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 September 30, 2001
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: 001-16073
OPENWAVE SYSTEMS INC.
(Exact name of registrant as specified in its charter)
Delaware
(State or other jurisdiction of incorporation or organization)
94-3219054
(I.R.S. Employer Identification No.)
1400 Seaport Blvd.
Redwood City, California 94063
(Address of principal executive offices, including zip code)
(650) 480-8000
(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 October 31, 2001 there were 173,928,080 shares of the registrant's Common
Stock outstanding.
1
OPENWAVE SYSTEMS INC. AND SUBSIDIARIES
INDEX
PART I. FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements (Unaudited)
Condensed Consolidated Balance Sheets as of September 30, 2001
and June 30, 2001 ................................................. 3
Condensed Consolidated Statements of Operations for the three-month
periods ended September 30, 2001 and 2000 ......................... 4
Condensed Consolidated Statements of Cash Flow for the three-month
periods ended September 30, 2001 and 2000 ......................... 5
Notes to Condensed Consolidated Financial Statements ............... 6
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations ............................................. 15
Item 3. Quantitative and Qualitative Disclosures about Market Risk ......... 30
PART II. OTHER INFORMATION
Item 1. Legal Proceedings .................................................. 31
Item 2. Changes in Securities and Use of Proceeds........................... 31
Item 3. Defaults Upon Senior Securities..................................... 31
Item 4. Submission of Matters to a Vote of Security Holders................. 31
Item 5. Other Information................................................... 31
Item 6. Exhibits and Reports on Form 8-k ................................... 31
SIGNATURE ................................................................... 32
2
OPENWAVE SYSTEMS INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except per share amounts)
September 30, June 30,
2001 2001
ASSETS ------------- -------------
- -------------------------------------------------------------------------------
Current assets:
Cash and cash equivalents $ 165,628 $ 161,987
Short-term investments 138,127 186,506
Accounts receivable, net 134,083 153,701
Prepaid and other current assets 16,057 14,364
----------- -----------
Total current assets 453,895 516,558
Property and equipment, net 101,182 98,582
Long-term and restricted cash and investments 83,649 41,873
Deposits and other assets 15,183 11,774
Goodwill and other intangible assets, net 979,845 1,056,928
----------- -----------
$ 1,633,754 $ 1,725,715
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
- -------------------------------------------------------------------------------
Current liabilities:
Current portions of capital lease obligations and long-term debt $ 1,645 $ 1,776
Accounts payable 10,004 20,600
Accrued liabilities 65,022 54,370
Deferred revenue 67,740 90,262
----------- -----------
Total current liabilities 144,411 167,008
Capital lease obligations and long-term debt, less current portion 463 754
----------- -----------
Total liabilities 144,874 167,762
----------- -----------
Commitments and contingencies
Stockholders' equity:
Common stock 174 170
Additional paid-in capital 2,735,625 2,623,466
Deferred stock-based compensation (16,877) (6,079)
Treasury stock (1,300) -
Accumulated other comprehensive income (loss) 1,011 (247)
Notes receivable from stockholders (629) (684)
Accumulated deficit (1,229,124) (1,058,673)
----------- -----------
Total stockholders' equity 1,488,880 1,557,953
----------- -----------
$ 1,633,754 $ 1,725,715
=========== ===========
See accompanying notes to condensed consolidated financial statements.
3
OPENWAVE SYSTEMS INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
For the three months ended
September 30,
-----------------------------
2001 2000
-------------- -------------
Revenues:
License $ 88,285 $ 57,100
Maintenance and support services 19,196 10,540
Professional services 9,686 13,172
-------------- -------------
Total revenues 117,167 80,812
-------------- -------------
Cost of revenues:
License 4,220 5,639
Maintenance and support services 7,827 6,307
Professional services 5,906 8,000
-------------- -------------
Total cost of revenues 17,953 19,946
-------------- -------------
Gross profit 99,214 60,866
-------------- -------------
Operating expenses:
Research and development 38,409 27,160
Sales and marketing 47,754 33,580
General and administrative 18,422 10,749
Stock-based compensation 4,986 4,674
Amortization of goodwill and other intangible assets 159,017 158,414
Merger, acquisition and integration-related costs 570 -
-------------- -------------
Total operating expenses 269,158 234,577
-------------- -------------
Operating loss (169,944) (173,711)
Interest and other, net 3,470 8,313
-------------- -------------
Loss before income taxes
(166,474) (165,398)
Income taxes 3,977 2,623
-------------- -------------
Net loss $ (170,451) $ (168,021)
============== =============
Basic and diluted net loss per share attributable to common stockholders $ (0.99) $ (1.04)
============== =============
Shares used in computing basic and diluted net loss per share attributable to
common stockholders 171,352 162,026
============== =============
See accompanying notes to condensed consolidated financial statements.
4
OPENWAVE SYSTEMS INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
For the three months ended
September 30,
--------------------------
2001 2000
--------- ---------
Cash flows from operating activities:
Net loss ................................................................... $(170,451) $(168,021)
Adjustments to reconcile net loss to net cash used for operating activities:
Depreciation and amortization ......................................... 167,348 162,308
Amortization of deferred stock-based compensation ..................... 4,986 2,041
Employee stock-based compensation ..................................... - 1,674
Nonemployee stock-based compensation .................................. - 959
Loss on sale of assets ................................................ 138 -
Write-down of non-marketable securities ............................... 263 -
Provision for (recovery of) doubtful accounts ......................... (731) 9
Changes in operating assets and liabilities:
Accounts receivable .............................................. 20,349 (25,864)
Prepaid expenses and other assets ................................ (3,226) (7,804)
Accounts payable ................................................. (10,596) (4,131)
Accrued liabilities .............................................. 9,316 13,029
Deferred revenue ................................................. (22,522) 24,942
--------- ---------
Net cash used for operating activities ...................... (5,126) (858)
--------- ---------
Cash flows from investing activities:
Purchases of property and equipment ........................................ (10,648) (9,406)
Restricted cash and investments ............................................ (1,649) -
Investment in non-marketable equity securities ............................. (2,000) -
Purchases of short-term investments ........................................ (22,150) (68,053)
Proceeds from maturities of short-term investments ......................... 70,800 107,898
Acquisitions, net of cash acquired ......................................... 3,205 (19,795)
Purchases of long-term investments ......................................... (39,277) -
--------- ---------
Net cash provided by (used for) investing activities ........ (1,719) 10,644
--------- ---------
Cash flows from financing activities:
Net proceeds from issuance of common stock ................................. 1,556 12,817
Net proceeds from issuance of put options .................................. 10,460 -
Repayment of notes receivable from stockholders ............................ 55 80
Repurchase of treasury stock .............................................. (1,300) -
Repayments of capital lease obligations and long-term debt ................. (422) (826)
--------- ---------
Net cash provided by financing activities ................... 10,349 12,071
--------- ---------
Effect of exchange rate on cash and cash equivalents ............................ 137 165
--------- ---------
Net increase in cash and cash equivalents ....................................... 3,641 21,692
Cash and cash equivalents at beginning of period ................................ 161,987 120,585
--------- ---------
Cash and cash equivalents at end of period ...................................... $ 165,628 $ 142,277
========= =========
Supplemental disclosures of cash flow information:
Cash paid for income taxes ................................................. $ 959 $ 2,566
========= =========
Cash paid for interest ..................................................... $ 121 $ 293
========= =========
Noncash investing and financing activities:
Common stock issued and options assumed in acquisition ..................... $ 96,260 $ -
========= =========
Common stock issued to officers and employees for notes receivable ......... $ - $ 367
========= =========
Deferred stock-based compensation .......................................... $ 3,582 $ -
========= =========
See accompanying notes to condensed consolidated financial statements.
5
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2001
(1) Basis of Presentation
The accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with accounting principles generally accepted in the
United States of America 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 notes required by accounting principles generally
accepted in the United States of America 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 September 30, 2001 and June 30, 2001, and the results
of operations and cash flows for the three months ended September 30, 2001 and
2000. The following information should be read in conjunction with the audited
financial statements and accompanying notes thereto included in the Company's
Annual Report on Form 10-K for the year ended June 30, 2001.
On November 17, 2000, a subsidiary of the Company merged with and into
Software.com, Inc.(Software.com). The merger was accounted for as a pooling of
interests. Accordingly, the financial information has been restated to reflect
the combined financial position and operations of the Company and Software.com
for all dates and periods presented.
(2) Revenue Recognition
The Company's primary revenue categories consist of applications, including
e-mail and unified messaging products; infrastructure software, including Mobile
Access Gateway and Mobile Browser; and customer services, including maintenance
and support services and professional services. The Company licenses and
provides new version coverage for applications and infrastructure products
primarily to communication service providers through its direct sales force and
indirectly through its channel partners. The Company's license agreements for
such products do not provide for a right of return. Applications and
infrastructure products are licensed either under a perpetual license model or
under a monthly or quarterly time-based license model.
Cost of license revenues consists primarily of third-party license and support
fees. Cost of maintenance and support services revenues consists of compensation
and related overhead costs for personnel engaged in training and support
services to communication service providers and wireless device manufacturers.
Cost of professional services revenues consists of compensation and independent
consultant costs for personnel engaged in the professional services operations
and related overhead costs.
The Company recognizes revenue in accordance with Statement of Position 97-2,
Software Revenue Recognition (SOP 97-2), as amended by SOP 98-9, and generally
recognizes revenue when all of the following criteria are met as set forth in
paragraph 8 of SOP 97-2: (1) persuasive evidence of an arrangement exists, (2)
delivery has occurred, (3) the fee is fixed or determinable and (4)
collectibility is probable. The Company defines each of the four criteria above
as follows:
Persuasive evidence of an arrangement exists. It is the Company's customary
practice to have a written contract, which is signed by both the customer
and the Company, or a purchase order from those customers that have
previously negotiated a standard license arrangement.
Delivery has occurred. The Company's software may be either physically or
electronically delivered to its customer. Delivery is deemed to have
occurred upon the earlier of notification by customer of acceptance or
commercial launch of the software product by the customer. If undelivered
products or services exist in an arrangement that are essential to the
functionality of the delivered product, delivery is not considered to have
occurred until these products or services are delivered.
The fee is fixed or determinable. The fee the Company's communication
service provider customers pay for the Company's products is negotiated at
the outset of an arrangement, and is generally based on the specific volume
of customer activations. The Company's license fees are not a function of
variable-pricing mechanisms such as the expected number of users in an
arrangement. The Company's customary payment terms are such that a minimum
of 80% of the arrangement fee is due within one year or less. Arrangements
with payment terms extending beyond the customary payment terms are
considered not to be fixed or determinable. Revenue from such arrangements
is recognized as payments become due.
Collectibility is probable. Collectibility is assessed on a
customer-by-customer basis. The Company typically sells to customers for
which there is a history of successful collection. New customers are
subjected to a credit review process, which evaluates the customers'
financial positions and ultimately their ability to pay. If it is
determined from the outset of an
6
arrangement that collectibility is not probable based upon the Company's
credit review process, revenue is recognized on a cash-collected basis.
The Company allocates revenue on software arrangements involving multiple
elements to each element based on the relative fair values of the elements. The
Company's determination of fair value of each element in multiple-element
arrangements is based on vendor-specific objective evidence (VSOE). The Company
limits its assessment of VSOE for each element to the price charged when the
same element is sold separately. The Company has analyzed all of the elements
included in its multiple-element arrangements and determined that it has
sufficient VSOE to allocate revenue to new version coverage, maintenance and
support services and professional services components of its perpetual license
products. Accordingly, assuming all other revenue recognition criteria are met,
revenue from perpetual licenses is recognized upon delivery using the residual
method in accordance with SOP 98-9, and revenue from new version coverage and
maintenance and support services is recognized ratably over their respective
terms with new version coverage being included in license revenues. The Company
recognizes revenue from time-based licenses over the term of the license period.
Certain of the Company's licenses include unspecified additional products.
Revenue from contracts with unspecified additional products is recognized
ratably over the contract term. The Company recognizes revenue from licenses
that include unspecified additional software products and sold with extended
payment terms that are not considered to be fixed or determinable in an amount
that is the lesser of amounts due and payable or the ratable portion of the
entire fee.
For arrangements under which licenses are purchased under a perpetual license
model and maintenance and support fees are due on an as-deployed basis, but fees
are not considered fixed or determinable, license fees are recognized quarterly
as incremental subscribers are activated to use the services that are based on
the Company's products. For similar arrangements under which fees are considered
fixed or determinable, the Company recognizes the residual license amount after
deferral of the fair value of maintenance and support for the expected
deployment period.
The Company licenses its Mobile Browser software to wireless device
manufacturers through its direct sales force. The Company recognizes revenues
from Mobile Browser arrangements ratably over the period during which the
services are performed, generally one year. The Company provides its wireless
device manufacturer customers with support associated with their efforts to port
the Company's Mobile Browser software to their wireless devices, to correct
software errors and to make available new releases.
The Company provides integration services relating to the deployment of its
products. The Company's professional services generally are not essential to the
functionality of the software. The Company's software products are fully
functional upon delivery and implementation and do not require any significant
modification or alteration. Customers typically purchase these professional
services to facilitate the adoption of the Company's technology and dedicate
personnel to participate in the services being performed, but they may also
decide to use their own resources or appoint other professional service
organizations to provide these services. Software products are billed separately
and independently from professional services, which are generally billed on a
time-and-materials or milestone-achieved basis. The Company generally recognizes
revenue from professional services as the services are performed.
(3) Recent Accounting Pronouncements
In July 2001, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standard (SFAS) No. 141 Business Combinations (SFAS No.
141) and Goodwill and Other Intangible Assets (SFAS No. 142). SFAS 141 requires
that all business combinations be accounted for using the purchase method of
accounting; therefore, the pooling-of-interests method of accounting is
prohibited. SFAS No. 141 also requires that an intangible asset acquired in a
business combination be recognized apart from goodwill if: (i) the intangible
asset arises from contractual or other legal rights or (ii) the acquired
intangible asset is capable of being separated from the acquired enterprise, as
defined in SFAS No. 141. SFAS No. 141 is effective for all business combinations
completed by us after June 30, 2001.
For business combinations completed prior to July 1, 2001 and accounted for by
the purchase method, SFAS No. 141 provides that intangible assets that do not
meet the separate identifiable intangible asset criteria prescribed by this
pronouncement (e.g., assembled workforce, among others) be reclassified to
goodwill as of the date of adoption of SFAS No. 141. Conversely, if a portion of
the purchase price had been assigned to an intangible asset that meets the
criteria for recognition apart from goodwill and that intangible asset is
classified as part of goodwill for financial reporting purposes, the carrying
amount of that intangible asset must be reclassified and reported separately
from goodwill as of the date of adoption (July 1, 2002).
The Company applied the requirements of SFAS No. 141 to its acquisition of
Avogadro, Inc., during the quarter ended September 30, 2001 and will apply SFAS
No. 141 to all future acquisitions, if any.
7
SFAS No. 142 requires that goodwill not be amortized, but rather tested for
impairment at the "reporting unit level" (Reporting Unit) at least annually and
more frequently upon the occurrence of certain events, as defined by SFAS No.
142. A Reporting Unit is the same level, as or one level below, an "operating
segment," as defined by SFAS No. 131 Disclosures About Segments of an Enterprise
and Related Information. Our identifiable intangible assets are required to be
amortized over their useful life and reviewed for impairment in accordance with
SFAS No. 121 Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to be Disposed Of (SFAS No. 121). Goodwill is not tested for
impairment under SFAS No. 121, but instead is tested for impairment as
prescribed in SFAS No. 142.
SFAS No. 142 requires that goodwill be tested for impairment in a two-step
process. First, a company must compare the "estimated fair value" of a Reporting
Unit to its carrying amount, including goodwill, to determine if the fair value
of the Reporting Unit is less than the carrying amount, which would indicate
that goodwill is impaired. If the Company determines that goodwill is impaired,
the Company must compare the "implied fair value" of the goodwill to its
carrying amount to determine if there is an impairment loss. The "implied fair
value" is calculated by allocating the fair value of the Reporting Unit to all
assets and liabilities as if the Reporting Unit had been acquired in a business
combination and accounted for under SFAS No. 141.
For goodwill and intangible assets acquired in business combinations completed
prior to July 1, 2001, SFAS No. 142 is effective for us beginning on July 1,
2002. However, goodwill and intangible assets acquired in a business combination
completed after June 30, 2001 are required to be accounted for in accordance
with the provisions of SFAS No. 142 from the date of the acquisition.
As of September 30, 2001, the Company had net goodwill of approximately $1.0
billion. During the quarter ended September 30, 2001, the Company acquired
Avogadro, Inc. and recorded goodwill of approximately $79.7 million and acquired
intangibles of $2.3 million, of which only the intangible portion will be
amortized. Under the Company's current accounting treatment, the Company expects
to have amortization expense resulting from goodwill and intangibles of
approximately $636.1 million for the fiscal year ending June 30, 2002.
The Company is currently evaluating the impact the adoption of SFAS No. 141 and
142 may have on our financial position and results of operations; however, our
evaluation is not complete and is subject to change due to these pronouncements
being issued in late July 2001 and due to our expectations that the FASB will
issue further guidance with respect to adoption of both SFAS No. 141 and 142.
(4) Business Combinations
(a) Poolings of Interests Acquisition
Software.com
On November 17, 2000, the Company merged with Software.com in a transaction that
was accounted for as a pooling-of-interests. Accordingly, the financial
information presented reflects the combined financial position and operations of
the Company and Software.com for all dates and periods presented. Software.com
was incorporated in October 1994. Software.com developed Internet infrastructure
software based on open standards and protocols for Internet and
telecommunications service providers. The Company issued 94,506,060 shares of
its common stock in exchange for all of the issued and outstanding common stock
of Software.com. The Company also reserved 12,520,161 shares for issuance in
connection with the assumption of Software.com's outstanding options, and
employee stock purchase plans. In connection with the merger, the Company and
Software.com have incurred approximately $89.4 million in merger and integration
expenses through the ten months ended September 30, 2001, of which $570,000 were
incurred during the three months ended September 30, 2001.
8
Separate operating results of the combined entities prior to their date of
combination for the three months ended September 30, 2001 and 2000, are shown
below (in thousands).
For the three months
ended September 30,
------------------------
2001 2000
--------- ---------
Revenues:
Openwave ........................ $ 117,167 $ 46,473
Software.com .................... - 34,339
--------- ---------
Combined ................... $ 117,167 $ 80,812
========= =========
Net loss:
Openwave ........................ $(170,451) $(165,214)
Software.com .................... - (2,807)
--------- ---------
Combined ................... $(170,451) $(168,021)
========= =========
The above pro-forma data primarily excludes revenues and cost of revenues
between the combined entities as of September 30, 2000 of $3.3 million and $1.2
million, respectively.
(b) Purchase Acquisition
On July 13, 2001, the Company consummated an agreement to acquire 100% of the
outstanding common stock of Avogadro, Inc. (Avogadro), a telecommunications
infrastructure software developer. As a result of the acquisition, the Company
will be able to offer a broader suite of its infrastructure products. The
acquisition was accounted for as a purchase and, accordingly, the operations of
Avogadro have been included in the consolidated financial statements since that
date. The total purchase price of the acquisition was allocated as follows (in
thousands):
Allocated Purchase Price Components
- --------------------------------------------------------------------------------------
Deferred Net Tangible
Purchase Developed Stock-Based Assets
Price Goodwill Technology Compensation Acquired
- ------- ------- ---------- ------------ ------------
$97,760 $79,660 $2,270 $11,900 $3,930
The net tangible assets of approximately $3.9 million are comprised of cash of
$3.6 million, prepaid assets of $140,000, fixed assets of $420,000, offset by
assumed liabilities of $260,000.
The developed technology is being amortized over its estimated useful life,
which is a period of three years. The Company also acquired the majority of the
employees of Avogadro, including its engineering team and expects to generate
revenue from future products derived from the acquired developed technology and
related support and maintenance services. Under SFAS No. 141, the fair value of
the acquired assembled workforce does not meet the criteria for separate
recognition and thus is included as part of the goodwill acquired. Likewise, the
fair value of the revenue expected to be derived from future products and
maintenance and support revenues are included as part of goodwill. The Company
paid the following (in thousands):
Purchase Price
- -----------------------------------------------------------------------------------
Assumption of Closing and
Common Stock Stock Options related costs Total
- ----------------------- ------------------- ---------------- -------
Shares Amount Shares Amount
- ------ ------ ------ ------
2,628 $94,002 72 $2,258 $ 1,500 $97,760
The value of the common stock issued was determined based on the average market
price of the Company's common stock over the five trading day period beginning
two trading days prior to the announcement date of the acquisition. The options
assumed in the above acquisitions were valued using the Black-Scholes option
pricing model with the following weighted average assumptions: expected life of
2 years; 0% dividend yield; 129% volatility and risk free interest rate of 5.5%.
The following table shows unaudited pro forma revenue, basic and diluted net
loss per share of the Company, including the results of Avogadro as if Avogadro
had been acquired as of July 1, 2000 (in thousands, except per share data). Pro
forma net
9
income for the three months ended September 30, 2000 and 2001 includes the
impact of amortization of goodwill and intangible assets and deferred
stock-based compensation of $2.2 million and ($665,000), respectively.
For the three months ended
September 30,
--------------------------
2001 2000
--------- ---------
Revenue ...................................... $ 117,167 $ 80,812
========= =========
Net loss ..................................... $(169,786) $(170,594)
========= =========
Basic and diluted net loss per share ......... $ (.99) $ (1.03)
========= =========
Shares used in pro forma basic and
diluted per share computation ............... 171,352 164,776
========= =========
The pro forma results are not necessarily indicative of what would have occurred
if the acquisition had been in effect for the periods presented. In addition,
they are not intended to be a projection of future results and do not reflect
any synergies that might be achieved from combined operations.
(5) Geographic, Segment, Significant Customer Information
The Company's chief operating decision maker is 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. The Company operates in one distinct operating segment:
the development and delivery of applications, infrastructure software and
customer services for communication service providers. The disaggregated
information reviewed on a product category basis by the CEO includes:
Applications, Infrastructure Software, and Customer Services.
Applications enable end users to exchange electronic mail, facsimile, voice mail
and multimedia messages from personal computers (PC's), wireline telephones and
mobile devices. The Company's applications also include, but are not limited to,
e-mail and unified messaging products.
The Company's infrastructure software contains the foundation software required
to enable Internet connectivity to mobile devices and to build a rich set of
applications for mobile users. Infrastructure software includes, but is not
limited to, Mobile Access Gateway and Mobile Browser. One set of the
infrastructure software provides mobile location and presence information and a
directory that serves as a standards-based repository of information about users
and devices in the network. In addition, another set of the infrastructure
software for mobile devices and PC's enables Internet connectivity, Web browsing
and synchronization of information among networks, mobile devices and PC's,
using a variety of protocols.
Finally, Customer Services are services provided by the Company to customers to
help them design, install, deploy, manage, maintain and support its products and
overall Internet implementations.
The disaggregated information reviewed on a product basis by the CEO is as
follows (in thousands):
Three months ended
September 30,
------------------
2001 2000
-------- -------
Revenue:
Applications ............................... $ 44,541 $26,924
Infrastructure software .................... 43,744 30,176
Customer services .......................... 28,882 23,712
-------- -------
$117,167 $80,812
======== =======
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
September 30,
------------------
2001 2000
-------- -------
Americas $ 41,647 $34,120
Europe, Middle East, Africa 31,426 23,136
Asia Pacific 44,094 23,556
-------- -------
$117,167 $80,812
======== =======
10
Information regarding the Company's revenues in different countries is as
follows (in thousands):
Three months ended
September 30,
------------------
2001 2000
-------- --------
United States.............................. $ 33,979 $29,493
Japan...................................... 36,594 14,892
United Kingdom............................. 12,349 11,263
Other foreign countries.................... 34,245 25,164
-------- -------
$117,167 $80,812
======== =======
The Company's long-lived assets residing in countries other than in the United
States are insignificant.
Significant customer information is as follows:
% of Total
% of Total Accounts
Revenue Receivables
Customer Three months ended September 30, September 30, 2001
- -------- -------------------------------- ------------------
2001 2000
------------ ------------
A 26% 14% 11%
B 8% 11% 6%
(6) Net Loss Attributable to Common Stockholders Per Share
Basic and diluted net loss attributable to common stockholders per share is
computed using the weighted-average number of outstanding shares of common stock
excluding shares of restricted stock subject to repurchase. The following
potential shares of common stock have been excluded from the computation of
diluted net loss attributable to common stockholders per share for all periods
presented because the effect would have been antidilutive (in thousands):
September 30
------------------
2001 2000
------ ------
Shares issuable under stock options ............... 17,513(a) 35,026
Shares of restricted stock
subject to repurchase ............................ 1,310 1,418
Shares issuable pursuant to warrants
to purchase common stock ......................... 237 237
(a) As a result of the stock option exchange program described in Note 10,
the Company is obligated to grant replacement options to acquire a maximum of
16.7 million shares of the Company's common stock. Also, the Company will be
granting the CEO 5.3 million shares in October 2001 as described in Note 12.
The weighted-average exercise price of stock options outstanding was $16.38 and
$46.15 as of September 30, 2001 and 2000, respectively. The weighted-average
purchase price of restricted stock was $0.07 and $0.09 as of September 30, 2001
and 2000, respectively. The weighted-average exercise price of warrants was
$2.38 as of September 30, 2001 and 2000.
11
(7) Long-term and restricted cash and investments
The following summarizes the Company's long-term investments and restricted cash
and investments (in thousands):
September 30, June 30,
2001 2001
------------- --------
Unrestricted investments at estimated
fair value (various maturities through the year
ended June 30, 2004) .............................. $ 61,300 $ 21,173
Restricted cash and investments .................... 22,349 20,700
---------- --------
$ 83,649 $ 41,873
========== ========
(8) Account Receivable, net
Accounts receivable is recorded net of allowance for doubtful accounts totaling
$9.7 million and $10.5 million as of September 30, 2001 and June 30, 2001,
respectively.
(9) Other Comprehensive Loss
Other comprehensive loss includes net loss, unrealized gains on marketable
securities, and foreign currency translation adjustments.
Other comprehensive loss is comprised of (in thousands):
For the three months
ended September 30,
----------------------
2001 2000
--------- ---------
Net loss ............................................ $(170,451) $(168,021)
Other comprehensive income:
Change in accumulated foreign currency translation
adjustment ...................................... 137 297
Change in accumulated unrealized gain on marketable
securities ...................................... 1,121 (165)
--------- ---------
Total comprehensive loss ............................ $(169,193) $(167,889)
========= =========
The components of accumulated other comprehensive income, net of tax, are as
follows (in thousands):
September 30, June 30,
2001 2001
------------- --------
Unrealized gain on investments ...... $ 1,197 $ 76
Cumulative translation adjustments... (186) (323)
--------- -------
Accumulated other comprehensive loss. $ 1,011 $ (247)
========= =======
(10) Tender Offer
On August 2, 2001, the Company announced a voluntary stock option exchange
program for its employees, except for the Company's Chief Executive Officer and
employees located in Australia, where such programs have certain undesirable tax
consequences. Members of the Company's Board of Directors and consultants
holding options also were ineligible to participate. Under the program, Company
employees had the opportunity to surrender previously granted outstanding stock
options in exchange for an equal or lesser number of replacement options to be
granted at a future date. Options to acquire a total of 35,832,309 shares of the
Company's common stock with exercise prices ranging from $163.13 to $0.01 were
eligible to be exchanged under the program. The Offer was open until 5:00 p.m.,
Pacific Daylight Time, on September 17, 2001.
As a result of the stock option exchange program, the Company is obligated to
grant replacement options to acquire a maximum of 16.7 million shares of the
Company's common stock. The exercise price of the replacement options will be
equal to the fair market value of the Company's common stock on the future date
of grant, which will be determined by the Compensation Committee of the Board of
Directors on a date falling between March 18, 2002, and April 17, 2002. The
program required a participant electing to exchange any options to also exchange
any other options granted to him or her during the six months before or after
September 17, 2001. The stock option exchange program was designed to comply
with Financial Accounting Standards
12
Board Interpretation No. 44, Accounting for Certain Transactions Involving Stock
Compensation, and is not expected to result in any additional compensation
charges or variable award accounting.
(11) Openwave Stock Repurchase Program
In September 2001, the Company announced that its Board of Directors had
authorized a stock repurchase program of up to 5 million shares. Any purchases
under the Company stock repurchase program may be made in the open market, in
privately negotiated transactions, or through the use of derivative securities.
As of September 30, 2001 the Company had repurchased 100,000 shares at a
weighted-average price of $13.00 on the open market and, therefore, had 4.9
million shares still available for repurchase under the current plan. In October
2001, the Company repurchased an additional 600,000 shares of a weighted-average
price of $7.73 on the open market, thereby leaving 4.3 million shares available
for repurchase under the current plan. As of September 30, 2001, the Company
also had sold 3.5 million put options under the program that entitle the holder
of each option to sell to the Company, for cash, by physical delivery or net
share settlement at the Company's election, one share of common stock at a
specified price. Should the put options become tendered to the Company at the
respective maturity dates, the potential cash outlay to repurchase the shares
would be $44.3 million. The cumulative net proceeds to the Company from the sale
of these put options total $10.5 million.
(12) Executive Stock Compensation
During the quarter ended September 30, 2001, the Compensation Committee of the
Board of the Company granted 210,000 restricted shares of the Company's common
stock to certain executive officers. The restricted shares will vest through
July 2003. During the quarter ended September 30, 2001, the Company recorded
deferred stock-based compensation totaling $3.6 million. The deferred
stock-based compensation consists of $3.15 million resulting from the grant of
the 210,000 restricted shares, and the remaining $450,000 arising from a loan
which contains a forgiveness feature made by the Company to an employee.
In April 2001, in consideration of the Chief Executive Officer's prior
cancellation of options to purchase a total of 6 million shares of the Company's
common stock, the Compensation Committee of the Board had agreed to grant the
CEO options to purchase a total of 5.8 million shares of the Company's common
stock on a date that falls between 6 and 7 months from the April 12, 2001
cancellation date. In October 2001, the CEO waived his right to the new options
with respect to 500,000 shares of the Company's common stock. Therefore, in
satisfaction of the Company's obligation to grant additional shares to the CEO,
the Company granted options to him to purchase a total of 5.3 million shares of
the Company's common stock. The new options have an exercise price equal to the
fair market value on the date of grant and the same 4-year vesting schedule and
vesting commencement date in September 2000 as the cancelled options. The
vesting of these shares are subject to acceleration in connection with a change
of control as provided in the CEO's employment agreement dated September 18,
2000.
(13) Commitments and Contingencies
On February 2, 2001, a complaint, Leon Stambler v. RSA Security Inc., Verisign
Inc., First Data Corporation, Openwave Systems Inc. and Omnisky Corporation,
Civil Action No. 01-0065, was filed in the U.S. District Court for the district
of Delaware against the Company and certain other companies. The complaint
alleges that the defendants have infringed claims of one or more patents that
Mr. Stambler asserts have been granted to him. On March 26, 2001, the Company
responded to the complaint. The Company denied the allegations that the Company
has infringed any claim in either of the patents asserted against the Company.
In addition, the Company asserted counterclaims against Mr. Stambler seeking a
declaratory judgment that the asserted patents are not infringed by the Company
and that the patents are also invalid and unenforceable. Although the parties
have exchanged some written discovery, discovery is still in its initial stages
and no trial date has been set. Based on the facts known to date, the Company
believes that it has meritorious defenses and claims, and does not believe
resolution of this matter will have a material adverse effect on the financial
condition of the Company.
On April 30, 2001, a complaint, Opuswave Networks, Inc. v. Openwave Systems Inc.
and Alain Rossmann, Civil Action No. 01-1681, was filed in the U.S. District
Court for the Northern District of California against the Company and a former
affiliate of the Company. The complaint alleges that the Company has infringed
claims of a common law trademark that Opuswave Networks asserts it has acquired.
On June 5, 2001, the Company responded to the complaint. The Company denied the
allegations that the Company has infringed any trademark rights asserted against
the Company. In addition, the Company asserted counterclaims against the
plaintiff seeking a declaratory judgment that the asserted trademark rights are
not infringed by the Company. On June 13, 2001, Opuswave Networks responded to
the counterclaims denying its allegations. Discovery has not commenced and no
trial date has been set. The Company and Opuswave Networks are engaged in
settlement discussions. Based on the facts known to date, the Company believes
that it has meritorious defenses and claims and intends to defend this suit if
the parties do not settle. The Company does not believe that resolution of this
matter will have a material adverse effect on the financial condition of the
Company.
Based upon certain publicly available information, on November 5, 2001, a
stockholder class action complaint was filed in the U.S. District Court for the
Southern District of New York against the Company, certain of the Company's
current and former officers and the underwriters of the Company's initial public
offering and secondary offering. The Company has not been formally served and,
as such, has not responded to the complaint. The complaint generally alleges
that the defendants made material misrepresentations and/or omissions in
prospectuses, dated June 10 and November 16, 1999, regarding certain alleged
excessive and undisclosed commissions received by the underwriters in connection
with the allocation of common stock in the Company's initial public offering and
secondary offering. Based upon the Company's current understanding of the facts,
the Company believes that the complaint is without merit, and does not believe
resolution of this matter will have a material adverse effect on the financial
condition of the Company.
13
(14) Subsequent Events
Restructuring
On October 29, 2001, the Company announced a restructuring plan in response to
current economic conditions that is expected to reduce the Company's workforce
to fewer than 2,000 employees. As of September 30, 2001, the Company had
approximately 2,300 employees. In connection with that reduction, the Company
expects to incur restructuring charges of approximately $35 to $40 million
during its second fiscal quarter ended December 31, 2001 to cover the costs of
severance, elimination of excess facilities and related leasehold improvements,
acceleration of the depreciation of certain property and equipment, and other
restructuring related charges. These charges will be recorded to align the
Company's cost structure with changing market conditions and to create a more
efficient organization.
14
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
Forward-Looking Statements
The following discussion contains forward-looking statements within the meaning
of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the
Securities Exchange Act of 1934, as amended. These forward-looking statements
are based upon current expectations and beliefs of our management and are
subject to certain risks and uncertainties, including economic and market
variables. Words such as "anticipates," "expects," "intends," "plans,"
"believes," "seeks," "estimates" and similar expressions identify such
forward-looking statements. These forward-looking statements are subject to
risks and uncertainties that could cause actual results to differ materially
from those indicated in the forward-looking statements. Factors which could
cause actual results to differ materially include those set forth in the risks
discussed below under the subheading "Risk Factors." We undertake no obligation
to revise or publicly release the results of any revision to these
forward-looking statements. Readers should carefully review the risk factors
described in this section below and in other documents the Company files from
time to time with the U.S. Securities and Exchange Commission (SEC) including,
but not limited to, the Company's mostly recently filed 10-K as filed on
September 28, 2001, and any subsequently filed reports.
Overview
We are a leading provider of infrastructure software, applications, and services
that enable the convergence of the Internet and wireless communications. We were
incorporated in Delaware in 1994. Our customers are primarily communication
service providers, including wireless and wireline carriers, Internet service
providers, portals and broadband providers worldwide. Our Openwave(TM) Services
Operating System (Services OS) is a suite of Internet protocol (IP) -based
software products designed to be installed on communication service providers'
systems. Services OS(TM) is designed to provide carrier-class scalability and
reliability and work with industry standards, such as WAP, XHTML, SyncML and
VoiceXML, to allow our operator customers to deploy our products and to
integrate our offerings into existing installed technology.
Using our software, communication service providers can offer Internet services
to their wireless and wireline subscribers, and wireless device manufacturers
can turn their mass-market mobile phones, personal digital assistants and other
wireless devices into mobile Internet appliances. Wireless subscribers thus can
gain access to Internet- and corporate intranet-based services, including
e-mail, news, stocks, weather, travel and sports. In addition, subscribers can
gain access via their wireless devices to communication service providers'
intranet-based telephony services, which can include over-the-air activation,
call management, billing history information, pricing plan subscription and
voice message management. As of September 30, 2001, we had 25.7 million active
mobile subscribers.
Communication service providers using our software can also provide their
subscribers with a variety of messaging applications, including e-mail, mobile
e-mail, unified messaging (single inbox for e-mail, voice mail, and facsimile)
as well as short messaging services. As of September 2001, we had 189.0 million
licensed mailbox seats and 40 predominantly wireline carriers with licensed
deployments of over one million mailbox seats each.
Our microbrowser software, Openwave Mobile Browser, is designed to be embedded
in wireless devices and to deliver the mobile Internet and the applications of
Services OS through a graphical user interface. As of September 30, 2001, over
166 million handsets have shipped with Mobile Browser embedded.
A majority of our sales have been to a limited number of customers, and sales
are highly concentrated. Sales to KDDI and its related entities accounted for
approximately 14% and 26% of total revenue for the three months ended September
30, 2000 and 2001, respectively. Sales to British Telecommunications PLC and its
related entities accounted for approximately 11% and 8% of total revenue for the
three months ended September 30, 2000 and 2001, respectively. No other customers
have accounted for 10% or more of total revenue for the three months ended
September 30, 2000 and 2001.
On August 8, 2000, Phone.com, Inc. and Software.com, Inc, signed an agreement to
merge the two companies subject to stockholder approval, regulatory reviews and
other conditions. On November 17, 2000, pursuant to the agreement, a
wholly-owned subsidiary of Phone.com was merged with and into Software.com so
that Software.com became a wholly-owned subsidiary of Phone.com. At the same
time, Phone.com changed its name to Openwave Systems Inc. The merger was
accounted for as a pooling-of-interests.
15
Donald Listwin, formerly an Executive Vice President of Cisco Systems, Inc.,
became the President and Chief Executive Officer of the combined company. In
June 2001, Mr. Listwin also became Chairman of the Board, replacing Alain
Rossmann, former Chief Executive Officer of Phone.com, who resigned from the
Company that same month.
In August 2001, Kevin Kennedy, a former Senior Vice President of Cisco Systems,
Inc., joined the Company to fill the newly-created position of Chief Operating
Officer (COO). At the same time, John MacFarlane, the former Executive Vice
President of Product Development was appointed to the newly-created position of
Chief Technology Officer (CTO).
Many of our customers have decreased or delayed commitments to purchase our
products due to continued weakness in the global economy, and, in particular,
across the communications industry. This, coupled with the events that occurred
on September 11/th/ and in its aftermath, have reduced the financial outlook for
these customers, as well as our financial outlook.
On October 29, 2001, in response to economic conditions, we announced a
restructuring plan that is expected to reduce our workforce by over 300
employees. In connection with that reduction, we will incur restructuring
charges expected to be approximately $35 to $40 million during the second
quarter ended December 31, 2001 to cover the costs of severance, elimination of
excess facilities and related leasehold improvements, acceleration of the
depreciation of certain property and equipment, and other restructuring-related
charges. These charges will be recorded to align our cost structure with
changing market conditions and to create a more efficient organization. We
expect that the realignment will result in modest operational cost savings
beginning in the second quarter ended December 31, 2001 and additional savings
in subsequent quarters.
We review our long-lived assets for impairment whenever events or changes in
circumstances indicate that the carrying amount (book value) of such assets may
not be recoverable. Long-lived assets include goodwill, identifiable intangible
assets, property and equipment, and investments in non-marketable securities.
Events or circumstances that can affect the carrying amount of these assets
include a decrease in the fair value of the underlying assets or a decrease in
the benefits realized from the acquired assets or a change or a change in the
operations of the acquired business. Fair value of identifiable intangible
assets and property and equipment will be determined by independent appraisal.
Fair value of goodwill will be determined by comparing our implied fair value,
based on market capitalization, to the fair value of our identifiable assets and
liabilities a manner similar to a purchase price allocation. Fair value of our
investments in non-marketable securities will be determined by the investments
current solvency, access to future capital, and the strategic importance to
Openwave's vision. Recoverability of these assets is measured by comparing the
carrying amount of each asset to the estimated future undiscounted net cash
flows we expect that asset to generate. If such assets are considered to be
impaired, the impairment to be recognized is measured by the amount by which the
carrying amount of its assets exceeds their fair value.
As of September 30, 2001, we had approximately $1.0 billion of goodwill and
other intangible assets, which were primarily related to the acquisitions of
APiON in October 1999, AtMotion in February 2000, Paragon in March 2000, and
Onebox in April 2000. Since the date of the acquisitions, there has been a
decline in our stock price such that our net book value has in the past and may
in the future exceed our market capitalization. Furthermore, the demand for our
services has been adversely affected by the general economic slowdown. As a
result of these circumstances, we have begun an analysis to determine whether an
impairment of our goodwill, other intangible assets and other long-lived assets
has occurred. This includes an analysis of estimated useful lives of the assets.
If the estimated future undiscounted net cash flows for the acquisitions are
insufficient to recover the carrying value of the assets over their estimated
lives, we will record an impairment of our goodwill, intangible assets and
property and equipment. Asset impairment charges will be recognized in the
quarter in which that analysis is concluded. Asset impairment charges of this
nature could be large and could have a material adverse effect on our financial
position and reported results of operations.
Results of Operations
Three Months ended September 30, 2000 and 2001
Revenues
We generate three different types of revenue. License revenues are primarily
associated with the licensing of our application and infrastructure software
products to communication service providers; maintenance and support revenues
are derived from providing support services to wireless device manufacturers and
communication services providers; and professional services revenues, which are
primarily a result of consultants providing deployment and integration services
to the communication service providers.
16
License Revenues
License revenues increased by 55% from $57.1 million for the quarter ended
September 30, 2000 to $88.3 million for the quarter ended September 30, 2001.
The increase in license revenues is due to an increase in our customer base and
the wider adoption of wireless and wireline data services generally, which
resulted in a higher number of active subscribers using our applications and
infrastructure software. License revenues represented 71% and 75% of total
revenues for quarters ended September 30, 2000 and 2001, respectively.
Maintenance and Support Services Revenues
Maintenance and support services revenues increased by 82% from $10.5 million
for the quarter ended September 30, 2000 to $19.2 million for the quarter ended
September 30, 2001. The increase in maintenance and support services revenues
reflects an increase in services provided to wireless device manufacturers and
increased support fees from communication service providers. Maintenance and
support services as a percent of total revenues represented 13% and 16% for
quarters ended September 30, 2000 and 2001, respectively.
Professional Services Revenues
Professional services revenues decreased by 26% from $13.2 million for the
quarter ended September 30, 2000 to $9.7 million in the quarter ended September
30, 2001. The $3.5 million decrease in professional services revenue was
primarily due to a decrease in the number of billable hours charged for
implementations and other professional services provided to new customers during
the quarter ended September 30, 2001 as compared to the quarter ended September
30, 2000. Professional services as a percent of total revenues represented 16%
and 8% for quarters ended September 30, 2000 and 2001, respectively.
Cost of License Revenues
Cost of license revenues consists primarily of third-party license and related
support fees, as well as costs associated with additional cost incurred due to
new product offerings. Cost of licenses decreased by 25% from $5.6 million for
the quarter ended September 30, 2000 to $4.2 million for the quarter ended
September 30, 2001. As a percentage of license revenues, costs of license
revenues represented 10% and 5% in the quarters ended September 30, 2000 and
2001, respectively. The $1.4 million decrease in cost of license revenues for
the quarter ended September 30, 2001 was primarily attributed to the reduction
of costs associated with our new product offerings as a result of the
subcontracting of such services to a third party. We anticipate the cost of
license revenues will remain constant as a percentage of related revenues in
future operating periods.
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 training and support services to
wireless device manufacturers and communication service providers. Cost of
maintenance and support services increased by 24% from $6.3 million for the
quarter ended September 30, 2000 to $7.8 million for the quarter ended September
30, 2001. As a percentage of maintenance and support services revenues, cost of
maintenance and support services revenues in the quarters ended September 30,
2000 and 2001 represented 60% and 41%, respectively. The $1.5 million increase
in cost of maintenance and support services was attributed to an increase in
personnel dedicated to support the growth in wireless device manufacturers and
communication service providers. We anticipate that the cost of maintenance and
support services will remain relatively constant as a percentage of related
revenues in future operating periods.
Cost of Professional Services Revenues
Cost of professional services revenues consists of compensation and independent
consultant costs for personnel engaged in our professional services operations
and related overhead. Cost of professional services revenues decreased by 26%
from $8.0 million in the quarter ended September 30, 2000 to $5.9 million for
the quarter ended September 30, 2001. As a percentage of professional services
revenues, cost of professional services revenues in the quarters ended September
30, 2001 and 2000 were 61% in each respective period. The $2.1 million decrease
in cost of professional services for quarter ended September 30, 2001 was
attributed to a decrease in professional services revenue. We anticipate that
the gross profit margin on professional services will remain relatively constant
in future operating periods.
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 by 41% from $27.2 million in the quarter ended September 30, 2000 to
$38.4 million in the quarter ended September 30, 2001. As a percentage of
revenues, research and development expenses remained
relatively flat from 34% for the quarter ended September 30, 2000 to 33% for the
quarter ended September 30, 2001. We anticipate that the cost of research and
development expenses will decrease in absolute dollars in future operating
periods as a result of our product realignment and restructuring plan.
Sales and Marketing Expenses
Sales and marketing expenses consist primarily of compensation and related costs
for sales and marketing personnel, sales commissions, marketing programs, travel
expenses, public relations, promotional materials and trade show exhibit
expenses. Sales and marketing expenses increased by 42% from $33.6 million for
the quarter ended September 30, 2000 to $47.8 million for the quarter ended
September 30, 2001. As a percentage of revenues, sales and marketing expenses
remained relatively flat from 42% for the quarter ended September 30, 2000 to
41% for the quarter ended September 30, 2001. We expect to decrease our sales
and marketing costs in absolute dollars in accordance with our restructuring
plan.
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 by 72% from $10.7 million for the quarter ended September 30, 2000 to
$18.4 million in the quarter ended September 30, 2001. As a percentage of
revenues, general and administrative expenses increased from 13% for the quarter
ended September 30, 2000 to 16% for the quarter ended September 30, 2001. The
increase in dollars was due primarily to the addition of personnel, additional
provisions for doubtful accounts, and to a lesser extent, legal expenses
associated with increased product licensing and patent activity. General and
administrative expenses are expected to decrease in absolute dollars.
Stock-Based Compensation Expense
Stock-based compensation expense totaled $4.7 million and $5.0 million for the
quarters ended September 30, 2000 and 2001, respectively. All stock-based
compensation expense is being amortized in a manner consistent with Financial
Accounting Board Interpretation No. 28. Stock-based compensation expense
remained relatively constant during the quarter ended September 30, 2001 as
compared to the quarter ended September 30, 2000, and consisted of continued
amortization of the deferred stock-based compensation expense related to
acquisitions, as well as compensation expense recognized on warrants and
restricted stock granted to executives. We expect stock-based compensation
expense to increase during the year ended June 30, 2002 as compared to June 30,
2001 as a result of acquisitions, including Avogadro, which was completed in
July 2001, and restricted stock granted to executives.
Amortization of Goodwill and Intangible Assets
Amortization of goodwill and intangible assets totaled $158.4 million and $159.0
million for the quarters ended September 30, 2000 and 2001, respectively, and
primarily resulted from our acquisitions of Telarc, APiON and Angelica in
October 1999 and the acquisitions of AtMotion in February 2000, Paragon in March
2000, Onebox in April 2000, bCandid and MyAble in June 2000, and Avogadro in
July 2001. Amortization of goodwill and other intangible assets is computed
using the straight-line basis over a three to five-year period. We expect
amortization of goodwill and other intangible assets will be approximately
$636.1 million for the fiscal year ending June 30, 2002. Consistent with FAS
142, goodwill resulting from the acquisition of Avogadro will not be amortized
and is, therefore, not included in estimated amortization for the fiscal year
ending June 30, 2002.
Merger and Integration costs
As a result of the merger with Software.com, we recorded merger and integration
costs of approximately $88.9 million during the year ended June 30, 2001. Merger
costs, which totaled approximately $79.8 million, were comprised of banker's
fees of $73.4 million, regulatory fees of $2.2 million, and professional
services of $4.2 million. Integration costs of approximately $9.1 million
related to the merger with Software.com included costs associated with the
Company's name change and other consulting fees. During the quarter ended
September 30, 2001, the Company increased its merger and integration costs by
$570,000 to a total of $89.5 million for the entire merger as a result of
additional professional services fees associated with the merger.
Interest and Other Income, Net
Interest and other income, net decreased by $4.8 million or 58% from $8.3
million in the quarter ended September 30, 2000 to $3.5 million for the quarter
ended September 30, 2001. The decrease is primarily attributed to a decrease in
interest income as prevailing interest rates declined as evidenced by the
federal funds rate, which averaged 6.50% during the quarter ended September 30,
2000 and averaged 3.6% during the quarter ended September 30, 2001, a decline of
2.9%. Accordingly, our yield on investments in marketable securities declined
approximately 2.4% from approximately 6.6% in the quarter ended September 30,
2000 to 4.2% in the quarter ended September 30, 2001.
18
Income Taxes
Income tax expense totaled $2.6 million and $4.0 million for the quarters ended
September 30, 2000 and 2001, respectively. Income taxes in all periods presented
consisted primarily of foreign withholding and foreign income taxes.
Liquidity and Capital Resources
As of September 30, 2001, we had $303.7 million of cash, cash equivalents and
short-term investments.
Net cash used for operating activities was $900,000 and $5.1 million for the
quarters ended September 30, 2000 and 2001, respectively. The net cash used
during the quarter ended September 30, 2001 was primarily attributable to a
decrease in deferred revenue of $22.5 million, a $10.6 million decrease in
accounts payable, and a $3.2 million increase in prepaid expenses and other
assets, offset by an increase in accounts receivable of $20.3 million and an
increase in accrued expenses of $9.3 million and after consideration of non-cash
depreciation and amortization expenses of $167.3 million.
Net cash provided by (used for) investing activities was $10.6 million and
$(1.7) million for the quarters ended September 30, 2000 and 2001, respectively.
The net cash used for investing activities during the quarter ended September
30, 2001 primarily reflected purchases of property and equipment of $10.6
million, the investment of $2.0 million in a private entity, and an increase in
restricted cash of $1.6 million, offset by net maturities from short-term and
long-term investments of $9.3 million, and net cash provided by acquisitions of
$3.2 million.
Net cash provided by financing activities was $12.0 million and $10.3 million
for the quarters ended September 30, 2000 and 2001, respectively. The net cash
provided by financing activities during the quarter ended September 30, 2001
primarily reflected $10.5 million in proceeds from the sale of put options and
$1.6 million from the exercise of stock options, offset by the repurchase of
treasury stock in the amount of $1.3 million and repayments of operating leases
and our equipment loans and capitalized lease obligations of $400,000.
As of September 30, 2001, our principal commitments consisted of obligations
outstanding under operating leases and our equipment loans, capitalized lease
obligations, and obligations under certain put options. On March 30, 2000, we
entered into a lease for approximately 280,000 square feet of office space in
Redwood City, California. The lease commenced upon completion of construction in
the fourth quarter of fiscal year ended June 30, 2001. The lease requires a base
rent of $3.25 per square foot per month and will increase by 3.5% annually. The
lease term is for a period of 12 years from the commencement date of the lease.
The lease required that we pay leasehold improvements that totaled $29.3 million
at September 30, 2001. The agreement further required that we provide a letter
of credit in the amount of $16.5 million. As of June 30, 2000, we guaranteed the
letter of credit and pledged approximately $20.7 million, or 125% of the letter
of credit. During the quarter ended September 30, 2001 we guaranteed additional
letters of credit and pledged approximately $1.6 million for additional new
locations outside Redwood City, California. The restricted cash and investments
held in trust under these agreements are earning approximately 4.2% interest,
and the resulting income earned is not subject to any restrictions. As of
September 30, 2001, the Company had a total maximum obligation that totaled
$44.3 million due to 3.5 million put options that the Company had sold for cash,
by physical delivery or net share settlement at the Company's election.
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 12 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 additional financing is
necessary and we are unable to obtain the 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.
Risk Factors
In addition to the other information in this report, the following factors
should be considered carefully in evaluating our business and prospects.
19
Because we have a limited operating history, it is difficult to evaluate our
business.
Because we commenced operation in 1994 and commercially released our first
products in 1996, we only have a limited operating history on which you can base
your evaluation of our business.
We may not continue to grow our business or reach profitability.
We face a number of risks encountered by early stage companies in the wireless
telecommunications and Internet software industries, including:
o our need for communication service providers to launch and maintain
commercial services utilizing our products;
o our substantial dependence on products with only limited market
acceptance to date;
o our need to introduce reliable and robust products that meet the
demanding needs of communication service providers and wireless device
manufacturers;
o our dependence on a limited number of customers;
o our ability to anticipate and respond to market competition;
o our dependence upon key personnel;
o the announcement or introduction of new or enhanced products or
services by our competitors;
o adverse customer reaction to technical difficulties or "bugs" in our
software;
o the growth rate and performance of wireless networks in general and
of wireless communications in particular;
o the volume of sales by our distribution partners and resellers;
o our pricing policies and those of our competitors; and
o our customers' willingness to incur the costs necessary to buy
third-party hardware and software required to use our software
products and any related price concessions on our product that our
customers demand as a result.
Our business strategy may not be successful, and we may not successfully address
these risks.
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:
o there is market acceptance of commercial services utilizing our
products;
o our competitors announce and develop, or lower the prices of,
competing products; and
o 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.
20
Our operating results are subject to significant fluctuations, and our stock
price may decline if we do not meet expectations of investors and analysts.
Our revenues and operating results are difficult to predict and may fluctuate
significantly from period to period due to a number of factors, some of which
are outside of our control. These factors include, but are not limited to:
o delays in market acceptance or implementation by our customers of our
products and services;
o changes in demand by our customers for additional products and
services;
o our lengthy sales and implementation cycles;
o 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 customer;
o introduction of new products or services by us or our competitors;
o delays in developing and introducing new products and services;
o changes in our pricing policies or those of our competitors or
customers;
o changes in our mix of domestic and international sales;
o risks inherent in international operations;
o changes in our mix of license, professional services and maintenance
and support services revenues;
o changes in accounting standards, including standards relating to
revenue recognition, business combinations and stock-based
compensation;
o general industry factors, including a slowdown in the
telecommunication industry, either temporary or otherwise; and
o general political and economic factors, including an economic
slowdown or recession.
Most of our expenses, such as compensation for current employees 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 period to period.
Due to the foregoing factors, we believe period-to-period comparisons of our
revenue levels and operating results are of limited use. You should not rely on
our period revenues and operating results to predict our future performance.
Our restructuring of operations may not achieve the results we intend and may
harm our business.
In October 2001, we announced plans to restructure our business to streamline
operations and reduce expenses, and which include cuts in discretionary
spending, reductions in capital expenditures, reductions in the work force and
consolidation of certain office locations, as well as other steps to reduce
expenses. The planning and implementation of our restructuring has placed, and
may continue to place, a significant strain on our managerial, operational,
financial, employee and other resources. Additionally, the restructuring may
negatively affect our employee turnover, recruiting and retention of important
employees. It is possible that these reductions could impair our marketing,
sales and customer support efforts or alter our product development plans. If we
are unable to implement our restructuring effectively, or if we experience
difficulties in carrying out the restructuring, our expenses could increase more
quickly than we expect. If we find that our planned restructuring does not
achieve our objectives, it may be necessary to implement further streamlining of
our expenses, to perform additional reductions in our headcount, or to undertake
additional restructurings of our business.
We may be unable to successfully integrate acquisitions of other businesses and
technologies into our business or achieve the expected benefits of such
acquisitions or business combinations.
21
To date, we have acquired (or combined with) numerous companies and technologies
and may acquire additional companies or technologies or enter into additional
business combinations in the future. We may not be able to successfully
assimilate the personnel, operations and customers of these businesses or
integrate their technology with our existing technology, products and services.
Additionally, we may fail to achieve the anticipated synergies from such
acquisitions, including product integration, marketing, product development,
distribution and other operations synergies.
Entering into any acquisition or business combination entails many risks, any of
which could materially harm our business, including:
o diversion of management's attention from other business concerns;
o failure to assimilate the acquired or combined businesses or
technologies with pre-existing businesses and technologies;
o potential loss of key employees from either our pre-existing business
or the acquired or merged business;
o dilution of our existing stockholders as a result of issuing equity
securities; and
o assumption of liabilities of the acquired or merged company,
business, or technology.
We may not be able to identify future suitable acquisition or business
combination candidates, and even if we do identify suitable candidates, we may
not be able to make these transactions on commercially acceptable terms, or at
all. If we do acquire companies, businesses, or technologies or combine with
other companies, we may not be able to realize the benefits we expected to
achieve at the time of entering into the transaction. As a result, we may incur
unexpected integration and product development expenses which could harm our
results of operations. Further, we may have to utilize cash reserves, incur debt
or issue equity securities to pay for any future acquisitions, the issuance of
which could be dilutive to our existing stockholders.
Our goodwill and other intangible assets may become impaired.
Due to rapidly changing market conditions, our goodwill and other intangible
assets may become impaired such that their carrying amounts may not be
recoverable, and we may be required to record an impairment charge impacting our
financial position. As of September 30, 2001, we had approximately $1.0 billion
of goodwill and other intangible assets, which were primarily related to the
acquisitions of APiON in October 1999, AtMotion in February 2000, Paragon in
March 2000, and Onebox in April 2000. Since the date of the acquisitions, there
has been a decline in our stock price such that our net book value has in the
past and may in the future exceed our market capitalization. Furthermore, the
demand for our services has been adversely affected by the general economic
slowdown. As a result of these circumstances, we have begun an analysis to
determine whether an impairment of our goodwill, other intangible assets and
other long-lived assets has occurred. This includes an analysis of estimated
useful lives of the assets. If the estimated future undiscounted net cash flows
for the acquisitions are insufficient to recover the carrying value of the
assets over their estimated lives, we will record an impairment of our goodwill,
intangible assets and property and equipment, asset impairment charges will be
recognized in the quarter in which that analysis is concluded. Asset impairment
charges of this nature could be large and could have a material adverse effect
on our financial position and reported results of operations.
We may not be successful in making strategic investments.
We have made, and in the future, we may continue to make strategic investments
in other companies. These investments have been made in, and future investments
will likely be made in, immature businesses with unproven track records and
technologies. Such investments have a high degree of risk, with the possibility
that we may lose the total amount of our investments. We may not be able to
identify suitable investment candidates, and, even if we do, we may not be able
to make those investments on acceptable terms, or at all. In addition, even if
we make investments, we may not gain strategic benefits from those investments.
Our sales cycle is long and our stock price could decline if sales are delayed
or cancelled.
Fluctuations in our operating performance are exacerbated by our sales cycle,
which is lengthy, typically between three months and twelve months, and
unpredictable. Many factors outside our control add to the lengthy education and
customer approval process for our products. 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. Further,
the emerging and evolving nature of the market for Internet-based services via
wireless devices may lead prospective customers to postpone their purchasing
decisions. Any delay in sales of our products could cause our operating results
to vary significantly from projected results, which could cause our stock price
to decline.
22
Our success depends on continued acceptance of our products and services by
communication service providers and their subscribers.
Our future success depends on our ability to increase revenues from sales of our
infrastructure software, applications and other services to communication
service providers. This dependence is exacerbated by the relatively small number
of communication service providers worldwide whose willingness to purchase our
products is critical to our success. To date, only a limited number of
communication service providers have implemented and deployed services based on
our products. Furthermore, we are dependent upon the carriers having growth in
subscriber adoption. We cannot assure you that communication service providers
will widely deploy or successfully market services based on our products, or
that large numbers of subscribers will use these services.
The market for the delivery of Internet-based services is rapidly evolving, and
we may not be able to adequately address this market.
The market for the delivery of Internet-based services is rapidly evolving. 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 could 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 communication service provider customers face implementation and support
challenges in introducing Internet-based services via wireless devices, which
may slow their rate of adoption or implementation of the services our products
enable. Historically, communication service providers have been relatively slow
to implement new complex services such as Internet-based services. In addition,
communication service providers may encounter greater customer service demands
to support Internet-based services via wireless devices than they do for their
traditional voice services. We have limited or no control over the pace at which
communication service providers implement these new services. The failure of
communication service providers to introduce and support services utilizing our
products in a timely and effective manner could harm our business.
We rely 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
communication service providers. Sales to KDDI accounted for approximately 14%
and 26% of total revenue for the three months ended September 30, 2000 and 2001,
respectively. We believe that we will continue to depend upon a limited number
of customers for a significant portion of our revenues from each period for the
foreseeable future. Any failure by us to capture a significant share of these
customers could materially harm our business. We believe that the
telecommunication industry is entering a period of consolidation. To the extent
that our customer base consolidates, we will have increased dependence on a few
customers who will be able to exert increased pressure on our prices and
contractual terms in general.
Furthermore, with the consolidation of the Internet specifically in the area of
Internet service providers (ISPs), future growth in sales to ISPs has and may
continue to decline.
We are exposed to the credit risk of some of our customers and to credit
exposures in weakened markets.
A portion of our sales are derived through customers who tend to have access to
more limited financial resources than others and, therefore, represent potential
sources of increased credit risk. Although we have programs in place to monitor
and mitigate the associated risk, there can be no assurance that such programs
will be effective in reducing our credit risk. We also continue to monitor
increased credit exposures from weakened financial conditions in certain
geographic regions, and the impact that such conditions may have on the
worldwide economy. We have recently experienced losses due to customers failing
to meet their obligations, primarily as a result of the weakened financial state
of the wireless and telecommunications industry. Although these losses have not
been significant, future losses, if incurred, could harm our business and have a
material adverse effect on our operating results and financial condition.
If widespread integration of browser technology does not occur in wireless
devices, our business could suffer.
23
Because our current software offers enhanced features and functionality that are
not currently covered by the specifications promulgated by the WAP Forum,
subscribers currently must use wireless devices enabled with our browser in
order to fully utilize these features and functionality. Additionally, we expect
that future versions of our software 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 if widespread
integration of our browser or WAP-compliant third-party browser software in
wireless devices does not occur. All of our agreements with wireless device
manufacturers are nonexclusive, so they may choose to embed a browser other than
ours in their wireless devices. We may not succeed in maintaining and developing
relationships with wireless device manufacturers, and any arrangements may be
terminated early or not renewed at expiration. In addition, wireless device
manufacturers may not produce products using our browser in a timely manner and
in sufficient quantities, if at all.
If wireless devices are not widely adopted for mobile delivery of Internet-based
services, our business could suffer.
We have focused a significant amount of our efforts on mass-market wireless
devices as the principal means of delivery of Internet-based services using our
products. If wireless devices are not widely adopted for mobile delivery of
Internet-based services, our business could suffer. Mobile individuals currently
use many competing products, such as portable computers, to remotely access the
Internet and e-mail. These products generally are designed for the visual
presentation of data, while wireless devices historically have been limited in
this regard. In addition, the development and proliferation of many types of
competing products capable of the mobile delivery of Internet-based service in a
rapidly evolving industry represents a significant risk to a primary standard
emerging. If mobile individuals do not adopt wireless devices as a means of
accessing Internet-based services, our business could suffer.
If unified messaging and instant messaging are not widely adopted by wireless
device subscribers, our business could suffer.
We have focused a significant amount of efforts on the development of unified
messaging and instant messaging applications for use on a variety of devices and
specifically, wireless devices. If our customers do not adopt our unified
messaging or instant messaging technology, our business could suffer materially.
If mobile individuals do not adopt unified messaging and instant messaging
applications as a means of communicating, our business could suffer.
If the GSM Association (GSMA) M-Services initiative is not successful, our
business could suffer.
The GSMA M-Services initiative is an attempt by European communication service
providers to reduce market fragmentation and offer advanced services in Europe.
If the GSMA M-Services initiative is not adopted in sufficient numbers or not
successful when deployed, then there will be less demand for our products in
Europe and our business could suffer. In addition, if European communication
service providers do not adopt our technology to meet the initiative, our
business could suffer.
The market for our products and services is highly competitive.
The market for our products and services is 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 standard. Furthermore, some
of our competitors, such as NTT DoCoMo, 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:
o wireless equipment manufacturers, such as Ericsson and Nokia;
o Wireless Knowledge, a subsidiary of Qualcomm;
o messaging software providers, such as Comverse;
o systems integrators, such as CMG plc, and software companies, such as
Microsoft, Oracle Corporation, iPlanet, a Sun/Netscape alliance and
Critical Path;
o service providers, such as E-Commerce Solutions and InfoSpace;
o browser competitors, such as Nokia, Access, AU Systems and Microsoft;
o communication service providers, such as NTT DoCoMo; and
o providers of Internet software applications and content, electronic
messaging applications and personal information management software
solutions.
Microsoft Corporation has announced its intention to introduce products and
services that may compete directly with many of our 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.
Nokia is marketing a WAP server to corporate customers and content providers.
This WAP server is designed to enable wireless device subscribers to directly
access applications and services provided by these customers, rather than
through gateways provided by communication service providers' WAP servers. If
Nokia's WAP server is widely adopted by corporate customers and content
providers, it could undermine the need for communication service providers 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, we will face additional
competitors.
In the unified messaging market, we face competition from established voice mail
providers such as CMG, 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 products and services. These existing and potential competitors may
include telecommunications companies such as Lucent Technologies, traditional
Internet portals such as AOL, InfoSpace, Microsoft MSN and Yahoo!, Internet
infrastructure software companies and several private mobile Internet portal
companies.
In addition to the existing competitors listed above, voice mail solutions
providers are expected to be competitors in the unified messaging market because
of their existing relationships with service providers and ownership of
technologies for the conversion of voice to data. If we are unable to compete
effectively against existing or emerging competitors, our business, financial
condition and operating results could suffer.
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 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. Competition for qualified personnel in
the telecommunications, Internet software and Internet messaging industries is
significant. We believe that there are only a limited number of persons with the
requisite skills to serve in many key positions, and it is difficult to hire and
retain these persons. Furthermore, it may become more difficult to hire and
retain key persons as a result of the restructuring. Competitors and others have
in the past, and may in the future, attempt to recruit our employees.
25
We may fail to support our 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 effectively, our business
could suffer. To manage, we must:
o successfully manage the business with fewer employees due to the
planned restructuring;
o continue to implement and improve our operational, financial and
management information systems;
o hire, train and retain qualified personnel;
o continue to expand and upgrade core technologies;
o effectively manage multiple relationships with various communication
service providers, wireless device manufacturers, content providers,
applications developers and other third parties; and
o successfully integrate the businesses of our acquired companies.
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 communication service providers 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 generally 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.
Our business depends on continued growth in use and improvement of the Internet
and customers ability to operate their systems effectively.
The infrastructure, products and services necessary to maintain and expand the
Internet may not be developed, and the Internet may not continue to be a viable
medium for secure and reliable personal and business communication, in which
case our business, financial condition and operating results could suffer.
Because we are in the business of providing Internet infrastructure software,
our future success depends on the continued expansion of, and reliance of
consumers and businesses on, the Internet for communications and other services.
The Internet may not be able to support an increased number of users or an
increase in the volume of data transmitted over it. As a result, the performance
or reliability of the Internet in response to increased demands will require
timely improvement of the high speed modems and other communications equipment
that form the Internet's infrastructure. The Internet has already experienced
temporary outages and delays as a result of damage to portions of its
infrastructure. The effectiveness of the Internet may also decline due to delays
in the development or adoption of new technical standards and protocols designed
to support increased levels of activity and due to the transmission of computer
viruses.
In addition to problems that may affect the Internet as a whole, our customers
have in the past experienced some interruptions in providing their
Internet-related services, including services related to our software products.
We believe that these interruptions will continue to occur from time to time.
Our revenues depend substantially upon the number of end users who use the
services provided by our customers. Our business may suffer if our customers
experience frequent or long system interruptions that result in the
unavailability or reduced performance of their systems or networks or reduce
their ability to provide services to their end users.
26
Our business depends on continued investment and improvement in communication
networks and our customers' ability to operate their systems effectively.
Many of our customers and other communication service providers have made major
investments in 2.5 generation ("2.5 g") networks that are intended to support
more complex applications and to provide end users with a more satisfying user
experience. If communication service providers delay their deployment of 2.5g
networks or fail to roll out such networks successfully, there could be less
demand for our products and services and our business could suffer. In addition,
if communication service providers fail to continue to make investments in their
networks or invest at a slower pace in the future, there may be less demand for
our products and services and our business could suffer.
We depend on others to provide content and develop applications for wireless
devices.
In order to increase the value to customers of our product platform and
encourage subscriber demand for Internet-based services via wireless devices, 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 content for Internet-based services via
wireless devices, our business could suffer. 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 communication service providers and
wireless device manufacturers large enough to justify significant and continued
investments in these endeavors. In addition, we depend on the wireless device
manufacturers to provide quality user-friendly handsets that enable the wireless
Internet.
If we are unable to continue to successfully integrate our products with
third-party technology, such as communication service providers' systems, our
business may suffer.
Our products are integrated with communication service providers' systems and
wireless devices. If we are unable to continue to successfully integrate our
platform products with these third-party technologies, our business could
suffer. For example, if, as a result of technology enhancements or upgrades of
these systems or devices, we are unable to integrate our products with these
systems or devices, we could be required to redesign our software products.
Moreover, many communication service providers use legacy, or custom-made,
systems for their general network management software. Legacy systems and
certain custom-made systems are typically very difficult to integrate with new
server software. 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.
Our intellectual property or proprietary rights could be misappropriated, which
could force us to become involved in expensive and time-consuming litigation.
Our ability to compete and continue to provide technological innovation is
substantially dependent upon internally developed technology. We rely on a
combination of patent, copyright, and trade secrets to protect our technology,
although we believe that other factors such as the technological and creative
skills of our personnel, new product developments, frequent product and feature
enhancements and reliable product support and maintenance are more essential to
maintaining a technology leadership position. We rely on trademark law to
protect our corporate brand.
We generally enter into confidentiality and nondisclosure agreements with our
employees, consultants, prospective customers, licensees and corporate partners.
In addition, we control access to and distribution of our software,
documentation and other proprietary information. Except for certain limited
escrow arrangements, we do not provide customers with access to the source code
for our products. Despite our efforts to protect our intellectual property and
proprietary rights, unauthorized parties may attempt to copy or otherwise obtain
and use our products or technology. Effectively policing the unauthorized use of
our products and trademarks is time-consuming and costly, and there can be no
assurance that the steps taken by us will prevent
27
misappropriation of our technology or trademarks, particularly in foreign
countries where in many instances the local laws or legal systems do not offer
the same level of protection as in the United States.
If others claim that our products infringe their intellectual property rights,
we may be forced to seek expensive licenses, reengineer our products, engage in
expensive and time-consuming litigation or stop marketing our products.
We attempt to avoid infringing known proprietary rights of third parties in our
product development efforts. However, we do not regularly conduct comprehensive
patent searches to determine whether the technology used in our products
infringes patents held by third parties. Because patent applications in the
United States are not publicly disclosed until the patent is issued,
applications may have been filed which relate to our software products. In
addition, our competitors and other companies as well as research and academic
institutions have conducted research for many years in the electronic messaging
field, and this research could lead to the filing of further patent
applications. If we were to discover that our products violated or potentially
violated third-party proprietary rights, we might not be able to obtain licenses
to continue offering those products without substantial reengineering. Any
reengineering effort may not be successful, nor can we be certain that any
licenses would be available on commercially reasonable terms.
Substantial litigation regarding intellectual property rights exists in the
software industry, and we expect that software products may be increasingly
subject to third-party infringement claims as the number of competitors in our
industry segments grows and the functionality of software products in different
industry segments overlaps. Any third-party infringement claims could be time
consuming to defend, result in costly litigation, divert management's attention
and resources, cause product and service delays or require us to enter into
royalty or licensing agreements. Any royalty or licensing arrangements, if
required, may not be available on terms acceptable to us, if at all. A
successful claim of infringement against us and our failure or inability to
license the infringed or similar technology could have a material adverse effect
on our business, financial condition and results of operations.
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 71% of our total
revenues for the quarter ended September 30, 2001. 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 conducting business internationally include:
o failure by us and/or third parties to develop localized content and
applications that are used with our products;
o fluctuations in currency exchange rates;
o problems caused by the ongoing conversion of various European
currencies into a single currency, the Euro;
o any imposition of currency exchange controls;
o unexpected changes in regulatory requirements applicable to the
Internet or our business;
o difficulties and costs of staffing and managing international
operations;
o differing technology standards;
o export restrictions on encryption and other technologies;
o difficulties in collecting accounts receivable and longer collection
periods;
o seasonable variations in customer buying patterns or electronic
messaging usage;
o political instability, acts of terrorism or war;
o economic downturns;
o potentially adverse tax consequences;
o reduced protection for intellectual property rights in certain
countries;
o costs of localizing our products for foreign markets;
28
o contractual provisions governed by foreign laws; and
o the burden of complying with complex and changing regulatory
requirements.
Any of these factors could harm our international operations and, consequently,
our business, financial condition and operating results.
The security provided by our products could be breached, in which case our
reputation, business, financial condition and operating results could suffer.
The occurrence or perception of security breaches could harm our business,
financial condition and operating results. A fundamental requirement for online
communications is the secure transmission of confidential information over the
Internet. Third parties may attempt to breach the security provided by our
products, or the security of our customers' internal systems. If they are
successful, they could obtain confidential information about our customers' end
users, including their passwords, financial account information, credit card
numbers or other personal information. Our customers or their end users may file
suits against us for any breach in security. Even if we are not held liable, a
security breach could result in costly litigation and harm our reputation. The
perception of security risks, whether or not valid, could inhibit market
acceptance of our products. Despite our implementation of security measures, our
software is vulnerable to computer viruses, electronic break-ins, intentional
overloading of servers and other sabotage, and similar disruptions, which could
lead to interruptions, delays, or loss of data. We may be required to expend
significant capital and other resources to license encryption or other
technologies to protect against security breaches or to alleviate problems
caused by these breaches. In addition, our customers might decide to stop using
or licensing our software if their end users experience security breaches.
Future governmental regulation of the Internet could limit our ability to
conduct our business.
Although there are currently few laws and regulations directly applicable to the
Internet and commercial messaging, a number of laws have been proposed involving
the Internet, including laws addressing user privacy, pricing, content,
copyrights, distribution, antitrust and characteristics and quality of products
and services. Further, the growth and development of the market for online
messaging may prompt calls for more stringent consumer protection laws that may
impose additional burdens on those companies, including us, that conduct
business online. The adoption of any additional laws or regulations may impair
the growth of the Internet or commercial online services, which could decrease
the demand for our services and could increase our cost of doing business or
otherwise harm our business, financial condition and operating results.
Moreover, the applicability of existing laws governing property ownership, sales
and other taxes, libel and personal privacy to the Internet is uncertain and may
take years to resolve.
Our stock price, like that of many companies in the Internet and
telecommunications software industries, may be volatile.
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 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:
o announcements or technological or competitive developments;
o acquisitions or strategic alliances by us or our competitors;
o the gain or loss of a significant customer or order;
o changes in estimates or our financial performance or changes in
recommendations by securities analysts; or
o changes in financial performance of competitors and other companies in
our industry.
Our stock price may be volatile, exposing us to expensive and time-consuming
securities class action litigation.
29
The stock market in general, and the stock prices of Internet-related companies
in particular, have recently experienced extreme volatility, which has often
been unrelated to the operating performance of any particular company or
companies. If market or industry-based fluctuations continue, our stock price
could decline below current levels regardless of our actual operating
performance. If a large number of shares of our stock relative to the trading
volume of our stock are sold in a short period of time, our stock price may
decline rapidly. In the past, securities class action litigation has often been
brought against companies following periods of volatility in their stock prices.
As described in Part II, Item 1, a stockholder class action complaint was filed
against us. We may in the future be the targets of similar litigation.
Securities litigation could result in substantial costs and divert management's
time and resources, which could harm our business, financial condition and
operating results.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
The tables below provide information about the Company's derivative financial
instruments and financial instruments that are subject to market risk. These
include: a foreign currency forward contract used to hedge a foreign currency
deposit, which is subject to exchange rate risk, and available-for-sale
short-term and long-term investments, which are subject to interest rate risk.
The Company manages its foreign currency exchange rate risk by entering into
contracts to sell or buy foreign currency at the time a foreign currency
receivable or payable is generated. When the foreign currency asset or liability
is extinguished, the contract is liquidated, and the resulting gain or loss on
the contract mitigates the exchange rate risk of the associated asset or
liability. We operate internationally and thus are exposed to potentially
adverse movements in foreign currency rate changes. We have entered into foreign
exchange forward contracts to reduce our exposure to foreign currency rate
changes on receivables, payables and intercompany balances denominated in a
non-functional currency. The objective of these contracts is to neutralize the
impact of foreign currency exchange rate movements on our operating results.
These contracts require us to exchange currencies at rates agreed upon at the
inception of the contracts. These contracts reduce the exposure to fluctuations
in exchange rate movements because the gains and losses associated with foreign
currency balances and transactions are generally offset with the gains and
losses of the foreign exchange forward contracts. Because the impact of
movements in currency exchange rates on forward contracts offsets the related
impact on the underlying items being hedged, these financial instruments help
alleviate the risk that might otherwise result from changes in currency exchange
rates. We do not designate our foreign exchange forward contracts as "accounting
hedges" and, accordingly, we adjust these instruments to fair value through
earnings in the period of change in their fair value.
The following summarizes the Company's foreign currency forward contract, which
matures in May 2002, by currency, as of September 30, 2001(in thousands):
Contract Fair
Amount Value at
(Local Contract September 30,
Currency) Amount 2001 (US$)
--------- -------- -------------
Japanese yen ("YEN") (contract to pay Yen/receive US$) (YEN)82,100 US$698 $ 10
Contract amounts are representative of the expected payments to be made under
these instruments. Derivatives, or portions of derivatives, that are not
designated as hedging instruments are adjusted to fair value through earnings
and are recognized in the period of change in their fair value.
The following is a chart of the principal amounts of short-term investments,
long-term investments, and restricted investments by expected maturity:
Expected maturity date for the year ended June 30, Cost Value Fair Value
-------------------------------------------------- ---------- ----------
Sept 30, 2001 Sept 30, 2001
------------- -------------
2002 2003 2004 2005 2006 Total
---- ---- ---- ---- ---- -------------
Corporate bonds $ 75,553 $39,079 $ - $ - $ - $ 114,632 $ 115,426
Commercial Paper 39,733 1,982 - - - 41,715 41,759
Federal Agencies 17,740 8,876 24,992 51,608 51,999
-------- ------- ------- ------ ------ ------------ -------------
Total $133,026 $49,937 $24,992 $ - $ - $ 207,955 $ 209,184
======== ======= ======= ====== ====== ============ =============
Weighted-average
interest rate 4.22%
====
30
Our exposure to market risks for changes in interest rates relates primarily to
corporate debt securities, U.S. Treasury Notes and certificates of deposit. We
place our investments with high credit quality issuers that have a rating by
Moody's of A1 or higher and Standard & Poors of P-1 or higher, 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; all investments with maturities of greater than one year
and less than two years are classified as available-for-sale and considered to
be long-term investments. We do not purchase investments with a maturity date
greater than two years from the date of purchase.
PART II Other Information
Item 1. Legal Proceedings
On February 2, 2001, a complaint, Leon Stambler v. RSA Security Inc., Verisign
Inc., First Data Corporation, Openwave Systems Inc. and Omnisky Corporation,
Civil Action No. 01-00065, was filed in the U.S. District Court for the district
of Delaware against us and certain other companies. The complaint alleges that
the defendants have infringed claims of one or more patents that Mr. Stambler
asserts have been granted to him. On March 26, 2001, we responded to the
complaint. We denied the allegations that we have infringed any claim in either
of the patents asserted against us. In addition, we asserted counterclaims
against Mr. Stambler seeking a declaratory judgment that the asserted patents
are not infringed by us and that the patents are also invalid and unenforceable.
Although the parties have exchanged some written discovery, discovery is still
in its initial stages and no trial date has been set. Based on the facts known
to date, we believe that we have meritorious defenses and claims and does not
believe resolution of this matter will have a material adverse effect on the
financial condition of the Company.
On April 30, 2001, a complaint, Opuswave Networks, Inc. v. Openwave Systems Inc.
and Alain Rossmann, Civil Action No. 01-1681, was filed in the U.S. District
Court for the Northern District of California against the Company and a former
affiliate of the Company. The complaint alleges that the Company has infringed
claims of a common law trademark that Opuswave Networks asserts it has acquired.
On June 5, 2001, the Company responded to the complaint. The Company denied the
allegations that the Company has infringed any trademark rights asserted against
the Company. In addition, the Company asserted counterclaims against the
plaintiff seeking a declaratory judgment that the asserted trademark rights are
not infringed by the Company. On June 13, 2001, Opuswave Networks responded to
the counterclaims denying its allegations. Discovery has not commenced and no
trial date has been set. The Company and Opuswave Networks are engaged in
settlement discussions. Based on the facts known to date, the Company believes
that it has meritorious defenses and claims and intends to defend this suit if
the parties do not settle. The Company does not believe that resolution of this
matter will have a material adverse effect on the financial condition of the
Company.
Based upon certain publicly available information, on November 5, 2001, a
stockholder class action complaint was filed in the U.S. District Court for the
Southern District of New York against us, certain of our current and former
officers and the underwriters of our initial public offering and secondary
offering. We have not been formally served and, as such, have not responded to
the complaint. The complaint generally alleges that the defendants made material
misrepresentations and/or omissions in prospectuses, dated June 10 and November
16, 1999, regarding certain alleged excessive and undisclosed commissions
received by the underwriters in connection with the allocation of common stock
in our initial public offering and secondary offering. Based upon our current
understanding of the facts, we believe that the complaint is without merit, and
do not believe resolution of this matter will have a material adverse effect on
the financial condition of our Company.
Item 2. Changes in Securities and Use of Proceeds
On July 13, 2001, in connection with our acquisition of Avogadro, Inc., or
Avogadro, we issued 2,700,000 shares of our common stock to the existing
stockholders of Avogadro in exchange for all of the outstanding shares of
capital stock of Avogadro. The actual number of shares issued in connection with
the transaction is subject to downward adjustment to the extent that claims are
made against an escrow fund created at the time of the transaction. The
transaction did not involve any underwriters, underwriting discount or
commissions, or any public offering. We believe that the transaction was exempt
from the registration requirements of the Securities Act by virtue of Section
3(a)(10) because the California Department of Corporations held a fairness
hearing and granted a permit pursuant to Section 25121 of the California
Code to issue the securities.
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
31
(a) Exhibits
3.1 Restated Certificate of Incorporation of the Company
10.1 Letter Amendment to Employment Agreement dated March 16, 2001
by and between the Company and Michael Mulica.
10.2 Offer Letter dated August 25, 2001 by and between the Company
and Kevin Kennedy (incorporated by reference to Exhibit 10.26
to the Company's annual report on Form 10-k filed on September
28, 2001)
(b) Reports on Form 8-K
The Company filed a Current Report on Form 8-K, dated July 2, 2001, during
the quarter ended September 30, 2001which reported "Item 7. Financial
Statements, Pro Forma Financial Information and Exhibits."
The Company filed a Current Report on Form 8-K, dated July 13, 2001,
during the quarter ended September 30, 2001 which reported "Item 5. Other
Events."
The Company filed a Current Report on Form 8-K, dated August 1, 2001,
during the quarter ended September 30, 2001 which reported "Item 5. Other
Events" and "Item 7. Exhibits."
The Company filed a Current Report on Form 8-K, dated September 12, 2001,
during the quarter ended September 30, 2001 which reported "Item 5. Other
Events" and "Item 7. Exhibits."
The Company filed a Current Report on Form 8-K, dated September 17, 2001,
during the quarter ended September 30, 2001 which reported "Item 5. Other
Events" and "Item 7. Exhibits."
SIGNATURE
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
Date: November 9, 2001
OPENWAVE SYSTEMS INC.
By: /s/ ALAN BLACK
-----------------------------------------
Alan Black
Senior Vice President, Corporate Affairs
and Chief Financial Officer
(Principal and Financial
Accounting Officer)
32