1 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 October 2, 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 0-22561 EFAX.COM, INC. (Exact name of Registrant as specified in its charter) Delaware 77-0182451 (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) 1378 Willow Road, Menlo Park, California 94025 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (650) 324-0600 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 November 12, 1999 there were 12,900,632 shares of common stock, $.01 par value, outstanding. This Report on Form 10-Q includes 25 pages with the Index to Exhibits located on page 23. 2 EFAX.COM, INC. AND SUBSIDIARIES INDEX TO REPORT ON FORM 10-Q FOR QUARTER ENDED OCTOBER 2, 1999 Page ---- PART I. FINANCIAL INFORMATION Item 1. Financial Statements: Condensed Consolidated Balance Sheets - September 30, 1999 and December 31, 1998........................................ 3 Condensed Consolidated Statements of Operations - Three Months and Nine Months Ended September 30, 1999 and 1998..... 4 Condensed Consolidated Statements of Cash Flows - Nine 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..... 22 PART II. OTHER INFORMATION Item 2. Changes in Securities.......................................... 23 Item 6. Exhibits and Reports on Form 8-K............................... 23 Signature...................................................... 24 2 3 PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS EFAX.COM, INC. (FORMERLY JETFAX, INC.) AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (in thousands, except share amounts) September 30, December 31, 1999 1998 (1) -------- -------- (Unaudited) ASSETS Current assets: Cash and cash equivalents $ 8,009 $ 1,305 Short-term investments 2,996 2,808 Accounts receivable, net 3,287 4,402 Inventories 2,386 4,519 Prepaid expenses 589 247 -------- -------- Total current assets 17,267 13,281 Property, net 2,224 1,339 Other assets 4,110 1,595 -------- -------- Total assets $ 23,601 $ 16,215 ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable $ 3,605 $ 777 Accrued liabilities 1,671 1,576 Current deferred revenue 124 - -------- -------- Total current liabilities 5,400 2,353 Deferred revenue 25 25 Stockholders' equity: Series A convertible preferred stock, $0.01 par value; 5,000,000 shares authorized, shares outstanding: 1,500 in 1999 and none in 1998 - - Common stock, $0.01 par value; 35,000,000 shares authorized, shares outstanding: 12,878,092 in 1999 and 11,873,711 in 1998 129 119 Additional paid-in capital 62,568 42,946 Accumulated deficit (44,521) (29,228) -------- -------- Total stockholders' equity 18,176 13,837 -------- -------- Total liabilities and stockholders' equity $ 23,601 $ 16,215 ======== ======== (1) Derived from the December 31, 1998 audited consolidated balance sheet included in the Company's Annual Report on Form 10-K for the year ended December 31, 1998. See notes to condensed consolidated financial statements. 3 4 EFAX.COM, INC. (FORMERLY JETFAX, INC.) AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited) (in thousands, except per share amounts) Three Months Ended Nine Months Ended September 30, September 30, ------------------ ------------------ 1999 1998 1999 1998 -------- -------- -------- -------- Revenues: Product $ 4,649 $ 5,986 $ 15,808 $ 18,092 Licenses and services 1,258 1,366 3,472 3,781 Development fees 242 396 921 1,296 -------- -------- -------- -------- Total revenues 6,149 7,748 20,201 23,169 -------- -------- -------- -------- Costs and expenses: Cost of product revenues 3,444 4,186 11,169 12,314 Cost of licenses and services 918 151 1,864 600 Research and development 1,545 1,267 4,779 4,055 Selling and marketing 6,841 1,749 13,337 5,660 General and administrative 877 480 4,072 1,884 -------- -------- -------- -------- Total costs and expenses 13,625 7,833 35,221 24,513 -------- -------- -------- -------- Loss from operations (7,476) (85) (15,020) (1,344) -------- -------- -------- -------- Other income (expense): Interest income 184 86 325 248 Interest expense - - - (2) Other income (expense) (6) 46 (68) 22 -------- -------- -------- -------- Total other income 178 132 257 268 -------- -------- -------- -------- Income (loss) before income taxes (7,298) 47 (14,763) (1,076) Provision for income taxes 21 10 61 59 -------- -------- -------- -------- Net income (loss) (7,319) 37 (14,824) (1,135) Series A Convertible Preferred stock dividends (299) - (470) - -------- -------- -------- -------- Net income (loss) applicable to common stockholders $ (7,618) $ 37 $(15,294) (1,135) ======== ======== ======== ======== Net income (loss) per share: Basic $ (0.59) $ 0.00 $ (1.23) $ (0.10) ======== ======== ======== ======== Diluted $ (0.59) $ 0.00 $ (1.23) $ (0.10) ======== ======== ======== ======== Shares used in computing net income (loss) per share: Basic 12,854 11,806 12,467 11,767 ======== ======== ======== ======== Diluted 12,854 12,838 12,467 11,767 ======== ======== ======== ======== For presentation purposes, the periods ended October 2, 1999 and October 3, 1998 are referred to above as ending on September 30, 1999 and 1998, respectively. 4 5 EFAX.COM, INC. (FORMERLY JETFAX, INC.) AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) (in thousands) Nine Months Ended September 30, ------------------- 1999 1998 -------- -------- Cash flows from operating activities: Net loss $(14,824) $ (1,135) Adjustments to reconcile net loss to net cash used for operating activities: Depreciation and amortization 872 295 Loss on disposal of asset (39) - Issuance of Common Stock for service 208 - Common Stock options - severance 1,367 - Common Stock options - services 302 - Changes in assets and liabilities: Trade receivables 1,115 568 Inventories 2,133 (717) Prepaid expenses (342) 6 Accounts payable 2,828 (469) Deferred revenue 124 (24) Accrued liabilities (330) (17) -------- -------- Net cash used for operating activities (6,586) (1,493) -------- -------- Cash flows from investing activities: Purchase of short-term investments (2,996) (1,537) Sale of short-term investments 2,808 - Purchase of property (1,301) (346) Increase in other assets (594) (258) -------- -------- Net cash used for investing activities (2,083) (2,141) -------- -------- Cash flows from financing activities: Proceeds from sale of Common Stock 1,158 3 Repurchase of Common Stock - (112) Proceeds from sale of Series A Convertible Preferred Stock, net 14,215 - -------- -------- Net cash provided by (used for) financing activities 15,373 (109) -------- -------- Increase (decrease) in cash and cash equivalents 6,704 (3,743) Cash and cash equivalents, beginning of period 1,305 4,200 -------- -------- Cash and cash equivalents, end of period $ 8,009 $ 457 ======== ======== Supplemental cash flow information: Interest paid $ - $ 2 ======== ======== Taxes paid - foreign withholding $ 29 $ 38 ======== ======== Supplemental noncash investing and financial information: Warrant expense - service $ 337 $ - ======== ======== Conversion of accrued ESPP for purchase of Common Stock $ 45 $ 76 ======== ======== Trademark settlement $ 2,000 $ - ======== ======== Cumulative dividends on Series A Convertible Preferred Stock $ 470 $ - ======== ======== See notes to condensed consolidated financial statements. 5 6 EFAX.COM, INC. (FORMERLY JETFAX, INC.) AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) 1. Basis of Presentation Interim Financial Information The accompanying condensed consolidated financial statements of eFax.comTM, Inc. and its wholly-owned subsidiaries ("eFax.com" or "eFax" or the "Company") as of September 30, 1999 and for the three and nine months ended September 30, 1999 and 1998 are unaudited. In the opinion of management, the condensed consolidated financial statements include all adjustments (consisting of normal recurring accruals) that management considers necessary for a fair presentation of its financial position, operating results and cash flows for the interim periods presented. Operating results and cash flows for interim periods are not necessarily indicative of results for the entire year. This financial data should be read in conjunction with the audited financial statements and notes thereto included in eFax.com's Annual Report on Form 10-K for the year ended December 31, 1998. Certain prior quarter amounts have been reclassified to conform to the current quarter presentation for cost of licenses and services as well as selling and marketing expenses. Fiscal Period End The Company uses a 52-53 week fiscal year ending on the first Saturday on or after December 31. For presentation purposes, the Company refers herein to the 13-week and 39-week periods ended October 2, 1999 and October 3, 1998 as the three and nine months ended September 30, 1999 and 1998, respectively. Per Share Information Basic earnings (loss) per share is computed by dividing net income (loss) by the weighted average common shares outstanding for the period while diluted earnings (loss) per share also includes the dilutive impact of stock options and warrants. Common stock equivalents from options and warrants have been excluded from the computation for all periods presented with net losses as their effect is antidilutive. Such options and warrants will be included, using the treasury stock method, in periods where eFax.com reports net income and the average fair market value of its common stock exceeds the exercise price. The net income (loss) and the shares used for the computation of both basic and diluted income (loss) per share are shown in the table below. Three Months Nine Months Ended September 30, Ended September 30, ------------------- ------------------- 1999 1998 1999 1998 -------- -------- -------- -------- Net income (loss) applicable to Shareholders $ (7,618) $ 37 $(15,294) $ (1,135) ======== ======== ======== ======== SHARES USED IN COMPUTATION: Weighted average common shares outstanding used in computation of basic earnings(loss) per share 12,854 11,806 12,467 11,767 Dilutive effect of stock options and warrants - 1,032 - - -------- -------- -------- -------- Shares used in computation of diluted net income (loss) per share 12,854 12,838 12,467 11,767 ======== ======== ======== ======== BASIC EARNINGS (LOSS) PER SHARE $ (0.59) $ 0.00 $ (1.23) $ (0.10) ======== ======== ======== ======== DILUTED EARNINGS (LOSS) PER SHARE $ (0.59) $ 0.00 $ (1.23) $ (0.10) ======== ======== ======== ======== 6 7 EFAX.COM, INC. (FORMERLY JETFAX, INC.) AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (Unaudited) 2. Inventories Inventories consist of the following (in thousands): September 30, December 31, 1999 1998 ------------- ------------ Materials and supplies $ 1,074 $ 1,982 Work-in-process 256 93 Finished goods 1,056 2,444 -------- -------- Total $ 2,386 $ 4,519 ======== ======== 3. Accrued Liabilities Accrued liabilities consist of (in thousands): September 30, December 31, 1999 1998 ------------- ------------ Compensation and related benefits $ 904 $ 632 Product warranty 44 78 Royalties 42 62 Other 681 804 -------- -------- Total $ 1,671 $ 1,576 ======== ======== 4. Comprehensive Income Effective January 1, 1998, eFax.com adopted Statement of Financial Accounting Standards ("SFAS") No. 130, "Reporting Comprehensive Income." SFAS No. 130 requires an enterprise to report, by major components and as a single total, the change in net assets during the period from non-owner sources. For the three and nine months ended September 30, 1999 and 1998, there were no differences between eFax.com's comprehensive loss and net loss. 5. Disclosures about Segments of an Enterprise and Related Information In June 1997, the Financial Accounting Standards Board issued SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information," which establishes annual and interim reporting standards for an enterprise's business segments and related disclosures about its products, services, geographic areas and major customers. Adoption of this statement does not impact eFax.com's consolidated financial position, results of operations or cash flows. It is eFax.com's opinion that its business is a single reportable segment, which addresses the communication and handling of electronic and paper documents. Organizational structure and internal management reporting are not segmented, nor are there specific segment profitability responsibilities within management. 7 8 EFAX.COM, INC. (FORMERLY JETFAX, INC.) AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (Unaudited) 6. Effect Of Changes In Accounting Principles In June 1998, the Financial Accounting Standards Board issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," which defines derivatives, requires that all derivatives be carried at fair value, and provides for hedging accounting when certain conditions are met. The Company is required to adopt this statement in the first quarter of fiscal year 2001, with early adoption permitted. On a forward-looking basis, although eFax.com has not fully assessed the implications of this new statement, eFax.com does not believe adoption of this statement will have a material impact on eFax.com's financial position or results of operations. 8 9 ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Overview The statements contained in this Report on Form 10-Q that are not purely historical are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 (the ''Securities Act'') and Section 21E of the Securities Exchange Act of 1934 (the "Exchange Act"), including statements regarding eFax.com's expectations, hopes, intentions or strategies regarding the future. When used herein, the words ''may,'' ''will,'' ''expect,'' ''anticipate,'' ''continue,'' ''estimate,'' ''project,'' ''intend'' and similar expressions are intended to identify forward-looking statements within the meaning of the Securities Act and the Exchange Act. Forward-looking statements include: statements regarding events, conditions and financial trends that may affect eFax.com's future plans of operations, business strategy, results of operations and financial position. All forward-looking statements included in this document are based on information available to eFax.com on the date hereof, and eFax.com assumes no obligation to update any such forward-looking statements. Investors are cautioned that any forward-looking statements are not guarantees of future performance and are subject to risks and uncertainties and that actual results may differ materially from those included within the forward-looking statements as a result of various factors. These forward- looking statements are made in reliance upon the safe harbor provision of The Private Securities Litigation Reform Act of 1995. Factors that could cause or contribute to such differences include, but are not limited to, those described below, under the heading "Factors That May Affect Operating Results" and elsewhere in this Report on Form 10-Q. On February 8, 1999, the corporate name of JetFax, Inc., a Delaware Corporation was changed to "eFax.com, Inc." All filings and reports made after February 8, 1999 bear the name "eFax.com, Inc." eFax.com, Inc. is a leading provider of Internet unified messaging services. eFax.com currently provides its free and fee-base Internet unified messaging services to more than 1.4 million users. In February 1999, eFax.com launched its unified messaging services that incorporate fax-to-email, voicemail and voice-to-email capabilities. Prior to entering this market, eFax.com had developed and marketed branded and OEM products and software solutions for the multifunction product ("MFP") market, which consists of electronic office devices that combine print, fax, copy and scan capabilities in a single unit. In addition, eFax.com has licensed its embedded systems technology and software to a number of manufacturers of MFPs. eFax.com recently announced that it will discontinue its branded product sales and dealer channel in order to increase its focus on Internet services and OEM opportunities in the MFP market. The Company operates on a 52-53 week reporting year ending on the first Saturday on or following December 31. The 13-week periods from July 4, 1999 to October 2, 1999 and from July 5, 1998 to October 3, 1998 are referred to herein as the three months ended September 30, 1999 and September 30, 1998, respectively. The 39-week periods from January 3, 1999 to October 2, 1999 and from January 4, 1998 to October 3, 1998 are referred to herein as the nine months ended September 30, 1999 and September 30, 1998, respectively. eFax.com's revenues are derived from three sources: (i) product revenues consisting of sales of JetFax branded MFPs, OEM branded MFPs, consumables and upgrades; (ii) licenses and services fees, which include eFax(R) Service revenues (introduced during the quarter ended June 30, 1999) and software and technology license fees related to both its embedded system technology for MFPs and its desktop software; and (iii) development fees for the customization and integration of eFax.com's embedded system technology and desktop software in OEM products. Historically, product revenues have accounted for the majority of eFax.com's total revenues. For the three months ended September 30, 1999, product revenues, licenses and services revenues, and development fees as a percentage of total revenues were 76%, 20%, and 4%, respectively, as compared to 77%, 18%, and 5% for the comparable period in the prior year. For the nine months ended September 30, 1999, product revenues, licenses and services revenues, and development fees as a percentage of total revenues were 78%, 17%, and 5%, respectively, as compared to 78%, 16%, and 6% for the comparable period in the prior year. Overall product revenues for the three month period ended September 30, 1999 have declined from prior quarters as a result of the transition to an OEM business model. Shipments of the new OEM platform MFP are anticipated to begin in the fourth quarter, but are not expected reach the historical volume of the established JetFax branded MFPs in that period. The new emphasis on Internet services has resulted in increased expenditures for both external promotions and other marketing expenses. The majority of these costs are related to media and Internet advertising promoting both 9 10 ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) the basic service and new products and features as introduced. Similarly infrastructure costs to support the planned expansion of services have increased. These infrastructure costs include the cost of delivery of the service such as telephony charges and depreciation on capital equipment, as well as technical and operational support personnel. eFax.com has experienced, and may continue to experience, significant fluctuations in quarterly operating results that have been or may be caused by many factors including: the timing of introductions of new products or product enhancements; initiation, expansion, reduction or termination of arrangements between eFax.com and significant OEM customers; the size and timing of and fluctuations in end user demand; currency fluctuations; and general economic conditions. eFax.com expects that its operating results will continue to fluctuate significantly as a result of these and other factors discussed under the heading "Factors That May Affect Operating Results". Results of Operations The following table sets forth, as a percentage of total revenues, certain items in eFax.com's statements of operations for the periods indicated. Three Months Ended Nine Months Ended September 30, September 30, ------------------ ------------------ 1999 1998 1999 1998 -------- -------- -------- -------- Revenues: Product 75.6% 77.3% 78.3% 78.1% Licenses and services 20.5 17.6 17.2 16.3 Development fees 3.9 5.1 4.5 5.6 -------- -------- -------- -------- Total revenues 100.0 100.0 100.0 100.0 -------- -------- -------- -------- Costs and expenses: Cost of product revenues 56.0 54.0 55.3 53.2 Cost of licenses and services 14.9 1.9 9.2 2.6 Research and development 25.1 16.4 23.7 17.5 Selling and marketing 111.3 22.6 66.0 24.4 General and administrative 14.3 6.2 20.2 8.1 -------- -------- -------- -------- Total costs and expenses 221.6 101.1 174.4 105.8 -------- -------- -------- -------- Loss from operations (121.6) (1.1) (74.4) (5.8) Other income, net 2.9 1.7 1.3 1.2 -------- -------- -------- -------- Income (loss) before income taxes (118.7) 0.6 (73.1) (4.6) Provision for income taxes 0.3 0.1 0.3 0.3 -------- -------- -------- -------- Net income (loss) (119.0) 0.5 (73.4) (4.9) Series A Convertible Preferred stock Dividends (4.9) - (2.3) - -------- -------- -------- -------- Net income (loss) applicable to common stockholders (123.9)% 0.5% (75.7)% (4.9)% ======== ======== ======== ======== Three and Nine Months Ended September 30, 1999 Compared to Three and Nine Months Ended September 30, 1998 Revenues. Total revenues decreased 21% to $6.1 million from $7.7 million -------- for the three months ended September 30, 1999 and September 30, 1998, respectively. For the nine-month periods ended September 30, 1999 and September 30, 1998, respectively, total revenues declined 13% to $20.2 million from $23.2 million. 10 11 ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) Product revenues decreased 22% to $4.6 million from $6.0 million for the three months ended September 30, 1999 and September 30, 1998, respectively, and dropped 6% from the preceding three months ended June 30, 1999. Revenue from shipments of MFPs declined 26% from the preceding three months, as final domestic units of the JetFax branded Series M900 product were sold. Final sales for the Series M900 product internationally are expected during the fourth quarter. Product revenues also reflected the continued erosion in average selling prices, driven by both the level of OEM business and general market pressures. Average selling prices for the three months ended September 30, 1999 declined 14% from the year ago period, and dropped 4% from the preceding three months ended June 30, 1999. Unit sales for the three months ended September 30, 1999 decreased also, down 30% from the three months ended September 30, 1998, and 5% from the preceding quarter. Once discontinuation of JetFax branded products is complete, the hardware business will focus exclusively on OEM channels. As a result, hardware product revenues are expected to decline for the remainder of the year as this move to a new business model is implemented. Consumable revenue increased 25% in the third quarter versus the year ago period, declining only slightly from the preceding quarter. For the nine months ended September 30, 1999 and September 30, 1998, overall product revenues declined 13% to $15.8 million from $18.1 million, a reflection of the factors related to the Company's JetFax branded products. Licensing and services revenues were down slightly for the three months ended September 30, 1999 as compared to the year ago three months ended September 30, 1998. Anticipated declines for: a) per unit royalties for the Hewlett-Packard SureStore CD-Writer, due to a product transition and; b) software revenues due to the withdrawal of PaperMaster products from the retail distribution channel were offset by revenues recognized from the eFax Service. Licensing and services revenues increased 18% from the preceding three month period ended June 30,1999. eFax Service revenue totaled $442,000, up significantly from $33,000 in the preceding quarter, and consisted primarily of recurring monthly subscription fees, signup fees, usage-based charges and revenues from advertising activities. For the nine-month period, licensing and services revenues declined 8% to $3.5 million from $3.8 million for the comparable year ago period, the result of the aforementioned anticipated decline. Development fees dropped 39% to $242,000 from $396,000 for the three months ended September 30, 1999 and September 30, 1998, respectively, as current projects neared completion. For the nine-month period, development revenues declined 29% to $921,000 from $1.3 million for the prior year period, reflecting the completion of current projects and conversion of development fees to per unit royalties. International revenue increased to 19% of total revenues for the three months ended September 30, 1999 from 17% for the comparable period in 1998, primarily as a result of overall revenue declines, attributable to the refocus and transition of efforts in the US to an OEM model. One customer, Hewlett- Packard, accounted for $770,000 (13%) of total revenues for the current quarter, compared with $1.3 million (17%) for the year ago period. Cost of Product Revenues. Cost of product revenues decreased 18% to ------------------------ $3.4 million from $4.2 million for the three months ended September 30, 1999 and September 30, 1998, respectively, and decreased 9% to $11.2 million from $12.3 million for the nine months ended September 30, 1999 and September 30, 1998, respectively. Product gross margin was 26%, down from 30% for the year ago period. This decrease was attributable to volume and average selling price declines and the absence of favorable foreign exchange rates experienced on inventory purchases in the third quarter of 1998. For the nine-month periods ended September 30, 1999 and September 30, 1998, margins were 29% and 32%, respectively. Print engines are purchased for the Series M900 product line in Yen from OkiData Corporation. For the nine months ended September 30, 1999 the average exchange rate for purchases weakened to 113 from 136 Yen to the dollar for the same year ago period. As a result of this rate change, cost of goods sold was increased by $455,000, a major component of the margin decline. Cost of Licenses and Services. Cost of licenses and services climbed ----------------------------- 508% to $918,000 from $151,000 for the three months ended September 30, 1999 and September 30, 1998, respectively, and increased 150% to $1.5 million from $600,000 for the nine months ended September 30, 1999 and September 30, 1998, respectively. Costs related to software and licensing for the current quarter were essentially flat with the year ago period. Direct costs for the eFax Service totaled $751,000 for the three months ended September 30, 1999, up significantly from the preceding quarter. Planned expansion in support of the business growth included service delivery costs such as telephony 11 12 ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) charges, depreciation on capital equipment, operations personnel as well as all technical and customer support related expenses. Research and Development. Research and development expenses rose 22% to ------------------------ $1.5 million from $1.3 million for the three months ended September 30, 1999 and September 30, 1998, respectively, driven by higher personnel costs related to headcount growth, as well as an increase in prototype and tooling charges in support of the next generation OEM MFP platform. Average headcount for the current quarter rose 9% over the year ago period. Research and development expenses grew 18% to $4.8 million from $4.1 million for the nine months ended September 30, 1999 and September 30, 1998, respectively. Increased costs for the nine-month period included software development charges in support of the new eFax Service as well as the impact of headcount growth. Selling and Marketing. Selling and marketing expenses climbed 291% to --------------------- $6.8 million from $1.7 million for the three months ended September 30, 1999 and September 30, 1998, respectively. Increased promotional activity in support of the new eFax Service accounted for effectively all of the increase, more than offsetting the elimination of external marketing efforts related to the branded hardware business. Selling and marketing expenses rose 135% to $13.3 million from $5.7 million for the nine months ended September 30, 1999 and September 30, 1998, respectively, the result of these same activities. Selling and marketing expenses are expected to continue at the same level on a dollar basis for the fourth quarter of fiscal 1999. General and Administrative. General and administrative expenses rose -------------------------- 83% to $877,000 from $480,000 for the three months ended September 30, 1999 and September 30, 1998, respectively. Amortization of trademarks, legal expenses, expenses related to external reporting for public companies, and, to a lesser degree, hiring and compensation expenses were primarily responsible for this increase. General and administrative expenses rose 116% to $4.1 million from $1.9 million for the three months ended September 30, 1999 and September 30, 1998, respectively, driven primarily by $1.4 million of stock-based severance charges related to changes in executive management in the second quarter, as well as the aforementioned expenses. Interest and Other Income (Expense). Interest and other income, net, ----------------------------------- increased to $178,000 from $132,000 for the three months ended September 30, 1999 and September 30, 1998, respectively, driven by interest income from investments. For the six-month period, interest and other income, net, decreased slightly to $257,000 from $268,000, the result of increased interest income, offset by unfavorable foreign currency fluctuations and loss on disposals of fixed assets. Provision for Income Tax. Due to eFax.com's net losses, there were no ------------------------ provisions for federal or state income taxes for three months ended September 30, 1999 and September 30, 1998, respectively. Income tax provisions of $21,000 and $10,000, respectively, relate primarily to foreign withholding taxes on certain royalty fees, but also include minimum state and franchise taxes. Net Income (Loss). The net loss applicable to common shareholders for ----------------- the three months ended September 30, 1999 was $7.6 million or $0.59 per share compared to net income for the three months ended September 30, 1998 of $37,000 or $0.00 per share. The net loss for the nine months ended September 30, 1999 was $15.3 million or $1.23 per share compared to $1.1 million or $0.10 per share for the nine months ended September 30, 1998. Significant drivers to the current year loss include: 1) heavy spending on external promotions for the new eFax Service, 2) a shift in the hardware business model from branded products to OEM channels, and 3) costs associated with changes in management. Liquidity and Capital Resources eFax.com has financed its operations to date principally through private placements of debt and equity securities, proceeds from borrowings under a bank line of credit, debt associated with the Crandell Acquisition, and sales of common stock. The total amount of equity raised through September 30, 1999 was $62 million through a series of private financing rounds at both eFax.com and DocuMagix, and sales of common and preferred stock. 12 13 ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) The Company's revolving line of credit terminated on August 23, 1999 and negotiations are now in progress to establish a new line of credit. There can be no assurance that a new line of credit will be established on terms favorable to the Company or at all. On May 10, 1999, eFax.com entered into a purchase agreement with an investor for the private placement of $15.0 million of Series A Convertible Preferred Stock, convertible into Common Stock at $21.1375 per share. The conversion price is subject to an adjustment after one year to the greater of the then current market price of the Common Stock or 60% of the initial conversion price if the current market price is less than the initial conversion price. The agreement also includes 300,000 warrants exercisable at a 10% premium to the Series A Convertible Preferred Stock conversion price. The Series A Convertible Preferred Stock includes an 8% dividend payable in cash or common stock at the option of eFax.com. The closing occurred on May 13, 1999. eFax.com has agreed to file a registration statement for the resale of the shares of Common Stock acquired on conversion of the Convertible Preferred Stock and upon exercise of the warrants. Cash, cash equivalents and short-term investments rose to $11.0 million at September 30, 1999 from $4.1 million at December 31, 1998, a result of proceeds from the private placement, partially offset by expenditures for external promotions of the eFax Service. Inventories of $2.4 million at September 30, 1999 decreased from $4.5 million at December 31, 1998 due to improved inventory management and end-of-product life cycle for the Series M900. Accounts receivable also declined to $3.3 million at September 30, 1999 from $4.4 million, the result of the lowered sales volume and continuing improved collection on aged accounts. Accounts payable rose to $3.6 million at September 30, 1999 from $777,000 at December 31, 1998, driven primarily by commitments for external promotions in support of the eFax Service. Investing activities for the nine months ended September 30, 1999 consumed $2.1 million of cash: $1.3 million for property purchases, $594,000 for investment in other assets and $188,000 for net purchases of short-term investments. Financing activities for the nine months ended September 30, 1999 provided $15.4 million of cash: $14.2 million in proceeds from the sale of Series A Convertible Preferred Stock, and $1.2 million in proceeds from the sale of Common Stock. eFax.com currently believes that its cash and equivalents, together with proceeds from the recent private placement of convertible preferred stock, the expected renewal of its line of credit, and funds from current and anticipated operations, will be sufficient to meet eFax.com's working capital and capital expenditure requirements for the next twelve months. If eFax.com acquires one or more businesses or products, eFax.com's capital requirements could increase substantially. To raise additional capital, the Company may issue equity securities which could dilute existing investors. Factors That May Affect Operating Results eFax.com operates in a dynamic and rapidly changing environment that involves numerous risks and uncertainties. The following section lists some, but not all, of those risks and uncertainties which may have a material adverse effect on eFax.com's business, financial condition or results of operations. This section should be read in conjunction with the unaudited Condensed Consolidated Financial Statements and Notes thereto included in Part I - Item 1 of this Quarterly Report on Form 10-Q and the audited Consolidated Financial Statements and Notes thereto and Management's Discussion and Analysis of Financial Condition and Results of Operations for the year ended December 31, 1998, contained in eFax.com's Annual Report on Form 10-K for the year ended December 31, 1998. This Quarterly Report on Form 10-Q and the documents incorporated by reference into this Quarterly Report on Form 10-Q may contain projections of results of operations and financial condition or other "forward-looking statements" which involve risks and uncertainties. The words "anticipate," "believe," "estimate," and "expect" and similar expressions when used in this prospectus in relation to eFax.com or its management are intended to identify such forward-looking statements. eFax.com's actual results, performance, or achievements could differ 13 14 ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) materially from these projections or forward-looking statements as a result of many factors, including those discussed in this "Factors That May Affect Operating Results" section of the Quarterly Report on Form 10-Q. WE HAVE EXPERIENCED FLUCTUATIONS IN OUR QUARTERLY OPERATING RESULTS. eFax.com in the past has experienced, and in the future may experience, significant fluctuations in its quarterly operating results. These fluctuations have been or may be caused by many factors, including: o acceptance and timing of new products combining fax technology with the Internet; o the size and timing of development or software licensing agreements; o the timing of new introductions or phase-out of eFax.com's brand products; o fluctuations in consumer demand for eFax.com's brand products and for products which are made by eFax.com's manufacturing customers incorporating eFax.com's products; and o seasonal trends, competition and pricing. eFax.com expects that its operating results will continue to fluctuate as a result of these and other factors. eFax.com has often received a substantial portion of its quarterly revenues during the last month of a quarter. These revenues frequently concentrate in the last weeks or days of a quarter. One reason for this is that eFax.com's brand products are primarily sold through dealers, and these dealers often place orders for products at or near the end of a quarter. The booking and shipping of one or more key orders at the end of a quarter may be delayed until the beginning of the next quarter or it may be cancelled. As a result, we are not able to predict future revenues with any significant degree of accuracy. For these and other reasons, we believe that period-to-period comparisons of eFax.com's results of operations are not necessarily meaningful. We believe that you should not rely upon these comparisons as indicators of future performance. It is likely that in future quarters, eFax.com's operating results will sometimes be below the expectations of public market analysts and investors. This could have a material adverse effect on the price of eFax.com's common stock. We believe that the accuracy of eFax.com's report of its quarterly license revenues received from its manufacturing customers has been, and will continue to be, dependent on the timing and accuracy of product sales reports which we receive from these manufacturing customers. Our manufacturing customers only provide these reports on a quarterly basis and this quarterly basis may not coincide with eFax.com's quarter. Our manufacturing customers may also delay or revise these reports. Therefore, we are required to estimate all of the recurring license revenues from manufacturing customers for each quarter. As a result, we will record an estimate of such revenues prior to public announcement of eFax.com's quarterly results. In the event the product sales reports we receive from our manufacturing customers are delayed or subsequently revised, we may be required to restate eFax.com's recognized revenues or adjust revenues for subsequent periods. This restatement or adjustment of revenues could have a material adverse effect on eFax.com's business, financial condition and results of operations and, as a result, the price of eFax.com's common stock. THE PRICE OF EFAX.COM STOCK MAY BE VOLATILE DUE TO MANY FACTORS, INCLUDING OUR STATUS AS AN INTERNET-RELATED COMPANY, FLUCTUATIONS IN OUR QUARTERLY OPERATING RESULTS, THE RAPID PACE OF TECHNOLOGICAL CHANGE, THE UNCERTAINTY OF OUR BUSINESS TRANSACTIONS AND THE CONTENTS OF NEWS AND SECURITY ANALYST REPORTS. The trading price of eFax.com's common stock is likely to be highly volatile. The price could be subject to wide fluctuations in response to factors such as: o actual or anticipated variations in eFax.com's quarterly operating results; o announcements of technological innovations or new services by eFax.com or its competitors; 14 15 ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) o announcements of significant acquisitions or strategic partnerships by eFax.com or its competitors; o changes in financial estimates and recommendations by securities analysts; and o news reports relating to trends in eFax.com's markets. In addition, the stock market in general, and the market prices for Internet- related companies in particular, have experienced extreme volatility that is often unrelated to the operating performance of these companies. These broad market and industry fluctuations may adversely affect the price of eFax.com's common stock, regardless of eFax.com's actual operating performance. ALTHOUGH WE TAKE STEPS TO PROTECT OUR INTELLECTUAL PROPERTY RIGHTS, WE MAY BECOME SUBJECT TO TIME-CONSUMING AND COSTLY LITIGATION WHERE WE ARE ACCUSED OF INFRINGING THE INTELLECTUAL PROPERTY RIGHTS OF OTHER PARTIES. IN FACT, WE WERE RECENTLY SUED FOR INFRINGING A TRADEMARK OF E-FAX COMMUNICATIONS. eFax.com's success is heavily dependent upon its intellectual property. To protect its proprietary rights, eFax.com relies on a combination of copyright, trade secret and trademark laws, patents, nondisclosure agreements and other contractual restrictions. As part of its confidentiality procedures, eFax.com generally enters into nondisclosure agreements with its employees, consultants, manufacturing customers and strategic partners. eFax.com also limits access to and distribution of its designs, software and other proprietary information. Despite these efforts, eFax.com may be unable to effectively protect its proprietary rights. In addition, enforcement of eFax.com's proprietary rights may be expensive. We cannot assure you that eFax.com's means of protecting its proprietary rights will be adequate. Nor can we assure you that eFax.com's competitors will not independently develop similar technology. As the number of patents, copyrights, trademarks and other intellectual property rights in eFax.com's industry increases, eFax.com's intellectual property may increasingly become the subject of infringement claims. In the past, eFax.com has received communications from other parties claiming that eFax.com's trademarks or products infringe the proprietary rights of these parties. eFax.com has also received communications asking for "indemnification" against such infringement. "Indemnification" means that eFax.com would promise to repay or reimburse the other party for loss or damages suffered by that other party as a result of infringement. eFax.com's manufacturing customers generally require eFax.com to reimburse or "indemnify" the manufacturing customers for claims of infringement from third parties. We can give you no assurance that third parties will not make infringement claims against eFax.com or its manufacturing customers in the future. Any of these claims, even if they have no legal merit, could be time consuming (especially for key management and technical personnel), result in costly litigation or cause delays in revenues. In addition, these claims could require eFax.com to enter into royalty or licensing agreements on terms unacceptable to eFax.com. If eFax.com fails to develop a substitute technology, or to license a substitute technology on acceptable terms, this could have a material adverse effect on eFax.com's business, financial condition and results of operations. As an example, eFax.com was recently sued by E-Fax Communications which claimed that the use of the name "eFax.com" infringed this party's trademark rights. In settlement of the matter, eFax.com has agreed to pay E-Fax Communications a combination of cash and Common Stock in an amount not exceeding $2.5 million based on the average share price of the Common Stock just prior to the stock registration becoming effective. OUR REVENUES MAY NOT GROW AS ANTICIPATED BECAUSE THE MARKET FOR OUR INTERNET- RELATED SERVICES IS NEW, RAPIDLY CHANGING AND UNCERTAIN. The market for Internet-related document communication and handling services is very new and is evolving rapidly. eFax.com expects to rely significantly in the future on revenues generated through its "eFax" service, a free fax-to-e-mail service, and products which support this service. We cannot assure you, however, that the base of customers subscribing to our eFax(c) service will continue to expand rapidly. Nor can we assure you that users will be willing to pay fees for premium services or that the subscriber base will grow large enough to be capable of 15 16 ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) generating advertising revenue. As a result, our revenues may not grow as anticipated, which would have a negative effect on our business. WE HAVE CHANGED THE FOCUS OF OUR BUSINESS TO INTERNET-RELATED SERVICES, PRODUCTS AND TECHNOLOGIES AND GROWTH OF BUSINESS IN THIS NEW FOCUS AREA IS UNCERTAIN. Historically, eFax.com has focused primarily on the development, manufacture and sale of its brand multifunction products. eFax.com currently derives a substantial portion of its revenues from the sale of these brand multifunction products. However, eFax.com expects that its future revenue growth will be dependent, in part, on expansion of its recently introduced Internet-based document services, such as its fax-to-e-mail service, and on further licensing of eFax.com's hardware and software technologies and software products. However, we cannot assure you that eFax.com will realize growth in revenues from such sales. If such growth in revenues does not occur and if revenues from the sale of eFax.com's brand multifunction products does not to continue at past growth rates, it could have a material adverse effect on eFax.com's business, financial condition and results of operations. WE DEPEND ON THE CONTINUED GROWTH OF INTERNET COMMERCE. WE FACE THE RISKS THAT INTERNET COMMERCE MAY NOT GROW AS RAPIDLY AS ANTICIPATED AND THAT THE INTERNET MAY EXPERIENCE TECHNICAL PROBLEMS DUE TO INSUFFICIENT INFRASTRUCTURE AND INADEQUATE TECHNOLOGICAL IMPROVEMENTS. eFax.com intends to derive a significant portion of its revenues from its fax-to-e-mail service, called "eFax", and related products. Rapid growth in the use of and interest in the Internet and online Internet services is a recent phenomenon. As a result, a sufficiently broad base of consumers may not adopt and continue to use the Internet and other online services as a way of purchasing and conducting business. Internet web-based advertising and the sales of premium Internet services are relatively new. It is difficult to predict the extent that these will grow, or if they will grow at all. In addition, the Internet may not prove to be a viable commercial marketplace for reasons such as potentially inadequate development of: o Internet network infrastructure; o technologies which enable use of the Internet; and o performance improvements to support increased levels of Internet activity. If any of the following take place, it could have a material adverse effect on eFax.com's business, financial condition and results of operation: o if the use of the Internet and other online services does not continue to increase or increases more slowly than expected; o if the infrastructure for the Internet and online services proves to be inadequate to effectively support expansion; or o if the Internet does not become a viable commercial marketplace. OUR MANUFACTURING CUSTOMERS, WHICH PROVIDE A SIGNIFICANT PORTION OF OUR REVENUES, MAY NOT CONTINUE TO DEVELOP, MARKET OR SELL PRODUCTS INCORPORATING EFAX.COM'S TECHNOLOGY. eFax.com has derived a significant portion of its revenues from licensing of its software and hardware and software technologies to other parties and from providing development services to manufacturing customers. eFax.com currently has manufacturing relationships with Hewlett-Packard Company, Oki Data Corporation, and Konica Business Systems. eFax.com anticipates that it will derive a significant portion of its revenues in the future from its manufacturing customers and that eFax.com's revenues will be dependent upon, among other things, the ability and willingness of its manufacturing customers to develop and promote multifunction products that 16 17 ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) incorporate eFax.com's technology. The ability and willingness of these manufacturing customers to do this is based upon a number of factors, including eFax.com's ability to complete timely development of designs for them. We cannot give you any assurances regarding the ability or willingness of eFax.com's manufacturing customers to continue developing, marketing and selling products incorporating eFax.com's technology. The loss of any of eFax.com's significant manufacturing customers could have a material adverse effect on eFax.com's business, financial condition and results of operations. OUR DEALERS AND DISTRIBUTORS MAY REDUCE OR DELAY SALES OR STOP MARKETING EFAX.COM'S PRODUCTS WITH A RESULTING LOSS OF REVENUES. eFax.com has derived a substantial portion of its revenues from sales of its JetFax brand multifunction products through dealers and distributors. eFax.com expects that sales of these products through its dealers and distributors will continue to account for a substantial portion of eFax.com's revenues for the foreseeable future. eFax.com currently maintains distribution relationships with dealers associated with IKON Office Solutions, a national group of office equipment dealers, and A. Messerli AG, one of eFax.com's office equipment dealers located in Switzerland. Each of eFax.com's dealers and distributors can stop marketing eFax.com's products with only limited notice to eFax.com and with little or no penalty. The loss of one or more of eFax.com's major dealers or distributors could have a material adverse effect on eFax.com's business, financial condition and results of operations. eFax.com's dealers and distributors also offer competing products manufactured by third parties. We can give no assurance that eFax.com's dealers and distributors will give priority to the marketing of eFax.com's products as compared to the marketing of our competitors' products. Any reduction or delay in sales of eFax.com's products by our dealers and distributors could have a material adverse effect on eFax.com's business, financial condition and results of operations. WE HAVE A HISTORY OF OPERATING LOSSES AND AN ACCUMULATED DEFICIT. eFax.com has had annual net losses since the company was formed. eFax.com's historical losses and certain preferred stock dividends have resulted in an accumulated deficit of approximately $44.5 million as of September 30, 1999. We can give you no assurance that eFax.com will achieve profitability on a quarterly or annual basis in the future. WE MAY FAIL TO ADAPT TO OUR MARKET'S RAPIDLY CHANGING TECHNOLOGY AND EVOLVING INDUSTRY STANDARDS AND WE MAY LOSE COMPETITIVENESS AND REVENUES AS A RESULT. The market for eFax.com's products and services is characterized by rapidly changing technology, evolving industry standards and needs, and frequent new product introductions. As the market for Internet-based document communication and handling services grows, this market will begin to exert more pressure on companies to develop advanced features at more economical pricing. The multifunction product market already expects the continued development and release of new products with better performance and improved features at competitive prices. As product development increases in complexity and the expected time to bring a product to market continues to decrease, the risk and difficulty in meeting these development schedules increases and the costs to eFax.com and its manufacturing customers also increases. In addition, eFax.com, its manufacturing customers and their competitors may, from time to time, announce new products, capabilities or technologies that may replace or shorten the life cycles of eFax.com's brand products and software and the life cycles of manufacturing customers' products incorporating eFax.com's technology. eFax.com's success will depend on, among other things: o market acceptance of eFax.com's product offerings; and o the ability of eFax.com and its manufacturing customers to respond to industry changes and market demands. Any failure of eFax.com to anticipate or respond adequately to the rapidly changing technology and evolving industry standards and needs could result in a loss of our competitiveness or revenues. Any significant delay in our development or introduction of new and enhanced products and services could also result in a loss of 17 18 ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) competitiveness or revenues. Such a loss of competitiveness or revenues could have a material adverse effect on eFax.com's business, financial condition and results of operations. WE FACE A HIGH LEVEL OF COMPETITION IN OUR INTERNET-RELATED INDUSTRY. The market for Internet-related document communication and handling services, such as eFax.com's fax-to-e-mail service, is a newly emerging market and competitors are just beginning to appear. eFax.com anticipates that it will need to: o provide good service and grow its business rapidly to meet demand; o create name recognition for eFax.com in advance of competitors; o build its subscriber base prior to any significant entry by the competition; and o continue to expand and improve on its eFax fax-to-e-mail service offerings. eFax.com's technology, development services and software primarily compete with solutions developed internally by manufacturing customers. Virtually all of eFax.com's manufacturing customers have significant investments in their existing solutions. These manufacturing customers have the substantial resources necessary to develop competing multifunction technologies and software that may be implemented into their own products. eFax.com also competes with technologies, software and development services provided in the multifunction product market by other systems and software suppliers to manufacturing customers. With respect to hardware and software technologies for multifunction products, eFax.com competes with Peerless Systems Corporation, Personal Computer Products, Inc. and Xionics Document Technologies, Inc., among others. With respect to desktop software, eFax.com competes with Caere Corporation, Simplify Development Corporation, Smith Micro Software, Inc., Visioneer Inc., Wordcraft International and Xerox, among others. In the newly evolving market for fax- to-e-mail services, competitors include JFAX.com, Inc., an established business, and CallWave, a start-up that is just introducing its product. The market for multifunction products and related technology and software is highly competitive. This market is characterized by continuous pressure to improve performance, to introduce new features and to accelerate the release of new products. eFax.com's brand products compete primarily with the dominant vendors in the fax market, all of whom have substantially greater resources than eFax.com. These dominant vendors include Canon Inc., Panasonic, a division of Matsushita Electrical Industrial Co., Ltd., Pitney Bowes Inc., Ricoh Co. Ltd., Sharp Electronics Corporation and Xerox, among others. eFax.com also competes on the basis of vendor name and recognition, technology and software expertise, product functionality, development time and price. eFax.com anticipates increasing competition for its multifunction products, technologies, software under development and Internet services. Most of eFax.com's existing competitors, many of its potential competitors and all of eFax.com's manufacturing customers have substantially greater financial, technical, marketing and sales resources than eFax.com. In the event that price competition increases, competitive pressures could cause eFax.com to: o reduce the cost of its eFax Service offerings; o reduce the price of its brand products; o reduce the amount of royalties received on new licenses; and o reduce the fees for its development services in order to maintain existing business and generate additional product sales and license and development revenues. 18 19 ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) In turn, these reductions could reduce eFax.com's profit margins and result in losses and a decrease in market share, which would have a material adverse effect on eFax.com's business, financial condition and results of operations. WE ARE DEPENDENT ON KEY PERSONNEL AND COULD BE AFFECTED BY THE LOSS OF THEIR SERVICES. eFax.com is largely dependent upon the skills and efforts of its senior management, particularly Edward R. Prince, III, known as ''Rudy", its Chief Executive Officer, and Lon Radin, its Vice President of Engineering, as well as other officers and key employees, some of whom only recently have joined eFax.com. eFax.com maintains key person life insurance policies on Rudy Prince and Lon Radin. None of eFax.com's officers or key employees have an employment agreement with eFax.com. eFax.com believes that its future success will depend in large part upon its ability to attract and retain highly skilled engineering, managerial, sales, marketing and operations personnel, many of whom are in great demand. Competition for such personnel, especially engineering personnel, has recently increased significantly. The loss of key personnel or the inability to hire or retain qualified personnel could have a material adverse effect on eFax.com's business, financial condition and results of operations. OUR RAPID GROWTH PLACES A STRAIN ON OUR OPERATIONS AND FINANCIAL RESOURCES AND WE MAY FAIL TO MANAGE OUR GROWTH EFFECTIVELY. IN ADDITION, WE MAY FACE RISKS ASSOCIATED WITH ANY POTENTIAL ACQUISITION OF OTHER COMPANIES WHICH WE MAY CHOOSE TO UNDERTAKE. eFax.com has grown rapidly in recent years. A continuing period of rapid growth could place a significant strain on eFax.com's management, operations and other resources. eFax.com's ability to manage its growth will require eFax.com to continue to invest in its operational, financial and management information systems, procedures and controls, and to attract, retain, motivate and effectively manage its employees. We can give no assurance that eFax.com will be able to manage its growth effectively. Failure to manage growth effectively would have a material adverse effect on eFax.com's business, financial condition and results of operations. eFax.com may, from time to time, pursue the acquisition of other companies, assets or product lines that complement or expand its existing business. Acquisitions involve a number of risks that could adversely affect eFax.com's operating results. These risks include: o the diversion of management's attention from day-to-day business; o the difficulty of combining and assimilating the operations and personnel of the acquired companies; o charges to the company's earnings as a result of the purchase of intangible assets; and o the potential loss of key employees as a result of an acquisition. eFax.com has no present commitments nor is it engaged in any discussions or negotiations regarding possible acquisitions. However, should any acquisition by eFax.com take place, we can give no assurance that this acquisition will not materially and adversely affect eFax.com or that any such acquisition will enhance eFax.com's business. WE ARE DEPENDENT ON A LIMITED NUMBER OF SUPPLIERS AND MAY BE AFFECTED BY CHANGES, DELAYS OR INTERRUPTIONS IN SUPPLY OF COMPONENTS OF OUR PRODUCTS FROM THESE SUPPLIERS. eFax.com relies on various suppliers of components for its products. eFax.com generally buys components under purchase orders and does not have long-term agreements with its suppliers. Alternate suppliers may be readily available for some of these components. However, for other components, we do not know how long it would take to find a replacement supplier and to receive replacement components. If we need to find another supplier of those components which we now purchase from a single source, we may not have sufficient inventory to fill customer orders without interruption. Although we believe we could develop other sources for these single source components, no alternative source currently exists and the process of finding an alternate source could take several 19 20 ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) months or longer. Therefore, any interruption in the supply of these components could have a material adverse effect on eFax.com's business, financial condition and results of operations. eFax.com purchases many of the components used in its products from suppliers located outside the United States. Foreign manufacturing facilities are subject to the risk of changes in governmental policies, imposition of tariffs and import restrictions and other factors beyond eFax.com's control. We can give you no assurance that United States or foreign trading policies will not restrict the availability of components or increase their cost. Any significant increase in component prices or decrease in component availability could have a material adverse effect on eFax.com's business, financial condition and results of operations. Certain components used in eFax.com's products are available only from one source. eFax.com is dependent on Oki America, Inc., as the supplier of major components, contained in eFax.com's Series M900, one of eFax.com's most important products. Oki America is also a competitor of eFax.com. eFax.com is also dependent on: o American Microsystems, Inc. to provide customized integrated circuits incorporating eFax.com's imaging and logic circuitry; o Motorola, Inc. to provide microprocessors; o Pixel Magic, Inc., a subsidiary of Oak Technology, Inc., to provide a specialized imaging processor; o Conexant Systems, Inc., to provide modem chips. Given our dependence on single source suppliers, any of the following events could have a material adverse effect on eFax.com's business, financial condition and results of operations: o if any of these companies were to limit or reduce the sale of such components to eFax.com; o if these suppliers were to experience financial difficulties or other problems which prevented them from supplying eFax.com with necessary components; o any shortage or interruption in the supply of any of the components used in eFax.com's products; or o the inability of eFax.com to obtain these components from alternate sources on acceptable terms. WE GENERATE A SIGNIFICANT PORTION OF OUR REVENUES FROM OUR INTERNATIONAL ACTIVITIES AND WE ARE SUBJECT TO MANY RISKS AS A RESULT OF THESE ACTIVITIES. A significant portion of eFax.com's total revenues come from sales to eFax.com's customers outside the United States. The international market for eFax.com's brand products and products incorporating eFax.com's technology and software is highly competitive. Risks inherent in eFax.com's international business activities also include: o currency fluctuations and restrictions; o the burdens of complying with a wide variety of foreign laws and regulations; o longer accounts receivable cycles; o the imposition of government controls; o risks of localizing and internationalizing products to local requirements in foreign countries; o trade restrictions; o tariffs and other trade barriers; 20 21 ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) o restrictions on bringing earnings back into the United States; and o potentially adverse tax consequences. Any of these risks could have a material adverse effect on eFax.com's business, financial condition and results of operations. Substantially all of eFax.com's international sales are currently made in U.S. dollars. Therefore, increases in the value of the U.S. dollar relative to foreign currencies could make eFax.com's products less competitive in foreign markets. Because of eFax.com's international activities, it faces currency exposure and currency exchange risks. For example, eFax.com purchases some of its key components pursuant to purchase contracts which require payment in foreign currency which results in currency exchange risks. OUR ONLY MANUFACTURING FACILITY AND SEVERAL OF OUR SUPPLIERS ARE LOCATED IN ONE GEOGRAPHIC AREA. A DISRUPTION OF OUR MANUFACTURING FACILITY AND OUR SUPPLIERS IN THE SAME GEOGRAPHIC AREA WOULD HAVE A NEGATIVE EFFECT ON OUR BUSINESS. eFax.com's manufacturing operations are located in its facility in Northern California. In addition, eFax.com relies on several suppliers of components for eFax.com's products and a number of companies which assemble eFax.com products which are located in Northern California. eFax.com does not currently operate multiple facilities in different geographic areas and does not have alternative sources for many of its components or assembly processes. As a result, a disruption of eFax.com's manufacturing operations, or the operations of its suppliers, could cause eFax.com to cease or limit its manufacturing operations. Consequently, this would have a material adverse effect on eFax.com's business, financial condition and results of operations. WE MAY BE ADVERSELY AFFECTED IF OUR COMPUTER SYSTEMS OR THOSE OF OUR DISTRIBUTORS, SUPPLIERS AND CUSTOMERS FAIL BECAUSE OF YEAR 2000 PROBLEMS. Readiness for the year 2000 refers to the issue surrounding computer programs that use two digits rather than four to define a given year. These programs might read a date using "00" as the year 1900 rather than the year 2000, which could cause a system failure or a miscalculation. We do not believe eFax.com's manufacturing facilities are vulnerable in any significant way to year 2000 system failures involving non-information technology. In August 1998, eFax.com renovated its existing telephone system at a cost of approximately $40,000, which made the phone system ready for the year 2000. eFax.com has invested approximately $367,000 and will continue to make certain investments, estimated not to exceed $50,000, in its software systems and applications to ensure eFax.com's information systems are ready for the year 2000. The necessary funds to support these renovations have come from eFax.com's operating budget and eFax.com does not anticipate that it will need to allocate special future funding outside of historical levels for this item. The financial impact of eFax.com's year 2000 readiness effort has not been and is not anticipated to be material to eFax.com's financial position or results of operations in any given year. For example, during 1997 and 1998, eFax.com purchased and implemented new manufacturing and accounting information systems with a total capitalized cost of $338,000. eFax.com has obtained written assurances from the vendor, QAD Inc., that the systems are ready for the year 2000. However, eFax.com has not conducted internal testing of the systems' readiness. eFax.com believes that its current products are ready for the year 2000. Certain of eFax.com's older products, which may not be year 2000 ready, are no longer under warranty. eFax.com believes it has no obligation related to these products. If eFax.com is mistaken in this assessment, eFax.com could incur expenses in defending legal actions for breach of contract or other causes of action. We can give you no assurance that these expenses will not be material to eFax.com's financial position or results of operations. As discussed above, eFax.com has recently implemented new information systems and accordingly does not anticipate any internal year 2000 problems from those information systems, databases or programs. However, year 2000 problems faced by major distributors, suppliers, customers and financial service organizations with which we interact could adversely impact eFax.com. Our assessment of the potential impact of these additional issues was completed in October 1999. We can give you no assurance that we were able to detect all potential failures of eFax.com's computer systems or the computer systems of third parties. A significant failure of eFax.com's or a third 21 22 ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) party's computer system could have a material adverse effect on eFax.com's business, financial condition and results of operations. eFax.com has completed its contingency plan, detailing actions that would be taken in the event that such a failure occurs. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK No change has occurred since the filing by the Registrant on Form 10-K for the year ended December 31, 1998. Reference is made to Part II, Item 7A, Quantitative and Qualitative Disclosures About Market Risk, in the Registrant's Annual Report on Form 10-K for the year ended December 31, 1998. 22 23 PART II. OTHER INFORMATION ITEM 2. CHANGES IN SECURITIES (a) Not applicable. (c) During the quarter ended September 30, 1999, eFax.com sold the following unregistered securities: In April 1999, the Company issued 45,506 shares of common stock to E- Fax Communications, Inc. as part of a settlement agreement for trademark rights entered into on April 9, 1999 between E- Fax Communications, Inc. and eFax.com, Inc. In July 1999, an additional 82,086 shares were issued per the terms of the agreement in order to provide aggregate consideration of $2.0 million at the time the registration statement was declared effective. The average value of the shares used in the computation was $15.675. In November 1999, the Company issued warrants to purchase 22,500 shares of common stock to Global NAPS, Inc., in connection with the completion and acceptance of project milestones in September 1999. The warrant exercise price is $8.625. These warrants may be exercised immediately. The issuance and sale of all such securities was intended to be exempt from registration and prospectus delivery requirements under the Securities Act of 1933, as amended (the "Securities Act"), by virtue of Section 4(2) thereof due to, among other things, (i) the limited number and nature of persons to whom the securities were issued, (ii) the fact that such persons represented and warranted to the Company, among other things, that such persons were acquiring the securities for investment only and not with a view to the resale or distribution thereof, and (iii) the fact that a certificate representing the securities was issued with a legend to the effect that such securities had not been registered under the Securities Act or any state securities laws and could not be sold or transferred in the absence of such registration or an exemption therefrom. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits. -------- Exhibit Number Description ----- --------------------------------------------------------- 27.1 Financial Data Schedule. ----------------------- (b) Reports on Form 8-K. The Company did not file any Reports on Form 8-K ------------------- during the quarter ended September 30, 1999. 23 24 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. EFAX.COM, INC. ---------------------- (Registrant) Date: November 16, 1999 By: /s/ TODD J. KENCK ----------------------- Todd J. Kenck Vice President, Finance and Chief Financial Officer (Authorized Officer and Principal Financial and Accounting Officer) 24 25