000 shares of common stock. This warrant has
an exercise price of $9.35 per share and vests September 9, 2000. The aggregate
purchase price paid by Accenture for the common stock and this warrant was
$4,000,000. Accenture has no performance obligations under the stock and
warrant purchase agreement or this warrant. Prime Response has recorded the
stock at $9.35 per share. The fair value of the stock is $4,622,400. Prime
Response calculated the fair value of the warrants on date of grant using Black
Scholes model with the following assumptions: 7 year useful life (life of
warrant), 6.07% risk-free interest rate, zero dividends and 85.19% volatility.
Based on this calculation, the extended fair value of the warrants is
$6,536,080. Prime Response has recorded an intangible asset of $7,158,000 which
is equal to the excess of the aggregate fair values of the common stock and
warrants over the purchase price. This asset is being amortized as a non-cash
sales and marketing expense over its estimated useful life of four years, which
reflects the term of the marketing agreement. As of December 31, 1999 and 2000
accumulated amortization of this intangible was $147,000 and $2,088,000,
respectively.
Prime Response issued a performance warrant to purchase 375,000 shares of
common stock to Accenture. Of this amount, 300,000 shares will vest in share
increments determined by the extent to which $2.0 billion exceeds $357.8
million (which represents Prime Response's market capitalization at the time of
its initial public offering.) An additional 75,000 shares will vest in
increments of 7,500 shares for each $100.0 million that market capitalization
exceeds $2.0 billion, up to a maximum market capitalization of $3.0 billion.
This warrant has an exercise price of $9.35 per share. As of December 31, 2000,
there had not been any vesting of the performance warrants mentioned above.
Prime Response also issued a performance warrant to purchase 375,000 shares of
common stock to Accenture which will vest in increments of 10,500 shares for
each $1.0 million of sales resulting from joint marketing efforts up to $25
million and then in increments of 4,500 shares for each $1.0 million of sales
from $25 million to $50 million. As of December 31, 2000, warrants to purchase
31,500 shares of Prime Response common stock underlying the warrants had
vested.
F-55
18
PRIME RESPONSE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
All warrants have a seven-year term. In the event that the marketing
agreement is terminated as a result of a breach by Accenture, no further
vesting under the warrants will occur, but those warrants already exercisable
will remain exercisable during their term to the extent they are vested at the
time of termination.
Prime Response is obligated to pay Accenture a commission if designated
sales targets are met. The first five transactions were paid at a commission
rate of 50%, and all subsequent transactions will be paid at a commission rate
of 20%. The first five transactions were completed during the second quarter of
2000 and Prime Response paid $1,200,000 to Accenture. During the remainder of
2000, as a result of additional transactions, Prime Response recorded a
commission payable to Accenture in the amount of $250,000. The commissions are
included in sales and marketing expenses. In addition, if designated sales
targets are met, Accenture is obligated to provide up to $1,000,000 in funding
for joint marketing efforts, business development personnel, structure feedback
and sales support. The majority of the approximately $1,450,000 worth of
commission earned by Accenture in the year ended December 31, 2000 will be used
to fund these activities. The expenditure of these funds is controlled by a
committee comprised of both Accenture and Prime Response personnel. As of
December 31, 2000, $305,000 had been funded for joint marketing activities.
In addition, Prime Response is obligated to engage Accenture for consulting
services in connection with its services worth at least $1,000,000 before
December 31, 2001. As of December 31, 2000, Prime Response had engaged
Accenture for approximately $1,010,000 worth of consulting services.
8. Commitments and Contingencies
Leases
Prime Response has several operating lease agreements primarily involving
real estate and computers and equipment. These leases are noncancelable and
expire on various dates through 2013. Rent expense for operating leases
totaled, $2,291,000, $2,465,000 and $3,083,000 for the years ended December 31,
1998, 1999, and 2000, respectively. Future minimum rental payments under leases
are as follows:
Operating Capital
--------- -------
(in thousands)
Year ending December 31,
2001...................................................... $1,478 $46
2002...................................................... 1,079 40
2003...................................................... 1,013 --
2004 ..................................................... 837 --
2005...................................................... 758 --
Thereafter ............................................... 4,014 --
------ ---
Total future minimum lease payments ...................... $9,179 $86
====== ---
Less: portion representing interest ...................... 9
---
$78
===
9. Income Taxes
Prime Response, Inc.'s statutory and effective tax rates were 34% and 0%,
respectively, for each of the years ended December 31, 1999 and 2000. The
effective tax rate was 0% due to net operating losses ("NOL") and
nonrecognition of any deferred tax asset.
F-56
19
PRIME RESPONSE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Deferred tax assets (liabilities) are comprised of the following (in
thousands):
December 31,
------------------
1999 2000
-------- --------
Net operating loss carryforwards......................... $ 8,708 $ 17,891
Other deferred tax assets................................ 1,412 3,151
-------- --------
Gross deferred tax asset................................. 10,120 21,042
Valuation allowance...................................... (10,120) (21,042)
-------- --------
Net deferred taxes....................................... $ -- $ --
======== ========
Prime Response, Inc. has provided a full valuation allowance for the
deferred tax assets since it is more likely than not that these future benefits
will not be realized. If Prime Response, Inc. achieves profitability, a
significant portion of these deferred tax assets could be available to offset
future income taxes.
At December 31, 2000, Prime Response, Inc. has federal and state net
operating loss carryforwards of approximately $25,000,000 available to reduce
future federal and state income taxes payable. These net operating loss
carryforwards begin to expire in 2017 for federal purposes and 2002 for state
purposes. Prime Response, Inc. also has non-US net operating loss carryforwards
of $27,000,000, some of which begin to expire in 2003.
Ownership changes, as defined in the Internal Revenue Code, including those
resulting from the issuance of common stock in connection with an initial
public offering, may limit the amount of net operating loss and tax credit
carryforwards that can be utilized to offset future taxable income or tax
liability. The amount of the annual limitation is determined in accordance with
Section 382 of the Internal Revenue Code.
10. Segment Analysis
Prime Response earned all of its revenue from external customers. Prime
Response is organized into three segments, software licenses, services and
support and applications hosting, to reflect the key sales lines. The segment
information includes an allocation of certain corporate costs such as
depreciation, amortization and rent expense. The distribution of revenues and
total assets by geographic location is as follows (in thousands):
Year Ended December 31,
-------------------------------------------------------------------------------------------------
1998 1999 2000
-------------------------------- ------------------------------ --------------------------------
Rest Rest Rest
of of of
US UK World Total US UK World Total US UK World Total
------ ------- ------ ------- ------- ------- ------ ------- ------- ------- ------ -------
Revenues:
Software licenses...... $3,295 $ 5,094 $ 106 $ 8,495 $ 1,462 $ 7,797 $ 875 $10,134 $ 7,064 $ 6,241 $2,445 $15,750
Services and support... 1,075 3,104 35 4,214 2,025 4,092 402 6,519 3,387 5,439 1,080 9,906
Applications hosting... -- 3,827 -- 3,827 -- 3,869 -- 3,869 -- 3,207 -- 3,207
------ ------- ------ ------- ------- ------- ------ ------- ------- ------- ------ -------
Total revenues......... $4,370 $12,025 $ 141 $16,536 $ 3,487 $15,758 $1,277 $20,522 $10,451 $14,887 $3,525 $28,863
====== ======= ====== ======= ======= ======= ====== ======= ======= ======= ====== =======
Gross profit:
Software licenses...... $3,290 $ 4,947 $ 106 $ 8,343 $ 1,462 $ 7,797 $ 875 $10,134 $ 6,985 $ 6,241 $2,445 $15,671
Services and support... (631) (1,597) (35) (2,263) 118 1,745 21 1,884 (659) 1,886 517 1,744
Applications hosting... -- 1,350 -- 1,350 -- 1,093 -- 1,093 -- (107) -- (107)
------ ------- ------ ------- ------- ------- ------ ------- ------- ------- ------ -------
Total gross profit..... $2,659 $ 4,700 $ 71 $ 7,430 $ 1,580 $10,635 $ 896 $13,111 $ 6,326 $ 8,020 $2,962 $17,308
------ ------- ------ ------- ------- ------- ------ ------- ------- ------- ------ -------
Total assets......... $3,847 $ 3,555 $2,750 $10,152 $13,481 $11,392 $ 642 $25,515 $39,835 $10,558 $ 689 $51,082
====== ======= ====== ======= ======= ======= ====== ======= ======= ======= ====== =======
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PRIME RESPONSE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
11. Acquisitions
On January 19, 1998, Prime Response acquired certain intellectual property
rights and other intangible assets related to the MIND software business from
an Irish company, Admiral IT Services Limited, for consideration of $2,812,000.
The acquisition was accounted for under the purchase method of accounting. The
purchase price has been allocated to the assets acquired based upon the fair
market values as determined by Prime Response at the date of acquisition and
will be amortized on a straight-line basis over the estimated economic lives of
two years, principally for goodwill.
At December 31, 1999 and 2000 Prime Response had accumulated amortization
relating to this intangible asset of $2,560,000 and $2,812,000, respectively.
12. Quarterly Results of Operations (Unaudited)
The following is a summary of the unaudited quarterly results of operations
for the periods shown (in thousands, except per share data):
Year Ended December 31,
------------------------------------------------------------------------
1999 2000
----------------------------------- -----------------------------------
First Second Third Fourth First Second Third Fourth
Quarter Quarter Quarter Quarter Quarter Quarter Quarter Quarter
------- ------- -------- ------- -------- ------- ------- -------
Revenues................ $ 3,782 $ 5,081 $ 4,204 $ 7,455 $ 7,535 $ 9,033 $ 6,938 $ 5,357
Loss before income
taxes.................. (3,832) (4,502) (7,178) (4,892) (5,058) (6,094) (8,022) (8,490)
Net loss................ (3,833) (4,503) (7,185) (4,898) (5,076) (6,002) (8,022) (8,490)
Net loss attributable to
common stockholders.... $(4,444) $(5,180) $(10,253) $(5,576) $(46,310) $(6,002) $(8,022) $(8,490)
Net loss per share--
basic and diluted
diluted................ $ (0.64) $ (0.73) $ (1.35) $ (0.72) $ (3.99) $ (0.30) $ (0.39) $ (0.41)
13. Related Party Transactions
During the years ended December 31, 1999 and 2000, Prime Response made sales
totaling $540,000 and $345,000 to a company which is partly owned by a
significant shareholder of Prime Response. At December 31, 2000, $136,000
remained outstanding from this related party.
During the years ended December 31,1999 and 2000, Prime Response made sales
totaling $27,000 and $391,000 to a company which is partly owned by a
significant shareholder and which one of our Directors holds a directorship
position. At December 31, 2000, $71,000 remained outstanding from this related
party.
There were no material related party transactions during the year ended
December 31, 1998.
14. Employee Benefit Plan
Prime Response offers a 401(k) plan to its United States employees who meet
certain defined requirements. Under the terms of the 401(k) plan, eligible
employees may elect to make tax-deferred contributions, and Prime Response may
match 25% of the lesser of the contributing employee's elective deferral or 4%
of the contributing employee's total salary. During the year ended December 31,
1998, 1999 and 2000, Prime Response contributed approximately $11,000, $20,000
and $63,000 respectively, to the 401(k) plan.
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