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, 1999
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _____ to _____
Commission file number 000-25687
===============================================================================
PHONE.COM, INC.
(Exact name of registrant as specified in its charter)
Delaware 94-3219054
(State or other jurisdiction of incorporation or (I.R.S. Employer Identification No.)
organization)
800 Chesapeake Drive
Redwood City, California 94063
(Address of principal executive offices, including zip code)
(650) 562-0200
(Registrant's telephone number, including area code)
===============================================================================
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No [_]
As of October 31, 1999, there were 62,583,964 shares of the registrant's
Common Stock outstanding.
INDEX
-----
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements. 3
Condensed consolidated balance sheets at September 30, 1999 and
June 30, 1999 3
Condensed consolidated statements of operations for the three
months ended September 30, 1999 and 1998 4
Condensed consolidated statements of cash flows for the three
months ended September 30, 1999 and 1998 5
Notes to condensed consolidated financial statements 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations. 9
Item 3. Quantitative and Qualitative Disclosures About Market Risk. 21
PART II. OTHER INFORMATION
Item 1. Legal Proceedings. 22
Item 2. Changes in Securities and Use of Proceeds. 22
Item 3. Defaults Upon Senior Securities. 22
Item 4. Submission of Matters to a Vote of Security Holders. 22
Item 5. Other Information. 22
Item 6. Exhibits and Reports on Form 8-K. 22
SIGNATURES 22
-2-
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements.
PHONE.COM, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)
June 30, September 30,
1999 1999
---------- -------------
ASSETS
Current assets:
Cash and cash equivalents.................. $ 79,803 $ 22,425
Short-term investments..................... 33,283 95,383
Accounts receivable........................ 20,474 10,474
Prepaid expenses and other current assets.. 865 1,070
---------- -------------
Total current assets.................... 134,425 129,352
Property and equipment, net..................... 3,014 5,944
Deposits and other assets....................... 1,494 1,525
---------- -------------
$ 138,933 $ 136,821
========== =============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of equipment loan and
capital lease obligations............... $ 424 $ 424
Accounts payable........................... 1,749 2,216
Accrued liabilities........................ 7,173 7,781
Deferred revenue........................... 36,797 38,442
---------- -------------
Total current liabilities............... 46,143 48,863
Equipment loan and capital lease obligations,
less current portion....................... 498 387
---------- -------------
Total liabilities....................... 46,641 49,250
---------- -------------
Stockholders' equity:
Common stock............................... 62 62
Additional paid-in capital................. 136,178 136,183
Deferred stock-based compensation.......... (1,318) (1,106)
Treasury stock............................. (196) (196)
Notes receivable from stockholders......... (484) (484)
Accumulated deficit........................ (41,950) (46,888)
---------- -------------
Total stockholders' equity.............. 92,292 87,571
---------- -------------
$ 138,933 $ 136,821
========== =============
See accompanying notes to the condensed consolidated financial statements.
-3-
PHONE.COM, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
Three months
ended
September 30,
----------------
1998 1999
------- -------
Revenues:
License.............................................. $ 202 $ 5,262
Maintenance and support
services............................................ 1,005 2,465
Consulting services.................................. 161 820
------- -------
Total revenues..................................... 1,368 8,547
------- -------
Cost of revenues:
License.............................................. 62 228
Maintenance and support
services............................................ 433 1,585
Consulting services.................................. 58 537
------- -------
Total cost of revenues............................. 553 2,350
------- -------
Gross profit....................................... 815 6,197
------- -------
Operating expenses:
Research and development............................. 2,446 5,469
Sales and marketing.................................. 1,801 4,925
General and administrative........................... 684 1,938
Stock-based compensation............................. 249 212
------- -------
Total operating expenses........................... 5,180 12,544
------- -------
Operating loss..................................... (4,365) (6,347)
Interest income, net................................... 415 1,498
------- -------
Loss before income taxes........................... (3,950) (4,849)
Income taxes........................................... -- 89
------- -------
Net loss........................................... $(3,950) $(4,938)
======= =======
Basic and diluted net loss per
share................................................. $ (0.36) $ (0.08)
======= =======
Shares used in computing basic
and diluted net loss per
share................................................. 11,078 61,932
======= =======
See accompanying notes to the condensed consolidated financial statements.
-4-
PHONE.COM, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
Three months
ended
September 30,
-----------------
1998 1999
------- --------
Cash flows from operating
activities:
Net loss............................................ $(3,950) $ (4,938)
Adjustments to reconcile net
loss to net cash (used for)
provided by operating
activities:
Depreciation and
amortization....................................... 218 506
Amortization of deferred
stock-based compensation........................... 249 212
Changes in operating assets
and liabilities:
Accounts receivable............................... (174) 10,000
Prepaid expenses and
other assets..................................... (93) (236)
Accounts payable.................................. (39) 467
Accrued liabilities............................... 381 608
Deferred revenue.................................. 1,383 1,645
------- --------
Net cash (used for)
provided by operating
activities..................................... (2,025) 8,264
------- --------
Cash flows from investing
activities:
Purchases of property and
equipment, net...................................... (325) (3,436)
Purchases of short-term
investments......................................... (4,851) (66,600)
Proceeds from sales and
maturities of short-term
investments......................................... 6,560 4,500
------- --------
Net cash provided by
(used for) investing
activities..................................... 1,384 (65,536)
------- --------
Cash flows from financing
activities:
Issuance of common stock............................. 7 5
Repayment of equipment loan
and capital lease
obligations......................................... (101) (111)
------- --------
Net cash used for
financing activities........................... (94) (106)
------- --------
Net decrease in cash
and cash equivalents.................................. (735) (57,378)
Cash and cash equivalents at
beginning of period................................... 12,677 79,803
------- --------
Cash and cash equivalents at
end of period......................................... $11,942 $ 22,425
======= ========
Supplemental disclosures of
cash flow information:
Deferred stock-based compensation...................... $ 73 --
======= ========
See accompanying notes to the condensed consolidated financial statements.
-5-
PHONE.COM, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1999
NOTE 1 - BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial information, the instructions to Form 10-Q and Article 10 of
Regulation S-X. Accordingly, they do not contain all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, the accompanying unaudited
condensed consolidated financial statements include all adjustments, consisting
only of normal recurring adjustments, necessary for the fair presentation of the
Company's financial position as of September 30, 1999 and the results of its
operations and cash flows for the three month periods ended September 30, 1999
and 1998. These financial statements should be read in conjunction with the
Company's audited financial statements as of June 30, 1999 and 1998 and for each
of the years in the three-year period ended June 30, 1999, including notes
thereto, included in the Company's 1999 Annual Report on Form 10-K. Operating
results for the three month period ended September 30, 1999 are not necessarily
indicative of the results that may be expected for the year ending June 30,
2000.
NOTE 2 - Revenue Recognition
Effective July 1, 1998, the Company adopted SOP 97-2, Software Revenue
Recognition, as amended by SOP 98-4 and SOP 98-9. SOP 97-2, as amended,
generally requires revenue earned on software arrangements involving multiple
elements to be allocated to each element based on the relative fair value of the
elements.
The Company licenses its UP.Link Server Suite products to network operators
through its direct sales force and indirectly through its channel partners. The
Company's license agreements do not provide for a right of return. Allowances
for future estimated warranty costs are provided at the time revenue is
recognized. Licenses can be purchased on an as-deployed basis or on a prepaid
basis. For licenses purchased on an as-deployed basis, license revenue is
recognized as subscribers are activated to use the services that are based on
the Company's UP.Link Server Suite products. The Company has no obligation to
provide standards-compliant products once a subscriber has been activated. For
licenses purchased on a prepaid basis, prepaid license fees are recognized
under subscription accounting due to the Company's commitment to provide
standards-compliant products for each license covered by the prepaid
arrangement. This subscription revenue is recognized ratably over the
contractual term of the prepaid arrangement (i.e., the date the prepaid
licenses expire if not used), commencing at the beginning of the month delivery
and acceptance occur by the network operator. The prepaid license period is
generally 12 to 30 months. Licenses expire if not activated prior to the end of
the prepaid license term. The Company recognizes revenues from maintenance and
support services provided to network operators ratably over the term of the
agreement, generally one year, and recognizes revenues from consulting services
provided to network operators as the services are performed.
The Company recognizes revenues from UP.Browser agreements with wireless
telephone manufacturers ratably over the period during which the services are
performed, generally one year. The Company provides its wireless telephone
manufacturer customers with support associated with their efforts to port its
UP.Browser software to their wireless telephones, software error corrections,
and new releases as they become commercially available.
NOTE 3 - Comprehensive Income
The Company has no material components of other comprehensive income (loss)
for all periods presented.
-6-
Note 4 - Net Loss Per Share
Basic net loss per share is computed using the weighted-average number of
outstanding shares of common stock excluding shares of restricted stock subject
to repurchase summarized below. Diluted net loss per share is computed using
the weighted-average number of shares of common stock outstanding and, when
dilutive, potential shares of restricted common stock subject to repurchase,
common stock from options, and warrants to purchase common stock using the
treasury stock method and from convertible securities using the "as if
converted" basis. The following potential shares of common stock have been
excluded from the computation of diluted net loss per share for all periods
presented because the effect would have been antidilutive (in thousands):
Three months
ended
September 30,
-----------------
1998 1999
------ -----
Shares issuable under stock options.... 5,948 9,783
Shares of restricted stock subject to
repurchase............................ 1,068 456
Shares issuable pursuant to warrants to
purchase common stock................. 62 --
Shares of convertible preferred stock
on an "as if converted" basis......... 35,431 --
The weighted-average exercise price of stock options was $0.54 and $5.34 for
the three months ended September 30, 1998 and 1999, respectively. The weighted-
average purchase price of restricted stock was $0.26 and $0.38 for the three
months ended September 30, 1998 and 1999, respectively. The weighted-average
exercise price of warrants was $1.91 for the three months ended September 30,
1998. In June 1999, all outstanding shares of the Company's convertible
preferred stock were automatically converted into common stock upon completion
of the Company's initial public offering.
Note 5 - Recent Accounting Pronouncements
In June 1998, the FASB issued Statement of Financial Accounting Standards
(SFAS) No. 133, Accounting for Derivative Instruments and Hedging Activities.
SFAS No. 133, as amended by SFAS No. 137, establishes accounting and reporting
standards for derivative financial instruments and hedging activities related
to those instruments, as well as other hedging activities. Because the Company
does not currently hold any derivative instruments and does not engage in
hedging activities, the Company expects that the adoption of SFAS No. 133, as
amended, will not have a material impact on its consolidated financial
position, results of operations, or cash flows. The Company will be required to
adopt SFAS No. 133 in fiscal 2001.
-7-
Note 6 - Geographic, Segment, and Significant Customer Information
During 1999, the Company adopted the provisions of SFAS No. 131, Disclosures
about Segments of an Enterprise and Related Information. SFAS No. 131
establishes standards for the reporting by public business enterprises of
information about operating segments, products and services, geographic areas,
and major customers. The method for determining what information to report is
based on the way that management organizes the operating segments within the
Company for making operational decisions and assessments of financial
performance.
The Company's chief operating decision maker is considered to be the
Company's Chief Executive Officer (CEO). The CEO reviews financial information
presented on a consolidated basis accompanied by disaggregated information
about revenues by geographic region and by product for purposes of making
operating decisions and assessing financial performance. Therefore, the Company
operates in a single operating segment: software that enables the delivery of
Internet-based services to mass-market wireless telephones and related
services. The disaggregated information reviewed on a product basis by the CEO
is as follows (in thousands):
Three months
ended
September 30,
-------------
1998 1999
------ ------
Revenue:
UP.Link Server Suite....................................... $ 424 $5,800
UP.Browser................................................. 783 1,927
Consulting services........................................ 161 820
------ ------
$1,368 $8,547
====== ======
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,
-------------
1998 1999
------ ------
North America................................................ $ 362 $2,482
Europe....................................................... 648 1,896
Asia Pacific................................................. 358 4,169
------ ------
$1,368 $8,547
====== ======
Significant customer information is as follows:
Percent of
total revenue
---------------
Three months
ended Percent of total accounts
September 30, receivable at
--------------- -------------------------
1998 1999 September 30, 1999
---- ---- ------------------
Customer A...................................................... 5% 15% 23%
Customer B...................................................... 16% 2% 1%
Note 7 - Subsequent Events
On October 26, 1999, the Company acquired all of the outstanding capital
stock of APiON Telecom Limited ("APiON") in exchange for 2,393,026 shares of
its common stock in a transaction to be accounted for as a purchase. In
addition, the Company also agreed to issue cash and common stock with an
aggregate value of up to approximately $14,100,000 to current and former
employees of APiON.
The Company declared a two-for-one stock split of its common stock for
stockholders of record as of October 29, 1999. The accompanying condensed
consolidated financial statements have been retroactively restated to give
effect to the stock split.
-8-
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
This Management's Discussion and Analysis of Financial Condition and
Results of Operations and other parts of this Form 10-Q contain forward-looking
statements that involve risks and uncertainties. Words such as "anticipates,"
"expects," "intends," "plans," "believes," "seeks," "estimates," and similar
expressions identify such forward-looking statements. These statements are not
guarantees of future performance and are subject to certain risks and
uncertainties that could cause actual results to differ materially from those
expressed or forecasted. Factors that might cause such a difference include, but
are not limited to, those discussed in the section entitled "Factors That May
Affect Future Results" and those appearing elsewhere in this Form 10-Q. Readers
are cautioned not to place undue reliance on these forward-looking statements,
which reflect management's analysis only as of the date hereof. The Company
assumes no obligation to update these forward-looking statements to reflect
actual results or changes in factors or assumptions affecting such forward-
looking statements.
Overview
We were incorporated in December 1994 and, from inception until June 1996,
our operations consisted primarily of various start-up activities, including
development of technologies central to our business, recruiting personnel and
raising capital. In 1995, we developed our initial technology, which enables
the delivery of Internet-based services to wireless telephones. In 1996, we
introduced and deployed our first products based on this technology. We first
recognized license revenues in August 1996, and generated license revenues of
approximately $80,000, $522,000 and $5.2 million for the fiscal years ended
June 30, 1997, 1998 and 1999, respectively, and $5.3 million for the three
months ended September 30, 1999. We incurred net losses of approximately $4.9
million for the three months ended September 30, 1999 and $8.0 million, $10.6
million and $20.8 million for the fiscal years ended June 30, 1997, 1998 and
1999, respectively. As of September 30, 1999, we had an accumulated deficit of
approximately $46.9 million.
To provide a worldwide standard for the delivery of Internet-based services
over mass-market wireless telephones, we formed the WAP Forum in close
cooperation with Ericsson, Motorola and Nokia, the world's three largest
manufacturers of wireless telephones. In February 1998, the WAP Forum published
technical specifications for application development and product
interoperability based substantially on Phone.com's technology and on Internet
standards. Leading network operators, telecommunications device and equipment
manufacturers and software companies worldwide have sanctioned the
specifications promulgated by the WAP Forum.
We generate revenues from licenses, maintenance and support services and
consulting services. We receive license revenues from licensing our UP.Link
Server Suite software directly to network operators and indirectly through
value-added resellers. From our inception through September 30, 1999,
cumulative revenues from licensing our UP.Link Server Suite software
represented 57% of total cumulative revenues, inclusive of installation,
training and support services provided to network operators. Maintenance and
support services revenues also include engineering and support services
provided to wireless telephone manufacturers. Cumulative engineering and
support services fees from UP.Browser agreements with wireless telephone
manufacturers represented 30% of our total cumulative revenues from inception
through September 30, 1999. Consulting services revenues are derived from
consulting services provided to network operator customers either directly by
us or indirectly through resellers.
In September 1999, we introduced MyPhone, our mobile Internet portal
platform. We expect to incur significant additional expenses in developing and
commercializing the MyPhone service, including costs relating to operating the
portal, as well as sales and marketing and research and development expenses.
We expect to incur these costs and expenses in advance of generating revenues
from this service and cannot be certain that our business model for the MyPhone
service will result in significant revenues or profitability.
In October 1999, we completed the acquisition of the outstanding share
capital of APiON Telecoms Ltd., a company based in Belfast, Northern Ireland.
APiON is a provider of WAP software products to GSM network operators in Europe
and has expertise in GSM Intelligent Networks, wireless data and WAP
technology. In connection with this transaction, we acquired all of the
outstanding shares of capital stock of APiON in exchange for an aggregate of
approximately 2,393,026 shares of our common stock. A portion of these shares
are held in escrow for a period of one year to indemnify us against potential
liabilities of APiON and its former shareholders.
In addition, we also agreed to issue cash and common stock to current and
former employees of APiON. Current employees of APiON will receive cash in the
aggregate amount of approximately $2.5 million, less applicable withholdings
for taxes and insurance, upon the closing of this offering, and will receive
shares of common stock equal in value to approximately $2.5 million, less
applicable withholdings for taxes and insurance, on each of the first two
anniversaries of the closing of the APiON acquisition, subject to their
continued employment. Former employees of APiON who were engaged in APiON's
services business, which we did not acquire in the transaction, will receive
cash in the aggregate amount of approximately $2.2 million, less applicable
withholdings for taxes and insurance, upon the closing of this offering, and
will receive shares of common stock equal in value to approximately $4.3
million, less applicable withholdings for taxes and insurance, on the
anniversary of the closing of the APiON acquisition, subject to forfeiture upon
the occurrence of certain events.
-9-
In connection with the APiON acquisition, we will record a significant
amount of goodwill and deferred compensation that will significantly increase
our net loss for the foreseeable future. We expect to record goodwill of
approximately $244.6 million and additional deferred stock-based compensation
of approximately $5.1 million, to be amortized over a three-year period and a
two-year period, respectively. In addition, we expect that operating expenses
will increase as a result of the acquisition, due primarily to the additional
personnel and the costs of operating a European subsidiary. For example, as a
result of the addition of APiON's technical, sales and customer engineering
personnel, we expect that research and development expenses and sales and
marketing expenses may increase by as much as $5 million in the aggregate for
the fiscal year ended June 30, 2000.
Our future success depends on our ability to increase revenues from sales of
products and services to new and existing network operator customers. If the
market for Internet-based services via wireless telephones fails to develop or
develops more slowly than expected, then our business would be materially and
adversely affected. In addition, because there is a relatively small number of
network operators worldwide, any failure to sell our products to network
operator customers successfully could result in a shortfall in revenues that
could not be readily offset by other revenue sources. We also anticipate that
network operators may defer commercial launches of services based on our
product and services as they divert their resources and efforts to ensure year
2000 compliance.
Our business strategy also relies to a significant extent on the widespread
propagation of UP.Browser-enabled telephones through our relationships with
network operators and wireless telephone manufacturers. In order to encourage
adoption of UP.Browser-enabled wireless telephones, we license our UP.Browser
software to wireless telephone manufacturers free of per-unit royalties and
other license fees and provide maintenance and support services for an annual
flat fee. As of September 1999, we had licensed UP.Browser to 25 wireless
telephone manufacturers. As of September 1999, 10 wireless telephone
manufacturer customers had made commercial shipments of telephones with the
UP.Browser embedded. In addition, as of September 1999, we are currently
providing engineering support services in connection with 60 browser
integration projects.
For the three months ended September 30, 1999, DDI Corporation and AT&T
wireless services accounted for 28% and 15%, respectively, of our total
revenues. The foregoing calculations are based on revenues derived from direct
and indirect sales to these customers.
Effective July 1, 1998, we adopted SOP 97-2, Software Revenue Recognition, as
amended. SOP 97-2 generally requires revenue earned on software arrangements
involving multiple elements to be allocated to each element based on the
relative fair value of the elements.
We license our UP.Link Server Suite products to network operators through
our direct sales force and indirectly through our channel partners. Our license
agreements do not provide for a right of return. Allowances for future
estimated warranty costs are provided at the time revenue is recognized.
Licenses can be purchased on an as-deployed basis or on a prepaid basis. For
licenses purchased on an as-deployed basis, license revenue is recognized as
subscribers are activated to use the services that are based on our UP.Link
Server Suite products. We have no obligation to provide standards-compliant
products once a subscriber has been activated. For licenses purchased on a
prepaid basis, prepaid license fees are recognized under subscription
accounting due to our commitment to provide standards-compliant products for
each license covered by the prepaid arrangement. This subscription revenue is
recognized ratably over the contractual term of the prepaid arrangement (i.e.,
the date the prepaid licenses expire if not used), commencing at the beginning
of the month in which delivery and acceptance occur by the network operator.
The prepaid license period is generally twelve to thirty months. Licenses
expire if not activated prior to the end of the prepaid license term. We
recognize revenues from maintenance and support services provided to network
operators ratably over the term of the agreement, generally one year, and
recognize revenues from consulting services provided to network operators as
the services are performed.
We recognize revenues from UP.Browser agreements with wireless telephone
manufacturers ratably over the period during which the services are performed,
generally one year. We provide our wireless telephone manufacturer customers
with support associated with their efforts to port our UP.Browser software to
their wireless telephones, software error corrections and new releases as they
become commercially available.
Deferred revenue was $38.4 million as of September 30, 1999, comprised of
$33.9 million in prepaid fees charged to wireless network operators and $4.5
million in prepaid maintenance and other service fees charged to wireless
telephone manufacturers. We expect that deferred revenue will decline in the
long term as network operators deploy services based on our products. In
particular, we began recognizing license revenue in the third quarter of fiscal
1999 in connection with the launch by CEGETEL/SFR of commercial services based
on our products and the acceptance of our products by DDI Corporation. Relating
to our sales to CEGETEL/SFR, we recognized previously deferred license revenues
of $406,000 for the quarter ended September 30, 1999 and will recognize
approximately $400,000 in each of the quarters ending December 31, 1999 and
March 31, 2000. With regard to sales to DDI Corporation, we recognized license
revenues of $2.4 million for the quarter ended September 30, 1999 and will
recognize approximately $2.4 million in the quarter ending December 31, 1999,
$1.6 million in each of the quarters ending March 31, 2000 through March 31,
2001, and $1.1 million in the quarter ending June 30, 2001. The revenues
recognized and deferred for DDI Corporation include direct sales and sales
through an indirect channel partner, Itochu Techno Science Corporation. During
the quarter ended September 30, 1999 we recognized previously deferred revenues
of $1.3 million relating to AT&T Wireless Services, and will recognize
approximately $1.25 million in the quarter ending December 31, 1999. We also
began recognizing license revenue in the fourth quarter of fiscal 1999 in
connection with the launches by two other wireless network operator customers.
With respect to these customers, we recognized license revenue of $612,000 in
the quarter ended September 30, 1999, and will recognize substantially all of
the remaining deferred revenue by September 30, 2001.
-10-
We expect that our gross profit on revenues derived from sales through
indirect channel partners will be less than the gross profit on revenues from
direct sales. Our success, in particular in international markets, depends in
part on our ability to increase sales of our products and services through
value-added resellers and to expand our indirect distribution channels. In
addition, our agreements with our distribution partners generally do not
restrict the sale of products that are competitive with our products and
services, and each of our partners can cease marketing our products and
services at their option.
International sales of products and services accounted for 74% and 71% of our
total revenues for the quarters ended September 30, 1998 and 1999, respectively.
We expect international sales to continue to account for a significant portion
of our revenues, although the percentage of our total revenues derived from
international sales may vary. In particular, a number of manufacturers have
delayed commercial release of WAP-compliant wireless telephones, particularly
affecting European and other markets based on the GSM standard. Risks inherent
in our international business activities, include:
. failure by us and/or third parties to develop localized content and
applications that are used with our products;
. costs of localizing our products for foreign markets;
. difficulties in staffing and managing foreign operations;
. longer accounts receivable collection time;
. political and economic instability;
. fluctuations in foreign currency exchange rates;
. reduced protection of intellectual property rights in some foreign
countries;
. contractual provisions governed by foreign laws;
. export restrictions on encryption and other technologies;
. potentially adverse tax consequences; and
. the burden of complying with complex and changing regulatory
requirements.
Since early 1997, we have invested substantially in research and
development, marketing, domestic and international sales channels, professional
services and our general and administrative infrastructure. These investments
have significantly increased our operating expenses, contributing to net losses
in each fiscal quarter since our inception. Our limited operating history makes
it difficult to forecast future operating results. Although our revenues have
grown in recent quarters, our revenues may not increase at a rate sufficient to
achieve and maintain profitability, if at all. We anticipate that our operating
expenses will increase substantially in absolute dollars for the foreseeable
future as we expand our product development, sales and marketing, professional
services and administrative staff. Even if we were to achieve profitability in
any period, we may not sustain or increase profitability on a quarterly or
annual basis.
RESULTS OF OPERATIONS
License Revenues
License revenues increased from $202,000 for the three months ended
September 30, 1998 to $5.3 million for the three months ended September 30,
1999. The increase in license revenues was primarily due to the recognition of
revenues associated with the licensing of our products to AT&T Wireless
Services in the United States, DDI and IDO in Japan, Cegetel/SFR in France and
Omnitel in Italy.
-11-
Maintenance and Support Services Revenues
Maintenance and support services revenues increased from $1.0 million for
the three months ended September 30, 1998 to $2.5 million for the three months
ended September 30, 1999. The increase in maintenance and support services
revenues was attributable primarily to increased demand for maintenance and
engineering support services by wireless telephone manufacturers.
Consulting Services Revenues
Consulting services revenues increased from $161,000 for the three months
ended September 30, 1998 to $820,000 for the three months ended September 30,
1999. The quarter ended September 30, 1998 was the first period in which we
recognized consulting services revenue. The increase in consulting services
revenue was primarily due to the increased number of wireless network operators
who have licensed our technology.
Cost of License Revenues
Cost of license revenues consists primarily of third-party license and
support fees. Cost of license revenues increased from $62,000 for the three
months ended September 30, 1998 to $228,000 for the three months ended
September 30, 1999. The growth in cost of license revenues was attributable
primarily to the increase in license revenues. As a percentage of license
revenues, cost of license revenues for the three months ended September 30,
1998 and 1999 was 31% and 4%, respectively. The decrease as a percentage of
license revenues was attributable primarily to higher license revenues for the
three months ended September 30, 1999 and to the amortization of fixed
maintenance fees relating to third party software licenses. We expect that cost
of license revenues will vary as a percentage of license revenues from period
to period.
Cost of Maintenance and Support Services Revenues
Cost of maintenance and support services revenues consists of compensation
and related overhead costs for personnel engaged in the delivery of
installation, training and support services to network operators, and
engineering and support services to wireless telephone manufacturers. The
engineering and support services performed for wireless telephone manufacturers
includes assistance relating to integrating our UP.Browser software into the
manufacturers' wireless telephones. Cost of maintenance and support services
revenues increased from $433,000 for the three months ended September 30, 1998
to $1.6 million for the three months ended September 30, 1999. As a percentage
of maintenance and support service revenues, cost of maintenance and support
services revenues for the three months ended September 30, 1998 and 1999 was
43% and 64%, respectively. The growth in cost of maintenance and support
services revenues was attributable primarily to an increase in personnel
dedicated to support a larger number of wireless telephone manufacturer
customers and to increased staffing in anticipation of growth in the number of
network operator customers. We anticipate that the cost of maintenance and
support services revenues will increase in absolute dollars in future operating
periods.
Cost of Consulting Services Revenues
Cost of consulting services revenues consists of compensation and
independent consultant costs for personnel engaged in our consulting services
operations and related overhead. Cost of consulting services revenues increased
from $58,000 for the three months ended September 30, 1998 to $537,000 for the
three months ended September 30, 1999. As a percentage of consulting services
revenues, cost of consulting services revenues for the three months ended
September 30, 1998 and 1999 was 36% and 65%, respectively. Gross profit on
consulting services revenues is impacted by the mix of company personnel and
independent consultants assigned to projects. The gross profit we achieve is
also impacted by the contractual terms of the consulting assignments we
undertake, and the gross profit on fixed price contracts typically is more
susceptible to fluctuation than contracts performed on a time-and-materials
basis. We anticipate that the cost of consulting services revenues will
increase in absolute dollars as we continue to invest in the growth of our
consulting services operations.
Research and Development Expenses
Research and development expenses consist primarily of compensation and
related costs for research and development personnel. Research and development
expenses increased 124% from $2.4 million for the three months ended September
30, 1998 to $5.5 million for the three months ended September 30, 1999. This
increase was attributable primarily to the addition of personnel in our
research and development organization associated with product development. We
expect to continue to make substantial investments in research and development
and anticipate that research expenses will continue to increase in absolute
dollars. In particular, we anticipate that research and development expenses
will increase significantly due to product development efforts for the MyPhone
service and the addition of research and development personnel in connection
with the APiON acquisition.
Sales and Marketing Expenses
Sales and marketing expenses consist primarily of compensation and related
costs for sales and marketing personnel, sales commissions, marketing programs,
public relations, promotional materials, travel expenses and trade show exhibit
expenses. Sales and marketing expenses increased 173% from $1.8 million for the
three months ended September 30, 1998 to $4.9 million for the three months
ended September 30, 1999. This increase resulted from the addition of personnel
in our sales and marketing organizations, reflecting our increased selling
effort to develop market awareness of our products and services. We anticipate
that sales and marketing expenses will increase in absolute dollars as we
increase our investment in these areas. In addition, we expect that sales and
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marketing expenses will increase as a result of the addition of sales and
marketing personnel in connection with the APiON acquisition.
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 183% from $684,000 for the three months ended September 30,
1998 to $1.9 million for the three months ended September 30, 1999. This
increase was due primarily to the addition of personnel performing general and
administrative functions, additional expenses in connection with our operation
as a public company and, to a lesser extent, legal expenses associated with
increased product licensing and patent activity. We expect general and
administrative expenses to increase in absolute dollars as we add personnel and
incur additional expenses related to the anticipated growth of our business,
the management of our international operations and our operation as a public
company.
Stock-Based Compensation
Some stock options granted and restricted stock sold during the fiscal years
ended June 30, 1998 and June 30, 1999 have been deemed to be compensatory.
Total deferred stock-based compensation associated with these equity
arrangements through September 30, 1999 amounted to $2.4 million related to
stock options granted and restricted stock issued from October 1997 through
March 1999. These amounts are being amortized over the respective vesting
periods of these equity arrangements in a manner consistent with Financial
Accounting Standards Board Interpretation No. 28. Of the total deferred stock-
based compensation, $249,000 and $212,000 was amortized in the three months
ended September 30, 1998 and 1999, respectively. Relating to the amortization
of the deferred stock-based compensation associated with stock options granted
and restricted stock issued from October 1997 through March 1999, we expect
amortization of approximately $696,000, $375,000, $185,000 and $62,000 in the
fiscal years ending June 30, 2000, 2001, 2002 and 2003, respectively. In
addition, in connection with our acquisition of APiON, we expect to record
additional deferred stock-based compensation of approximately $5.1 million, to
be amortized over a period of two years.
Interest Income, Net
Net interest income is comprised primarily of interest earned on cash and
cash equivalents and short-term investments, offset by interest expense related
to obligations under capital leases and our equipment loan. Net interest income
was $415,000 and $1.5 million for the three months ended September 30, 1998 and
1999, respectively. The increase was due primarily to increased cash balances
as a result of our initial public offering in June 1999 and our private
placement financing in March 1999.
Income Taxes
Income tax expense was $-0- and $89,000 for the three months ended September
30, 1998 and 1999, respectively. Income tax expense for the three months ended
September 30, 1999 consisted primarily of foreign withholding taxes.
Liquidity and Capital Resources
Since inception, we have financed our operations through private sales of
convertible preferred stock which totaled $66.0 million in aggregate net
proceeds through March 31, 1999, through our initial public offering in June
1999 which generated net proceeds of $66.8 million, and through an equipment
loan and a capitalized lease, which totaled $811,000 in principal amount
outstanding at September 30, 1999. As of September 30, 1999, we had $117.8
million of cash, cash equivalents and short-term investments and working
capital of $80.5 million.
Net cash provided by operating activities was $8.3 million for the three
months ended September 30, 1999. The net cash provided by operating activities
for the three months ended September 30, 1999 was attributable primarily to a
decrease in accounts receivable and an increase in deferred revenue of $10.0
million and $1.6 million, respectively, offset in part by a net loss of $4.9
million.
To date, we have had no write-offs of accounts receivable and we have not
recorded any allowance for doubtful accounts.
Net cash used for investing activities was $65.5 million for the three months
ended September 30, 1999 reflecting purchases of property and equipment and
increased purchases of short-term investments.
Net cash used by financing activities was $106,000 for the three months ended
September 30, 1999.
As of September 30, 1999, our principal commitments consisted of obligations
outstanding under operating leases, our equipment loan and capitalized lease
obligations. Although we have no material commitments for capital expenditures,
we expect to increase capital expenditures and lease commitments consistent with
our anticipated growth in operations, infrastructure and personnel. We also may
increase our capital expenditures as we expand into additional international
markets.
We believe that our current cash, cash equivalents and short-term
investments, will be sufficient to meet our anticipated cash needs for working
capital and capital expenditures for at least the next twelve months. If cash
generated from operations is insufficient to satisfy our liquidity
requirements, we may seek to sell additional equity or debt securities or to
obtain a credit facility. If additional funds are raised through the issuance of
debt securities, these securities could have rights, preferences and privileges
senior to holders of common stock, and terms of any debt could impose
restrictions on our operations. The sale of additional equity or convertible
debt securities could result in additional dilution to our stockholders, and
additional financing may not be available in amounts or on terms acceptable to
us, if at all. If we are unable to obtain this additional financing, we may be
required to reduce the scope of our planned product development and marketing
efforts, which could harm our business, financial condition and operating
results.
Year 2000 Readiness Disclosure
Many currently installed computer systems and software products are coded to
accept only two digit entries in the date code field. These systems and software
products will need to accept four digit entries to distinguish 21st century
dates from 20th century dates. This problem may result in software failures or
the creation of erroneous results.
-13-
We have conducted a year 2000 readiness review for the current versions of
our products. The review includes assessment, implementation (including
remediation, upgrading and replacement of some product versions), validation
testing, and contingency planning. We have largely completed all phases of this
plan, except for contingency planning, for the current versions of our
products. As a result, we believe all current versions of our products are
capable of properly distinguishing between 20th and 21st century dates, when
configured and used in accordance with the related documentation, and provided
that the underlying operating system of the host machine and any other software
used with our products are also capable of properly distinguishing between 20th
and 21st century dates. We have not tested all noncurrent versions of our
products and do not intend to do so. However, we have delivered software
releases containing corrections to all identified year 2000 errors in our
UP.Link Server Suite software to our network operator customers with our
software in production and expect that those releases will be implemented by
our customers prior to December 31, 1999.
We are testing software obtained from third parties (licensed software,
shareware, and freeware) that is incorporated into our products, and we have
contacted our vendors to confirm that licensed software is capable of properly
distinguishing between 20th and 21st century dates. We have been informed by
many of our vendors that their products that we use are capable of properly
distinguishing between 20th and 21st century dates. Despite testing by us and
by current and potential customers, and assurances from developers of products
incorporated into our products, our products may contain undetected errors or
defects associated with year 2000 date functions. Known or unknown errors or
defects in our products could result in delay or loss of revenues, diversion of
development resources, damage to our reputation, or increased service and
warranty costs, any of which could materially and adversely affect our
business, operating results or financial condition. Some commentators have
predicted significant litigation regarding year 2000 compliance issues, and we
are aware of lawsuits against other software vendors. Because of the
unprecedented nature of this litigation, it is uncertain whether or to what
extent we may be affected by it.
Our internal systems include our information technology, or IT, non-IT
systems and embedded systems. We have completed an assessment of our material
internal IT, non-IT and embedded systems, including both our own software
products and third-party software and hardware technology. We expect to
complete validation testing of our IT systems and related contingency planning
by October 1999. To the extent that we are not able to test the technology
provided by third-party vendors, we are seeking assurances from vendors that
their systems are year 2000 compliant. We are not currently aware of any
material operational issues associated with preparing our internal IT, non-IT
and embedded systems for the year 2000. However, we may experience material
unanticipated problems or additional costs caused by undetected errors or
defects in the technology used in our internal IT, non-IT and embedded systems.
We do not currently have any information concerning the year 2000 compliance
status of our customers. Our network operator customers face implementation and
support challenges in introducing Internet-based services via wireless
telephones. Historically, network operators have been relatively slow to
implement new complex services, such as Internet-based services, and year 2000
compliance issues could slow adoption or implementation of our products. If our
current or future customers fail to achieve year 2000 compliance or if they
divert technology expenditures, especially technology expenditures that were
earmarked for our products, to address year 2000 compliance problems, our
business could suffer.
We have funded our year 2000 plan from available cash and have not
separately accounted for these expenses in the past. To date, these expenses
have not been material. Most of our expenses have related to, and are expected
to continue to relate to, the operating costs associated with time spent by
employees and management consultants in the evaluation process and year 2000
compliance matters generally. We expect to incur approximately $500,000 to
verify that our IT, non-IT and embedded systems are capable of properly
distinguishing between 20th century and 21st century dates. In addition, we may
experience material problems and expenses associated with year 2000 compliance
that could adversely affect our business, results of operations, and financial
condition. Finally, we are also subject to external forces that might generally
affect industry and commerce, such as year 2000 compliance failures by utility
or transportation companies and related service interruptions.
Factors That May Affect Future Results
In addition to the other information in this report, the following
factors should be considered carefully in evaluating the Company's business and
prospects.
Our future profitability is uncertain because we have a limited operating
history.
Because we commenced operations in December 1994 and commercially released
our first products in June 1996, we only have a limited operating history on
which you can base your evaluation of our business. We may not continue to grow
or achieve profitability. We face a number of risks encountered by early stage
companies in the wireless telecommunications and Internet software industries,
including:
. our need for network operators to launch and maintain commercial services
utilizing our products;
-14-
. the uncertainty of market acceptance of commercial services utilizing our
products;
. our substantial dependence on products with only limited market
acceptance to date;
. our need to introduce reliable and robust products that meet the
demanding needs of network operators and wireless telephone
manufacturers;
. our need to expand our marketing, sales, consulting and support
organizations, as well as our distribution channels;
. our ability to anticipate and respond to market competition;
. our need to manage expanding operations; and
. our dependence upon key personnel.
Our business strategy may not be successful, and we may not successfully
address these risks. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Overview."
We may not achieve or sustain our revenue or profit goals.
Because we expect to continue to incur significant product development,
sales and marketing, and administrative expenses, we will need to generate
significant revenues to become profitable and sustain profitability on a
quarterly or annual basis. We may not achieve or sustain our revenue or profit
goals, and our ability to do so depends on a number of factors outside of our
control, including the extent to which:
. there is market acceptance of commercial services utilizing our products;
. our competitors announce and develop, or lower the prices of, competing
products; and
. our strategic partners dedicate resources to selling our products and
services.
As a result, we may not be able to increase revenue or achieve profitability
on a quarterly or annual basis. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations--Overview."
Our quarterly operating results are subject to significant fluctuations, and
our stock price may decline if we do not meet expectations of investors and
analysts.
Our quarterly revenues and operating results are difficult to predict and
may fluctuate significantly from quarter to quarter due to a number of factors,
some of which are outside of our control. These factors include, but are not
limited to:
. delays in market acceptance or implementation by our customers of our
products and services;
. changes in demand by our customers for additional products and services;
. our lengthy sales cycle, our concentrated target market and the
potentially substantial effect on total revenues that may result from the
gain or loss of business from each incremental network operator customer;
. introduction of new products or services by us or our competitors;
. delays in developing and introducing new products and services;
. changes in our pricing policies or those of our competitors or customers;
. changes in our mix of domestic and international sales;
. risks inherent in international operations;
. changes in our mix of license, consulting and maintenance and support
services revenues;
. changes in accounting standards, including standards relating to revenue
recognition, business combinations and stock-based compensation; and
. the impact of year 2000 concerns on the timing of capital expenditures by
network operators and their launches of commercial services utilizing our
products and services.
Our sales cycle, which is lengthy--typically between nine and twelve
months--contributes to fluctuations in our quarterly operating results. Many
factors outside our control add to the lengthy education and customer approval
process for our products. For example, many of our prospective customers have
neither budgeted expenses for the provision of Internet-based services to
wireless subscribers nor specifically dedicated personnel for the procurement
and implementation of our products and services. Further, the emerging and
evolving nature of the market for Internet-based services via wireless
telephones may lead prospective customers to postpone their purchasing
decisions. In addition, general concerns regarding year 2000 compliance may
further delay purchase decisions by prospective customers.
Most of our expenses, such as employee compensation and lease payments for
facilities and equipment, are relatively fixed. In addition, our expense levels
are based, in part, on our expectations regarding future revenues. As a result,
any shortfall in revenues relative to our expectations could cause significant
changes in our operating results from quarter to quarter. Due to the foregoing
factors, we believe period to period comparisons of our revenue levels and
operating results are not meaningful. You should not rely on our quarterly
revenues and operating results to predict our future performance.
We may be unable to successfully integrate APiON into our business or achieve
the expected benefits of the APiON acquisition.
-15-
Our acquisition of APiON, which was completed in October 1999, will require
integrating the business and operations of APiON with our company. We may not
be able to successfully assimilate the personnel, operations and customers of
APiON into our business. Additionally, we may fail to achieve the anticipated
synergies from the acquisition of APiON, including marketing, product
development, distribution and other operational synergies.
The integration process may further strain our existing financial and
managerial controls and reporting systems and procedures. This may result in
the diversion of management and financial resources from our core business
objectives. In addition, we are not experienced in managing significant
facilities or operations in geographically distant areas. Finally, we cannot be
certain that we will be able to retain APiON's key employees.
Our sales cycle is long, and our stock price could decline if sales are delayed
or cancelled.
Quarterly fluctuations in our operating performance are exacerbated by our
sales cycle, which is lengthy, typically between nine and twelve months, and
unpredictable. Because our products represent a significant capital investment
for our customers, we spend a substantial amount of time educating customers
regarding the use and benefits of our products and they in turn spend a
substantial amount of time performing internal reviews and obtaining capital
expenditure approvals before purchasing our products. Any delay in sales of our
products could cause our quarterly operating results to vary significantly from
projected results, which could cause our stock price to decline.
Our success depends on acceptance of our products and services by network
operators and their subscribers.
From inception through September 30, 1999, 30% of our total cumulative
revenues have come from fees paid to us by wireless telephone manufacturers
that embed our browser in their wireless telephones. However, our future
success depends on our ability to increase revenues from sales of our UP.Link
Server Suite software and related services to new and existing network operator
customers and on market acceptance of new products and services, and we may not
be able to achieve widespread adoption by these customers. This dependence is
exacerbated by the relatively small number of network operators worldwide. To
date, we currently have only a limited number of network operator customers,
including AT&T Wireless Services, Bell Atlantic Mobile, DDI, GTE Wireless, IDO,
SFR/Cegetel and Sprint, that have implemented and deployed services based on
our products. We cannot assure you that network operators will widely deploy or
successfully market services based on our products, or that large numbers of
subscribers will use these services. See "Management's Discussion and Analysis
of Financial Condition and Results of Operations--Overview."
The market for the delivery of Internet-based services through wireless
telephones is rapidly evolving, and we may not be able to adequately address
this market.
The market for the delivery of Internet-based services through wireless
telephones is rapidly evolving and is characterized by an increasing number of
market entrants that have introduced or developed, or are in the process of
introducing or developing, products that facilitate the delivery of Internet-
based services through wireless telephones. As a result, the life cycle of our
products is difficult to estimate. We may not be able to develop and introduce
new products, services and enhancements that respond to technological changes
or evolving industry standards on a timely basis, in which case our business
would suffer. In addition, we cannot predict the rate of adoption by wireless
subscribers of these services or the price they will be willing to pay for
these services. As a result, it is extremely difficult to predict the pricing
of these services and the future size and growth rate of this market.
Our network operator customers face implementation and support challenges in
introducing Internet-based services via wireless telephones, which may slow
their rate of adoption or implementation of the services our products enable.
Historically, network operators have been relatively slow to implement new
complex services such as Internet-based services. In addition, network
operators may encounter greater customer service demands to support Internet-
based services via wireless telephones than they do for their traditional voice
services. We have limited or no control over the pace at which network
operators implement these new services. The failure of network operators to
introduce and support services utilizing our products in a timely and effective
manner could harm our business. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations--Overview."
To date, we have relied on sales to a small number of customers, some of whom
are our stockholders, and the failure to retain these customers or add new
customers may harm our business.
To date, a significant portion of our revenues in any particular period has
been attributable to a limited number of customers, comprised primarily of
network operators and wireless telephone manufacturers, some of whom are our
stockholders. We believe that we will continue to depend upon a limited number
of customers for a significant portion of our revenues for each quarter for the
foreseeable future. Any failure by us to capture a significant share of those
customers could materially harm our business. For example, during the fiscal
year ended June 30, 1998, AT&T Wireless Services, which owned approximately
2.5% of our common stock as of June 30, 1999, and Matsushita Communication
Industrial accounted for approximately 22% and 18%, respectively, of our total
revenues. For the fiscal year ended June 30, 1999, AT&T Wireless Services
accounted for approximately 17% of our total revenues, and DDI Corporation,
which owned approximately 0.6% of our common stock as of June 30, 1999,
accounted for approximately 14% of our total revenues. For the three months
-16-
ended September 30, 1999, DDI Corporation and AT&T Wireless Services accounted
for 28% and 15%, respectively, of our total revenues. The foregoing calculations
are based on revenues derived from direct and indirect sales to these
customers.
If wireless telephones are not widely adopted for mobile delivery of Internet-
based services, our business could suffer.
We have focused our efforts on mass-market wireless telephones as the
principal means of delivery of Internet-based services using our products. If
wireless telephones are not widely adopted for mobile delivery of Internet-
based services, our business would suffer materially. Mobile individuals
currently use many competing products, such as portable computers, to remotely
access the Internet and email. These products generally are designed for the
visual presentation of data, while wireless telephones historically have been
limited in this regard. If mobile individuals do not adopt wireless telephones
as a means of accessing Internet-based services, our business would suffer. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--Overview."
If widespread integration of browser technology does not occur in wireless
telephones, our business could suffer.
Because our current UP.Link Server Suite software offers enhanced features
and functionality that are not currently covered by the specifications
promulgated by the WAP Forum, subscribers currently must use UP.Browser-enabled
wireless telephones in order to fully utilize these features and functionality.
Additionally, we expect that future versions of our UP.Link Server Suite
software will offer features and functionality that are compatible with the
specifications promulgated by the WAP Forum. Our business could suffer
materially if widespread integration of UP.Browser or WAP-compliant third party
browser software in wireless telephones does not occur. Recently, a number of
manufacturers have delayed commercial release of WAP-compliant wireless
telephones, particularly affecting European and other markets based on the GSM
standard. All of our agreements with wireless telephone manufacturers are
nonexclusive, so they may choose to embed a browser other than ours in their
wireless telephones. We may not succeed in maintaining and developing
relationships with telephone manufacturers, and any arrangements may be
terminated early or not renewed at expiration. In addition, wireless telephone
manufacturers may not produce products using UP.Browser in a timely manner and
in sufficient quantities, if at all. See "Management's Discussion and Analysis
of Financial Condition and Results of Operations--Overview."
Our strategy for the MyPhone service is subject to uncertainties, and we may
not be able to achieve market acceptance of the service.
In September 1999, we announced our MyPhone service. The MyPhone service
will be used by network operator customers on a trial basis beginning in late
1999. We intend to offer MyPhone as an OEM service to enable network operators
to create branded mobile Internet portals for their subscribers, and we do not
currently intend to develop our own branded portal site. We have limited
experience in developing mobile Internet portals, and we may not be successful
in executing our business strategy for the MyPhone service. The success of
MyPhone will depend on a number of factors, including the adoption of MyPhone
by network operators, our ability to establish strong relationships with
content and information service providers, our ability to provide compelling
applications and services through MyPhone and the acceptance by wireless
subscribers of the MyPhone service. Developing these capabilities and
commercializing this service will require us to incur significant additional
expenses, including costs relating to operating the portal, as well as sales
and marketing and research and development expenses. We expect to incur these
costs and expenses in advance of generating revenues from this service.
Furthermore, our business model for MyPhone is new and evolving. Even if we are
successful in executing this strategy, we cannot be certain that our business
model for the MyPhone service will result in significant revenues or
profitability.
The market for our products and services is highly competitive.
The market for our products and services is becoming increasingly
competitive. The widespread adoption of open industry standards such as the WAP
specifications may make it easier for new market entrants and existing
competitors to introduce products that compete with our software products. In
addition, a number of our competitors, including Nokia, have announced or are
expected to announce enhanced features and functionality as proprietary
extensions to the WAP protocol. Furthermore, some of our competitors, such as
NTT, have introduced or may introduce services based on proprietary wireless
protocols that are not compliant with the WAP specifications.
We expect that we will compete primarily on the basis of price, time to
market, functionality, quality and breadth of product and service offerings.
Our current and potential competitors include the following:
. Wireless equipment manufacturers, such as Ericsson and Nokia;
. Microsoft;
. Wireless Knowledge, a joint venture of Microsoft and Qualcomm;
. Systems integrators, such as CMG plc, and software companies, such as
Oracle Corporation;
. Wireless network operators, such as NTT DoCoMo; and
. Providers of Internet software applications and content, electronic
messaging applications and personal information management software
solutions.
In particular, Microsoft Corporation has announced its intention to
introduce products and services that may compete directly with our UP.Link,
UP.Browser and UP.Application products. In addition, Microsoft has announced
that it intends to enable its Windows CE operating system to run on wireless
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handheld devices, including wireless telephones, and to develop and market its
own browser for these devices. Furthermore, Nokia is marketing a WAP server to
corporate customers and content providers. This WAP server is designed to
enable wireless telephone subscribers to directly access applications and
services provided by these customers, rather than through gateways provided by
network operators' WAP servers. If Nokia's WAP server is widely adopted by
corporate customers and content providers, it could undermine the need for
network operators to purchase WAP servers. Many of our existing competitors, as
well as potential competitors, have substantially greater financial, technical,
marketing and distribution resources than we do.
As we enter new markets and introduce new services, such as the MyPhone
service, we will face additional competitors. These competitors may include
telecommunications companies such as Lucent Technologies, traditional Internet
portals such as AOL, InfoSpace, Microsoft and Yahoo!, Internet infrastructure
software companies and several private mobile Internet portal companies.
Our 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. We currently maintain key
person life insurance policies for Alain Rossmann, our Chief Executive Officer,
and Charles Parrish, our Executive Vice President. We are seeking to hire a
general manager of the MyPhone service. Competition for qualified personnel in
the telecommunications and Internet software industries is intense, and finding
qualified personnel with experience in both industries is even more difficult.
We believe that there are only a limited number of persons with the requisite
skills to serve in many key positions, and it is becoming increasingly
difficult to hire and retain these persons. Competitors and others have in the
past, and may in the future, attempt to recruit our employees.
We may fail to support our anticipated growth in operations.
To succeed in the implementation of our business strategy, we must rapidly
execute our sales strategy and further develop products and expand service
capabilities, while managing anticipated growth by implementing effective
planning and operating processes. If we fail to manage our growth effectively,
our business could suffer materially. To manage anticipated growth, we must:
. continue to implement and improve our operational, financial and
management information systems; for example, we are currently in the
process of implementing Oracle financial software;
. hire, train and retain additional qualified personnel;
. continue to expand and upgrade core technologies; and
. effectively manage multiple relationships with various network operators,
wireless telephone manufacturers, content providers, applications
developers and other third parties.
Our systems, procedures and controls may not be adequate to support our
operations, and our management may not be able to achieve the rapid execution
necessary to exploit the market for our products and services.
Our success, particularly in international markets, depends in part on our
ability to maintain and expand our distribution channels.
Our success depends in part on our ability to increase sales of our products
and services through value-added resellers and systems integrators and to
expand our indirect distribution channels. If we are unable to maintain the
relationships that we have with our existing distribution partners, increase
revenues derived from sales through our indirect distribution channels, or
increase the number of distribution partners with whom we have relationships,
then we may not be able to increase our revenues or achieve profitability.
To date, the majority of our revenues from international markets have
resulted from our direct sales efforts. We expect that network operators in
international markets generally will require that our products and support
services be supplied through value-added resellers and systems integrators.
Thus, we expect that a significant portion of international sales will be made
through value-added resellers and systems integrators, and the success of our
international operations will depend on our ability to maintain productive
relationships with value-added resellers and systems integrators.
In addition, our agreements with our distribution partners do not restrict
the sale by them of products and services that are competitive with our
products and services, and each of our partners generally can cease marketing
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our products and services at their option and, in some circumstances, with
little notice and with little or no penalty.
We depend on others to provide content and develop applications for wireless
telephones.
In order to increase the value to customers of our product platform and
encourage subscriber demand for Internet-based services via wireless
telephones, we must successfully promote the development of Internet-based
applications and content for this market. If content providers and application
developers fail to create sufficient applications and content for Internet-
based services via wireless telephones, our business could suffer materially.
Our success in motivating content providers and application developers to
create and support content and applications that subscribers find useful and
compelling will depend, in part, on our ability to develop a customer base of
network operators and wireless telephone manufacturers large enough to justify
significant and continued investments in these endeavors.
If we are unable to integrate our products with third-party technology, such as
network operators' systems, our business may suffer.
Our products are integrated with network operators' systems and wireless
telephones. If we are unable to integrate our platform products with these
third-party technologies, our business could suffer materially. For example,
if, as a result of technology enhancements or upgrades of these systems or
telephones, we are unable to integrate our products with these systems or
telephones, we could be required to redesign our software products. Moreover,
many network operators use legacy, or custom-made, systems for their general
network management software. Legacy systems are typically very difficult to
integrate with new server software such as our UP.Link Server Suite. We may not
be able to redesign our products or develop redesigned products that achieve
market acceptance.
An interruption in the supply of software that we license from third parties
could cause a decline in product sales.
We license technology that is incorporated into our products from third
parties, such as RSA Data Security, Inc. and other companies. Any significant
interruption in the supply of any licensed software could cause a decline in
product sales, unless and until we are able to replace the functionality
provided by this licensed software. We also depend on these third parties to
deliver and support reliable products, enhance their current products, develop
new products on a timely and cost-effective basis, and respond to emerging
industry standards and other technological changes. The failure of these third
parties to meet these criteria could materially harm our business.
We may be unable to adequately protect our proprietary rights.
Our success depends significantly on our ability to protect our proprietary
rights to the technologies used in our products. If we are not adequately
protected, our competitors could use the intellectual property that we have
developed to enhance their products and services, which could harm our
business. We rely on patent protection, as well as a combination of copyright
and trademark laws, trade secrets, confidentiality provisions and other
contractual provisions, to protect our proprietary rights, but these legal
means afford only limited protection.
We may be sued by third parties for infringement of their proprietary rights.
The telecommunications and Internet software industries are characterized by
the existence of a large number of patents and frequent litigation based on
allegations of patent infringement or other violations of intellectual property
rights. As the number of entrants into our market increases, the possibility of
an intellectual property claim against us grows. Any intellectual property
claims, with or without merit, could be time-consuming and expensive to
litigate or settle and could divert management attention from administering our
core business.
International expansion is an important part of our strategy, and this
expansion carries specific risks.
International sales of products and services accounted for 74% and 71% of our
total revenues for the quarters ended September 30, 1998 and 1999, respectively.
We expect international sales to continue to account for a significant portion
of our revenues, although the percentage of our total revenues derived from
international sales may vary. Risks inherent in our international business
activities include business risks, economic and political risks, and legal
risks. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations--Overview".
Our year 2000 compliance efforts may involve significant time and expense, and
uncorrected problems could harm our business.
Many currently installed computer systems are not capable of distinguishing
21st century dates from 20th century dates. As a result, beginning on January
1, 2000, computer systems and software used by many companies in a wide variety
of industries, including technology, transportation, utilities, finance and
telecommunications, will produce erroneous results or fail unless they have
been modified or upgraded to process date information correctly. Year 2000
compliance efforts may involve significant time and expense, and uncorrected
problems could materially and adversely affect our business. We may face claims
based on year 2000 issues arising from the integration of multiple products,
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including ours, within an overall system. Network operators may also cease or
delay purchase and installation of new complex systems, such as our server
software products, as a result of, and during, their own internal year 2000
testing. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations--Year 2000 Readiness Disclosure."
We may acquire technologies or companies in the future, and these acquisitions
could result in the dilution of our stockholders and disruption of our
business.
We may acquire technologies or companies in the future. Entering into an
acquisition entails many risks, any of which could materially harm our
business, including:
. diversion of management's attention from other business concerns;
. failure to assimilate the acquired company with our pre-existing
business;
. potential loss of key employees from either our pre-existing business or
the acquired business;
. dilution of our existing stockholders as a result of issuing equity
securities; and
. assumption of liabilities of the acquired company.
Our stock price, like that of many companies in the Internet and
telecommunications software industries, may be volatile.
Since our initial public offering in June 1999, our stock price has
experienced significant volatility. We expect that the market price of our
common stock also will fluctuate in the future as a result of variations in our
quarterly operating results. These fluctuations may be exaggerated if the
trading volume of our common stock is low. In addition, due to the technology-
intensive and emerging nature of our business, the market price of our common
stock may rise and fall in response to:
. announcements of technological or competitive developments;
. acquisitions or strategic alliances by us or our competitors;
. the gain or loss of a significant customer or order; and
. changes in estimates of our financial performance or changes in
recommendations by securities analysts.
Our executive officers and directors own a large percentage of our voting stock
and could exert significant influence over matters requiring stockholder
approval.
Our executive officers and directors and their respective affiliates,
currently own approximately 37% of our outstanding common stock, based on
shares outstanding as of September 30, 1999. Accordingly, these stockholders
may, as a practical matter, be able to exert significant influence over matters
requiring approval by our stockholders, including the election of directors and
the approval of mergers or other business combinations. This concentration
could have the effect of delaying or preventing a change in control.
Our certificate of incorporation and bylaws and Delaware law contain provisions
that could discourage a takeover.
Provisions of our certificate of incorporation and bylaws and Delaware law
may discourage, delay or prevent a merger or acquisition that a stockholder may
consider favorable. These provisions include the following:
. establishing a classified board in which only a portion of the total
board members will be elected at each annual meeting;
. authorizing the board to issue preferred stock;
. prohibiting cumulative voting in the election of directors;
. limiting the persons who may call special meetings of stockholders;
. prohibiting stockholder action by written consent; and
. establishing advance notice requirements for nominations for election of
the board of directors or for proposing matters that can be acted on by
stockholders at stockholder meetings.
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Item 3. Quantitative and Qualitative Disclosures About Market Risk.
Foreign Currency Hedging Instruments
We transact business in various foreign currencies and, accordingly, we are
subject to exposure from adverse movements in foreign currency exchange rates.
To date, the effect of changes in foreign currency exchange rates on revenues
and operating expenses have not been material. Substantially all of our
revenues are earned in U.S. dollars. Operating expenses incurred by our
European and Japanese subsidiaries are denominated primarily in U.K. pounds
sterling and Japanese yen, respectively.
We currently do not use financial instruments to hedge operating expenses in
the U.K. or Japan denominated in their respective local currency. We intend to
assess the need to utilize financial instruments to hedge currency exposures on
an ongoing basis.
We do not use derivative financial instruments for speculative trading
purposes, nor do we currently hedge our foreign currency exposure to offset the
effects of changes in foreign exchange rates.
Fixed Income Investments
Our exposure to market risks for changes in interest rates relates primarily
to corporate debt securities. We place our investments with high credit quality
issuers and, by policy, limit the amount of the credit exposure to any one
issuer.
Our general policy is to limit the risk of principal loss and ensure the
safety of invested funds by limiting market and credit risk. All highly liquid
investments with a maturity of less than three months at the date of purchase
are considered to be cash equivalents; all investments with maturities of three
months or greater are classified as available-for-sale and considered to be
short-term investments.
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PART II. OTHER INFORMATION
Item 1. Legal Proceedings - Not Applicable.
Item 2. Changes in Securities and Use of Proceeds.
On June 11, 1999, in connection with the Company's initial public offering,
a Registration Statement on Form S-1 (No. 333-75219) was declared effective by
the Securities and Exchange Commission, pursuant to which 9,200,000 shares of
the Company's Common Stock were offered and sold for the account of the Company
at a price of $8.00 per share, generating gross offering proceeds of $73.6
million. The managing underwriters were Credit Suisse First Boston Corporation,
BancBoston Robertson Stephens Inc., Hambrecht & Quist LLC and U.S. Bancorp Piper
Jaffray Inc. After deducting approximately $5.2 million in underwriting
discounts and $1.4 million in other related expenses, the net proceeds of the
offering were approximately $67 million. The Company has not yet used any of the
funds from the initial public offering, and the $67 million has been invested in
investment grade, interest bearing securities. The Company intends to use such
remaining proceeds for capital expenditures, including the acquisition of
redundant computer and communication systems, and for general corporate
purposes, including working capital to fund increased accounts receivable and
inventory levels.
Item 3. Defaults Upon Senior Securities - Not Applicable.
Item 4. Submission of Matters to a Vote of Security Holders - Not
Applicable.
Item 5. Other Information - Not Applicable.
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits
Ex-27.1 Financial Data Schedule
(b) Reports on Form 8-K
On November 3, 1999, the Company filed a Form 8-K with
respect to the Company's acquisition of the outstanding
shares of capital stock of Apion Telecomms Ltd., a
telecommunications software company registered in Belfast,
Northern Ireland.
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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Phone.com, Inc.
By: /s/ ALAN BLACK
--------------------------------------------
Alan Black
Vice President of Finance and
Administration, Chief Financial Officer and
Treasurer (Principal Financial and
Accounting Officer)
Date: November 15, 1999