UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
FORM 10-Q
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[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER: 0-30903
------------------------
VIRAGE, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 38-3171505
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
411 BOREL ROAD, 100 SOUTH
SAN MATEO, CALIFORNIA 94402-3116
(650) 573-3210
(Address, including zip code, and telephone number, including
area code, of the registrant's principal executive offices)
------------------------
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.
[X] Yes [ ] No
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act).
[ ] Yes [X] No
The number of outstanding shares of the registrant's Common Stock, $0.001 par
value, was approximately 21,809,000 as of July 31, 2003.
- --------------------------------------------------------------------------------
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VIRAGE, INC.
INDEX
PAGE
PART I: FINANCIAL INFORMATION
Item 1. Financial Statements (unaudited)
Condensed Consolidated Balance Sheets - June 30, 2003
and March 31, 2003............................................. 1
Condensed Consolidated Statements of Operations -- Three Months Ended
June 30, 2003 and 2002......................................... 2
Condensed Consolidated Statements of Cash Flows -- Three Months Ended
June 30, 2003 and 2002......................................... 3
Notes to Condensed Consolidated Financial Statements.................... 4
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations...................................... 18
Item 3. Quantitative and Qualitative Disclosures About Market Risk........ 38
Item 4. Controls and Procedures........................................... 38
PART II: OTHER INFORMATION
Item 1. Legal Proceedings.................................................. 39
Item 2. Changes in Securities and Use of Proceeds.......................... 40
Item 3. Defaults Upon Senior Securities.................................... 40
Item 4. Submission of Matters to a Vote of Security Holders................ 40
Item 5. Other Information.................................................. 40
Item 6. Exhibits and Reports on Form 8-K................................... 41
Signature.................................................................. 42
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
VIRAGE, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands)
(unaudited)
June 30, March 31,
2003 2003
---------- ---------
ASSETS
Current assets:
Cash and cash equivalents ............................... $ 6,459 $ 2,934
Short-term investments .................................. 7,464 13,383
Accounts receivable, net ................................ 1,350 2,441
Prepaid expenses and other current assets ............... 698 920
--------- ---------
Total current assets ................................ 15,971 19,678
Property and equipment, net ............................... 1,044 1,347
Other assets .............................................. 1,247 1,293
--------- ---------
Total assets ........................................ $ 18,262 $ 22,318
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable ........................................ $ 491 $ 614
Accrued payroll and related expenses .................... 1,061 1,353
Accrued expenses ........................................ 2,009 1,923
Accrued restructuring charges ........................... 1,421 1,515
Deferred revenue ........................................ 2,420 3,212
--------- ---------
Total current liabilities ........................... 7,402 8,617
Commitments and contingencies
Stockholders' equity:
Preferred stock ......................................... -- --
Common stock ............................................ 21 21
Additional paid-in capital .............................. 121,661 121,513
Deferred compensation ................................... (519) (789)
Accumulated deficit ..................................... (110,303) (107,044)
--------- ---------
Total stockholders' equity .......................... 10,860 13,701
--------- ---------
Total liabilities and stockholders' equity .......... $ 18,262 $ 22,318
========= =========
See accompanying notes.
1
VIRAGE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
(unaudited)
Three Months Ended
June 30,
-----------------------
2003 2002
-------- --------
Revenues:
License revenues ............................ $ 1,276 $1,611
Service revenues ............................ 1,651 1,624
-------- --------
Total revenues ............................ 2,927 3,235
Cost of revenues:
License revenues ............................ 153 187
Service revenues(1) ......................... 948 1,159
-------- --------
Total cost of revenues .................... 1,101 1,346
-------- --------
Gross profit .................................. 1,826 1,889
Operating expenses:
Research and development(2) ................. 1,654 2,382
Sales and marketing(3) ...................... 2,095 3,685
General and administrative(4) ............... 1,120 1,142
Stock-based compensation .................... 270 371
-------- --------
Total operating expenses .................. 5,139 7,580
-------- --------
Loss from operations .......................... (3,313) (5,691)
Interest and other income ..................... 54 190
-------- --------
Net loss ...................................... $ (3,259) $ (5,501)
======== ========
Basic and diluted net loss per share .......... $ (0.15) $ (0.27)
======== ========
Shares used in computation of basic and diluted
net loss per share .......................... 21,185 20,687
======== ========
(1) Excluding $5 in amortization of deferred employee stock-based compensation
for the three months ended June 30, 2003 ($5 for the three months ended
June 30, 2002).
(2) Excluding $17 in amortization of deferred employee stock-based compensation
for the three months ended June 30, 2003 ($23 for the three months ended
June 30, 2002).
(3) Excluding $17 in amortization of deferred employee stock-based compensation
for the three months ended June 30, 2003 ($31 for the three months ended
June 30, 2002).
(4) Excluding $231 in amortization of deferred employee stock-based
compensation for the three months ended June 30, 2003 ($312 for the three
months ended June 30, 2002).
See accompanying notes.
2
VIRAGE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
Three Months Ended
June 30,
---------------------
2003 2002
---- ----
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss ......................................................................... $ (3,259) $ (5,501)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization .................................................. 335 685
Loss on disposal of assets ..................................................... -- 106
Amortization of deferred compensation related to
stock options ................................................................ 270 371
Amortization of technology right and warrant fair values ....................... 13 12
Changes in operating assets and liabilities:
Accounts receivable .......................................................... 1,091 481
Prepaid expenses and other current assets .................................... 222 (898)
Other assets ................................................................. 37 (26)
Accounts payable ............................................................. (123) (236)
Accrued payroll and related expenses ......................................... (292) 87
Accrued expenses and accrued restructuring charges ........................... (8) (378)
Deferred revenue ............................................................. (792) 58
Deferred rent ................................................................ -- 34
-------- --------
Net cash used in operating activities ............................................ (2,506) (5,205)
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment ............................................... (32) (118)
Purchase of short-term investments ............................................... (5,431) (22,600)
Sales and maturities of short-term investments ................................... 11,350 25,278
-------- --------
Net cash provided by investing activities ........................................ 5,887 2,560
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from exercise of stock options, net of repurchases ...................... 114 10
Proceeds from employee stock purchase plan ....................................... 30 151
-------- --------
Net cash provided by financing activities ........................................ 144 161
-------- --------
Net increase/(decrease) in cash and cash equivalents ............................. 3,525 (2,484)
Cash and cash equivalents at beginning of period ................................. 2,934 4,586
-------- --------
Cash and cash equivalents at end of period ....................................... $ 6,459 $ 2,102
======== ========
SUPPLEMENTAL DISCLOSURES OF NONCASH OPERATING, INVESTING AND FINANCING ACTIVITIES:
Deferred compensation related to stock options ................................... $ -- 36
Reversal of deferred compensation upon employee termination ...................... $ -- $ 34
See accompanying notes.
3
VIRAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2003
(unaudited)
1. Summary of Significant Accounting Policies
Basis of Presentation
The accompanying unaudited condensed consolidated financial statements have
been prepared in accordance with generally accepted accounting principles for
interim financial information and in accordance with the instructions to Form
10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of
the information and footnotes required by generally accepted accounting
principles for complete financial statements. In the opinion of management, all
adjustments (consisting of normal recurring accruals) necessary for a fair
presentation of the financial statements at June 30, 2003 and for the three
month periods ended June 30, 2003 and 2002 have been included.
The condensed consolidated financial statements include the accounts of
Virage, Inc. (the "Company") and its wholly-owned subsidiaries, Virage Europe,
Ltd. and Virage GmbH. All significant intercompany balances and transactions
have been eliminated in consolidation.
Results for the three months ended June 30, 2003 are not necessarily
indicative of results for the entire fiscal year or future periods. These
financial statements should be read in conjunction with the consolidated
financial statements and the accompanying notes included in the Company's Annual
Report on Form 10-K, dated June 16, 2003, as amended by the Company's Amendment
to its Annual Report on Form 10-K/A, dated July 29, 2003, as filed with the
United States Securities and Exchange Commission. The accompanying balance sheet
at March 31, 2003 is derived from the Company's audited consolidated financial
statements at that date.
Management believes that its restructuring activities, including the
restructuring of its headquarters facility, have reduced its ongoing operating
expense such that the Company will have sufficient working capital to support
planned activities through fiscal 2004. As of June 30, 2003, the Company had
cash, cash equivalents and short-term investments totaling $13,923,000, working
capital of approximately $8,569,000 and stockholders' equity of approximately
$10,860,000. During the first quarter of fiscal 2004, the Company used cash and
cash equivalents in operating activities of approximately $2,506,000. During the
year ended March 31, 2003, the Company used cash and cash equivalents in
operating activities of approximately $14,510,000. Management is committed to
the successful execution of the Company's operating plan and will take further
action as necessary to align the Company's operations and reduce expenses to
ensure the Company continues as a going concern through at least March 31, 2004.
In July 2003, the Company and Autonomy Corporation entered into a
definitive agreement under which Autonomy will acquire the Company (see Note 6)
for a purchase price of $1.10 per share in cash. The transaction reflects a
fully-diluted cash purchase price of approximately $24,800,000.
Revenue Recognition
The Company enters into arrangements for the sale of licenses of software
products and related maintenance contracts, application services and
professional services offerings. Service revenues include revenues from
maintenance contracts, application services, and professional services,
including professional services performed directly for and via subcontract for
the U.S. Government.
4
VIRAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
June 30, 2003
(unaudited)
The Company's revenue recognition policy is in accordance with the American
Institute of Certified Public Accountants' ("AICPA") Statement of Position No.
97-2 ("SOP 97-2"), "Software Revenue Recognition", as amended by Statement of
Position No. 98-4, "Deferral of the Effective Date of SOP 97-2, "Software
Revenue Recognition"" ("SOP 98-4"), and Statement of Position No. 98-9,
"Modification of SOP No. 97-2 with Respect to Certain Transactions" ("SOP 98-9")
and is also consistent with the Securities and Exchange Commission's Staff
Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements." For
each arrangement, the Company determines whether evidence of an arrangement
exists, delivery has occurred, the fee is fixed or determinable, and collection
is probable. If any of these criteria are not met, revenue recognition is
deferred until such time as all criteria are met. The Company considers all
arrangements with payment terms longer than normal not to be fixed and
determinable. The Company's normal payment terms are generally considered to be
"net 30 days" to "net 60 days." For arrangements involving extended payment
terms, revenue recognition generally occurs when payments become due provided
all other revenue recognition criteria are met. No customer has the right of
return and arrangements generally do not have acceptance criteria. If right of
return or customer acceptance does exist within an arrangement, revenue is
deferred until the earlier of the end of the right of return/acceptance period
or until written notice of acceptance/cancellation of right of return is
received from the customer.
Arrangements consisting of license and maintenance. For those contracts
that consist solely of license and maintenance, the Company recognizes license
revenues based upon the residual method after all elements other than
maintenance have been delivered as prescribed by SOP 98-9. Revenue is recognized
on a per copy basis for licensed software when each copy of the license
requested by the customer is delivered. The Company recognizes maintenance
revenues over the term of the maintenance contract as vendor specific objective
evidence of fair value for maintenance exists. In accordance with paragraph ten
of SOP 97-2, vendor specific objective evidence of fair value of maintenance is
determined by reference to the price the customer will be required to pay when
it is sold separately (that is, the renewal rate). Customers that enter into
maintenance contracts have the ability to renew such contracts at the renewal
rate. Maintenance contracts are typically one year in duration.
Revenue is recognized on licensed software on a per user or per server
basis for a fixed fee when the product master is delivered to the customer.
There is no right of return or price protection for sales to domestic and
international distributors, system integrators, or value added resellers
(collectively, "resellers"). In situations where the reseller has a purchase
order or other contractual agreement from the end user that is immediately
deliverable upon, the Company recognizes revenue on the shipment to the
reseller, if other criteria in SOP 97-2 are met, since the Company has no risk
of concessions. The Company defers revenue on shipments to resellers if the
reseller does not have a purchase order or other contractual agreement from an
end user that is immediately deliverable upon or other criteria in SOP 97-2 are
not met. The Company recognizes royalty revenues upon receipt of the quarterly
reports from the vendors.
When licenses and maintenance are sold together with professional services
such as consulting and implementation, license fees are recognized upon
shipment, provided that (1) the criteria in the previous paragraphs have been
met, (2) payment of the license fee is not dependent upon the performance of the
professional services, (3) the services do not include significant alterations
to the features and functionality of the software and (4) the services are
deemed "perfunctory" both in level of effort to perform and in magnitude of
dollars based upon the Company's objective evidence of fair value for the
services relative to the fair value of other elements provided for in the total
arrangement fee.
5
VIRAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
June 30, 2003
(unaudited)
Should professional services be essential to the functionality of the
licenses in a license arrangement that contains professional services or should
an arrangement not meet the criteria mentioned above, both the license revenues
and professional service revenues are recognized in accordance with the
provisions of the AICPA's Statement of Position No. 81-1, "Accounting for
Performance of Construction Type and Certain Production Type Contracts" ("SOP
81-1"). When reliable estimates are available for the costs and efforts
necessary to complete the implementation services and the implementation
services do not include contractual milestones or other acceptance criteria, the
Company accounts for the arrangements under the percentage of completion
contract method pursuant to SOP 81-1 based upon input measures such as hours or
days. When such estimates are not available, the completed contract method is
utilized. When an arrangement includes contractual milestones, the Company
recognizes revenues as such milestones are achieved provided the milestones are
not subject to any additional acceptance criteria. For arrangements that include
customer acceptance clauses that the Company does not have an established
history of meeting or which are not considered to be routine, the Company
recognizes revenue when the arrangement has been completed and accepted by the
customer provided all other criteria for revenue recognition are met.
Application services. Application services revenues consist primarily of
web design and integration fees, video processing fees and application hosting
fees. Web design and integration fees are recognized ratably over the contract
term, which is generally six to twelve months. The Company generates video
processing fees for each hour of video that a customer deploys. Processing fees
are recognized as encoding, indexing and editorial services are performed and
are based upon time-based rates of video content. Application hosting fees are
generated by and based upon the number of video queries processed, subject in
most cases to monthly minimums. The Company recognizes revenues on transaction
fees that are subject to monthly minimums based upon the monthly minimum rate
since the Company has no further obligations, the payment terms are normal and
each month is a separate measurement period.
Professional Services. The Company provides professional services such as
consulting, implementation and training services to its customers. Revenues from
such services, when not sold in conjunction with product licenses, are generally
recognized as the services are performed provided that there are indications
that the customer is satisfied with and/or will pay for the services and all
other revenue recognition criteria are met.
Included as part of the Company's service revenues are services performed
for U.S. Government Defense and other security agencies, either from direct
arrangements or subcontracts with other U.S. Government contractors. The Company
generally performs these services in conjunction with existing or potential
software license sales. Should software be included as part of the arrangement,
the Company accounts for any software license fee according to its revenue
recognition accounting policy for multiple-element arrangements described above.
Virtually all of the Company's services with such U.S. Government entities
are performed under various firm-fixed-price, time-and-material, and
cost-plus-fixed-fee reimbursement contracts. Revenues on firm-fixed-price
contracts are generally recognized according to SOP 81-1 based upon costs
incurred in relation to total estimated costs from input measures such as hours
or days. Revenues on time-and-material contracts are recognized to the extent of
billable rates multiplied by hours worked plus materials expense incurred.
Revenues for cost-plus-fixed-fee contracts are recognized as costs are incurred,
including a proportionate amount of the fee earned.
Customer billings that have not been recognized as revenue in accordance
with the above policies are shown on the balance sheet as deferred revenue.
6
VIRAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
June 30, 2003
(unaudited)
Allowance for Revenue Adjustments and Doubtful Accounts
If the Company determines that payment from the customer is not probable at
the time all other revenue recognition criteria (as described above) have been
met, the Company defers revenues until payment from the customer is received.
The Company also makes judgments as to its ability to collect outstanding
receivables (that have not been deferred) and provides an allowance for the
portion of receivables when collection becomes doubtful. The Company also
provides an allowance for returns and revenue adjustments in the same period as
the related revenues are recorded. Allowances are made based upon a specific
review of all significant outstanding invoices. Allowances recorded offset the
Company's gross accounts receivable balance.
Stock-Based Compensation
The Company has elected to follow the intrinsic value method of Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees"
("APB Opinion No. 25"), in accounting for its employee stock options because, as
discussed below, the alternative fair value accounting provided for under the
Financial Accounting Standards Board's ("FASB") Statement of Financial
Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("FAS
123"), requires use of option valuation models that were not developed for use
in valuing employee stock options. Under APB Opinion No. 25, compensation
expense is based on the difference, if any, on the date of grant, between the
estimated fair value of the Company's common stock and the exercise price. FAS
123 defines a "fair value" based method of accounting for an employee stock
option or similar equity investment. The Company accounts for equity instruments
issued to nonemployees in accordance with the provisions of FAS 123 and the
FASB's Emerging Issues Task Force Issue No. 96-18, "Accounting for Equity
Instruments That Are Issued to Other Than Employees for Acquiring or in
Conjunction with Selling, Goods or Services ("EITF 96-18")."
Pro Forma Disclosures of the Effect of Stock-Based Compensation
As described above, the Company has elected to follow APB Opinion No. 25
and related interpretations in accounting for its employee stock plans. However,
FAS 123 requires pro forma information regarding net loss as if the Company had
accounted for and calculated the related non-cash, stock-based expense for its
employee stock plans under the fair value method prescribed under FAS 123.
In order to determine this pro forma net loss, the fair value for the
Company's options was estimated at the date of grant using the Black-Scholes
option valuation model with the following assumptions for the three months ended
June 30, 2003 and 2002: risk-free interest rates of 2.0% and 2.7%, respectively;
and volatility factors of 112%, no dividend yield and an expected life of the
options of four years for both periods presented. The fair value of shares
issued and to be issued pursuant to the Company's employee stock purchase plan
in the three months ended June 30, 2003 and 2002 were estimated using the
following weighted average assumptions: risk-free interest rate of 1.3%, and
1.7%, respectively, and no dividend yield, a volatility factor of 112%, and an
expected life of the option of six months for both periods. For purposes of pro
forma disclosures, the estimated fair value of the options is amortized to
expense over the options' vesting period.
The Black-Scholes option valuation model used by the Company to determine
fair value for purposes of its pro forma disclosure was developed for use in
estimating the fair value of traded options that have no vesting restrictions
and are fully transferable. In addition, option valuation models require the
input of highly subjective assumptions, including the expected price volatility.
Because the Company's employee stock options and stock purchase plan shares have
characteristics significantly different from those of traded options and because
changes in the subjective input assumptions can materially affect the fair value
estimate, in the Company's opinion, the existing models do not necessarily
provide a reliable single measure of the fair value of its employee stock
options.
7
VIRAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
June 30, 2003
(unaudited)
Had compensation expense for the Company's employee stock plans been
determined using the fair value at the grant dates for awards under those plans
calculated using the Black-Scholes valuation model, the Company's net loss and
basic and diluted net loss per share would have been increased to the pro forma
amounts indicated below (in thousands, except per share amounts):
Three Months Ended June 30,
---------------------------
2003 2002
------- -------
Net loss, as reported .................................... $(3,259) $(5,501)
Add: stock-based compensation expense included in
reported net loss, net of related tax effects .......... 270 371
Deduct: total stock-based compensation expense determined
under fair value method for all awards ................. (837) (1,010)
------- -------
Net loss, pro forma ...................................... $(3,826) $(6,140)
======= =======
Basic and diluted net loss per share, as reported ........ $ (0.15) $ (0.27)
======= =======
Basic and diluted net loss per share, pro forma .......... $ (0.18) $ (0.30)
======= =======
These pro forma amounts may not be representative of the effects on
reported net loss for future periods as options vest over several years and
additional awards are generally made each year.
The weighted-average grant date fair value of options granted during the
three months ended June 30, 2003 and 2002 was $0.61 and $0.97, respectively, and
the weighted-average grant date fair value of ESPP shares was $0.68 and $0.57
during the three months ended June 30, 2003 and 2002, respectively.
Use of Estimates
The preparation of the accompanying unaudited condensed consolidated
financial statements requires management to make estimates and assumptions that
effect the amounts reported in these financial statements. Actual results could
differ from those estimates.
Cash Equivalents and Short-Term Investments
The Company invests its excess cash in money market accounts and debt
instruments and considers all highly liquid debt instruments purchased with an
original maturity of three months or less to be cash equivalents. Investments
with an original maturity at the time of purchase of over three months are
classified as short-term investments regardless of maturity date, as all such
instruments are classified as available-for-sale and can be readily liquidated
to meet current operational needs. At June 30, 2003, all of the Company's total
cash equivalents and short-term investments were classified as
available-for-sale and consisted of obligations issued by U.S. government
agencies and multinational corporations, maturing within one year. Realized and
unrealized gains and losses were insignificant for all periods presented.
Comprehensive Net Loss
The Company has adopted the FASB's Statement of Financial Accounting
Standards No. 130, "Reporting Comprehensive Income" ("FAS 130"). FAS 130
establishes standards for the reporting and display of comprehensive income
(loss) and its components in a full set of general purpose financial statements.
To date, unrealized gains and losses have been insignificant and the Company has
had no other significant comprehensive income (loss), and consequently, net loss
equals total comprehensive net loss.
8
VIRAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
June 30, 2003
(unaudited)
Net Loss per Share
Basic and diluted net loss per share are computed in conformity with the
FASB's Statement of Financial Accounting Standards No. 128, "Earnings Per Share"
("FAS 128"), for all periods presented, using the weighted average number of
common shares outstanding less shares subject to repurchase.
The following table presents the computation of basic and diluted net loss
per share (in thousands, except per share data):
Three Months Ended
June 30,
-----------------------
2003 2002
-------- --------
Net loss ...................... $ (3,259) $ (5,501)
======== ========
Weighted-average shares of
common stock outstanding .... 21,185 20,706
Less weighted-average shares of
common stock subject to
repurchase .................. -- (19)
-------- --------
Weighted-average shares used
in computation of basic and
diluted net loss per share .. 21,185 20,687
======== ========
Basic and diluted net loss per
share ....................... $ (0.15) $ (0.27)
======== ========
Impact of Recently Issued Accounting Standards
In November 2002, the FASB's EITF reached a consensus on Issue No. 00-21,
"Revenue Arrangements with Multiple Deliverables (EITF 00-21)." EITF 00-21
provides guidance on how to account for arrangements that involve the delivery
or performance of multiple products, services and/or rights to use assets. The
provisions of Issue 00-21 will apply to revenue arrangements entered into in
fiscal periods beginning after June 15, 2003. We do not believe that the
adoption of EITF 00-21 will have a material effect on our consolidated financial
position, results of operations or cash flows.
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities ("FIN 46")." FIN 46 requires an investor with a
majority of the variable interests in a variable interest entity ("VIE") to
consolidate the entity and also requires majority and significant variable
interest investors to provide certain disclosures. A VIE is an entity in which
the equity investors do not have a controlling interest, or the equity
investment at risk is insufficient to finance the entity's activities without
receiving additional subordinated financial support from the other parties. For
arrangements entered into with VIEs created prior to January 31, 2003, the
provisions of FIN 46 are required to be adopted at the beginning of the first
interim or annual period beginning after June 15, 2003. The provisions of FIN 46
are effective immediately for all arrangements entered into with new VIEs
created after January 31, 2003. To date, the Company has not invested in any
VIE's and does not expect the adoption of FIN 46 to be material on its
operations, financial position or cash flows.
9
VIRAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
June 30, 2003
(unaudited)
In April 2003, the FASB issued Statement of Financial Accounting Standards
No. 149, "Amendment of Statement 133 on Derivative Instruments and Hedging
Activities ("FAS 149")." FAS 149 is intended to result in more consistent
reporting of contracts as either freestanding derivative instruments subject to
FAS 133 in its entirety, or as hybrid instruments with debt host contracts and
embedded derivative features. In addition, FAS 149 clarifies the definition of a
derivative by providing guidance on the meaning of initial net investments
related to derivatives. FAS 149 is effective for contracts entered into or
modified after June 30, 2003. The Company does not believe the adoption of FAS
149 will have a material effect on our consolidated financial position, results
of operations or cash flows.
2. Commitments and Contingencies
In the normal course of business, the Company is subject to commitments and
contingencies, including operating leases, restructuring liabilities and
litigation including securities-related litigation and other claims in the
ordinary course of business. The Company may also be subject to termination fees
or expense reimbursements to Autonomy in certain circumstances where their
acquisition of the Company is not consummated. The Company records accruals for
such contingencies based upon its assessment of the probability of occurrence
and, where determinable, an estimate of the liability. The Company considers
many factors in making these assessments including past history and the
specifics of each matter. The Company reviews its assessment of the likelihood
of loss on any outstanding contingencies as part of its on-going financial
processes. However, actual results may differ from these estimates under
different assumptions and conditions.
Commitments
At June 30, 2003, the Company has contractual and commercial commitments
not included on its balance sheet primarily for its San Mateo, California
facility that it has an obligation to lease through September 2006. For the
remainder of the fiscal year ended March 31, 2004, the Company's total
commitments amount to $2,610,000. Future full fiscal year commitments are as
follows: $1,972,000 in 2005, $1,715,000 in 2006 and $1,057,000 in 2007
($7,354,000 in total commitments as of June 30, 2003). The aforementioned
amounts include estimates of expected fair market rental rates in fiscal years
ending March 31, 2004 to March 31, 2007 and the payments of cash and forfeiture
of other collateral of $1,000,000 for the year ending March 31, 2004, pursuant
to the Lease Amendment described below.
Operating Lease Amendment
In December 2002, the Company amended its lease for its headquarters (the
"Lease Amendment"). The Lease Amendment reduces, from December 2002 until
December 2003, the Company's rent rate to half of what the rent rate was under
the original operating lease agreement. In December 2003, and on each annual
anniversary thereafter through the Amendment's termination date of September
2006, the Company's rent rate will be adjusted to fair market value as to be
mutually determined by the Company and its landlord, subject to a minimum rate
that is equivalent to the Lease Amendment's initial reduced rate discussed above
(the "Minimum Rate").
In addition, the Company and its landlord will use best efforts to have the
landlord lease, to a third party, certain space that the Company abandoned in
March 2003. If the space is leased to a third party, the space will be excluded
from the Lease Amendment as of the date an agreement for the third party lease
is executed, subject to the Company guaranteeing its landlord the Minimum Rate
for the leased space. This guarantee will continue for a minimum of 24 months
after the date of execution for the leased space.
Furthermore, if the Company is acquired by an unrelated entity, the
acquirer may terminate the lease obligation for a termination fee equal to 67%
of the total minimum monthly rent payable for the remaining term of the lease
subsequent to such acquisition.
10
VIRAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
June 30, 2003
(unaudited)
In consideration for the above, the Company issued its landlord a warrant
to purchase 200,000 shares of the Company's common stock at $0.57 per share (see
Note 3). In addition, the Company forfeited $1,250,000 of $2,000,000 of
restricted cash used to collateralize a letter of credit. The Company also
forgave approximately $240,000 of security deposits. The $2,000,000 of
restricted cash and $240,000 of security deposits were classified as other
assets on the Company's consolidated balance sheet prior to forfeiture.
The Company is obligated to forfeit $750,000 of restricted cash, which
collateralizes its obligation and is classified as other assets on the Company's
consolidated balance sheet, to its landlord if the landlord is able to lease the
Company's excess space. The Company estimates it will also incur approximately
$359,000 of other collateral forfeitures relating to certain provisions set
forth within the Lease Amendment.
In addition, the landlord, under certain limited conditions and exceptions
specified in the Lease Amendment, may have the option to extend the term of the
Lease Amendment for an additional five (5) years, with the base rent for the
renewal term based on fair market value.
The Company is amortizing the payments and other collateral described above
as rent expense over the life of the lease and the amortization of these
payments and other collateral totaled $71,000 for the three months ended June
30, 2003. In March 2003, the Company abandoned approximately half of its
headquarters facility to facilitate the leasing of the excess space to a third
party. As a result, the Company incurred charges of approximately $2,239,000
(including $89,000 of equipment write-downs) during the year ended March 31,
2003. The charges are related to the write-off of approximately half of the
unamortized portion of payments and other collateral forfeiture described above
and an accrual of approximately $1,026,000 relating to the expected leasing of
the excess space to a third party at a rate that is below the Minimum Rate
guarantee. The Company paid out $129,000 relating to its excess space for the
three months ended June 30, 2003 and reduced its accrual for such excess space
accordingly.
The Company has made a number of assumptions, such as length of time
required to engage a sublessee, and estimates, such as the assumed sublease
rate, in deriving the accounting for its lease amendment and excess facility
space. The Company's assumptions and estimates are based upon the best
information the Company has at the time any charges are derived. There are a
number of external factors outside of the Company's control that could
materially change the Company's assumptions and estimates and require the
Company to record additional charges in future periods. The Company monitors all
of these external factors and the impact on its assumptions and estimates as
part of its on-going financial reporting processes.
Restructuring
During the three months ended June 30, 2003, appropriate levels of the
Company's management approved and committed the Company to restructuring
programs to better align operating expenses with anticipated revenues. The
Company recorded $35,000 of employee severance costs as limited individuals who
performed general and administrative duties were notified about the specific
actions of the restructuring programs as of June 30, 2003. The Company expects
to notify the remaining individuals to be affected by the recently adopted
restructuring programs and expects to pay the majority of all employee severance
related to these programs during the three months ending September 30, 2003. In
addition, the Company had $1,386,000 of accrued restructuring costs related to
monthly rent for excess facility capacity that the Company has ceased to use,
and potential cash payments and potential forfeiture of cash-based collateral in
conjunction with the Lease Amendment described above. The Company expects to pay
out its excess facility charges accrued as of June 30, 2003 over the life of the
operating lease, which runs through September 2006. The Company expects to
sublease its excess space and forfeit its cash-based collateral and pay out cash
payments related to its Lease Amendment over the course of the next twelve
months.
11
VIRAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
June 30, 2003
(unaudited)
The following table depicts the Company's restructuring activity during the
three months ended June 30, 2003 (in thousands):
Expenditures
Balance at ------------ Balance at
Category March 31, 2003 Additions Cash Non-cash Adjustments June 30, 2003
-------- -------------- --------- ---- -------- ----------- -------------
Excess facilities $1,515 $ -- $129 $ -- $ -- $1,386
Employee severance -- 35 -- -- -- 35
------ ----- ---- ------ ------- ------
Total ........ $1,515 $ 35 $129 $ -- $ -- $1,421
====== ===== ==== ====== ======= ======
The Company has experienced excess operating lease capacity and should it
continue to be unable to find a sub lessee at a rate equivalent to its operating
lease rate, the Company may be required to record a charge for the rental
payments that it owes to its landlord relating to any excess facility capacity
that it ceased to use. The Company's management reviews its facility
requirements and assesses whether any excess capacity exists as part of its
on-going financial processes.
During the three months ended June 30, 2002, the Company implemented
additional restructuring programs to better align operating expenses with
anticipated revenues. The Company recorded a $731,000 restructuring charge,
which consisted of $625,000 in employee severance costs and $106,000 in
equipment write-downs across most of the expense line items in the Company's
consolidated statement of operations for the three months ended June 30, 2002.
The restructuring programs resulted in a reduction in force across all company
functions of approximately 30 employees. At March 31, 2002, the Company had
$763,000 of accrued restructuring costs related to monthly rent for excess
facility capacity, employee severance payments and other exit costs. As of June
30, 2003, the Company has paid out all restructuring amounts accrued as of June
30, 2002.
The following table depicts the Company's restructuring activity during the
three months ended June 30, 2002 (in thousands):
Expenditures
Balance at ------------ Balance at
Category March 31, 2002 Additions Cash Non-cash June 30, 2002
-------- -------------- --------- ---- -------- -------------
Excess facilities ... $ 460 $ -- $ 163 $ -- $ 297
Employee severance .. 259 625 235 -- 649
Equipment write-downs -- 106 -- 106 --
Other exit costs .... 44 -- -- 6 38
------ ------ ------ ------ ------
Total ............ $ 763 $ 731 $ 398 $ 112 $ 984
====== ====== ====== ====== ======
12
VIRAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
June 30, 2003
(unaudited)
Litigation
Securities class action lawsuits were filed, starting on August 22, 2001,
in the United States District Court for the Southern District of New York . The
cases have been consolidated under the caption In re Virage, Inc. Initial Public
Offering Securities Litigation, No. 01-CV-7866 (SAS) (S.D.N.Y.), related to In
re Initial Public Offerings Securities Litigation, No. 21 MC 92 (SAS). The
lawsuit is brought purportedly on behalf of all persons who purchased the common
stock of the Company from June 28, 2000 through December 6, 2000. The defendants
are the Company, one of its current officers and one of its former officers (the
"Virage Defendants"); and investment banking firms that served as underwriters
for the Company's initial public offering. The operative amended complaint
alleges liability under Sections 11 and 15 of the Securities Act of 1933 and
Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, on the grounds
that the registration statement for the IPO did not disclose that: (1) the
underwriters agreed to allow certain customers to purchase shares in the IPO in
exchange for excess commissions paid to the underwriters; and (2) the
underwriters arranged for certain customers to purchase additional shares in the
aftermarket at predetermined prices. The complaint also appears to allege that
false or misleading analyst reports were issued. The complaint does not claim
any specific amount of damages. Similar allegations were made in other lawsuits
challenging over 300 other initial public offerings and follow-on offerings
conducted in 1999 and 2000. The cases were consolidated for pretrial purposes.
On February 19, 2003, the Court ruled on all defendants' motions to dismiss. The
Court denied the motions to dismiss the claims under the Securities Act of 1933.
The Court granted the motions to dismiss the claims under the Securities
Exchange Act of 1934.
The Company has decided to accept a settlement proposal presented to all
issuer defendants. In this settlement, plaintiffs will dismiss and release all
claims against the Virage Defendants, in exchange for a contingent payment by
the insurance companies collectively responsible for insuring the issuers in all
of the IPO cases, and for the assignment or surrender of control over certain
claims the Company may have against the underwriters. The Virage Defendants will
not be required to make any cash payments in the settlement, unless the pro rata
amount paid by the insurers in the settlement exceeds the amount of the
insurance coverage, a circumstance which the Company does not believe will
occur. The settlement will require approval of the Court, which cannot be
assured, after class members are given the opportunity to object to the
settlement or opt out of the settlement.
From time to time, the Company may become involved in litigation claims
arising from its ordinary course of business. The Company believes that there
are no claims or actions pending or threatened against it, the ultimate
disposition of which would have a material adverse effect on the Company's
consolidated financial position, results of operations or cash flows.
NASDAQ Listing Requirements
Through June 30, 2003, the Company's stock was traded on The NASDAQ National
Market and the bid price for its common stock had been under $1.00 per share for
over 30 consecutive trading days. Under NASDAQ's listing maintenance standards,
if the closing bid price of the Company's common stock is under $1.00 per share
for 30 consecutive trading days, NASDAQ may choose to notify the Company that it
may delist its common stock from The NASDAQ National Market.
13
VIRAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
June 30, 2003
(unaudited)
The Company received a NASDAQ letter on May 1, 2003 that stated the Company
was not in compliance with NASDAQ's minimum bid price listing requirement and
that the Company had seven calendar days to do one of the following:
o Submit an application for transfer of the Company's securities for
trading to The NASDAQ SmallCap Market;
o Request a hearing to appeal the delisting notice; or
o Have the Company's securities delisted from The NASDAQ National
Market.
The Company initiated an appeal process with NASDAQ whereby it requested an
in-person hearing with NASDAQ regulators to present relevant measures the
Company has taken in order to improve its operating results and, as a result,
bolster its stock price to levels required by NASDAQ. The hearing took place in
June 2003. The Company received a verdict letter from NASDAQ's compliance
department in July 2003 (see Note 6).
Guarantees
The Company generally provides a warranty for its software products and
services to its customers for a period of 90 days and accounts for its
warranties under the FASB's Statement of Financial Accounting Standards No. 5,
"Accounting for Contingencies." From time to time, the Company may enter into
contracts that extend the warranty period for its products and services.
However, such extensions have not historically impacted the level of warranty
workmanship or expense levels. The Company's software products' media are
generally warranted to be free of defects in materials and workmanship under
normal use and the products are also generally warranted to substantially
perform as described in certain Company documentation. The Company's services
are generally warranted to be performed in a professional manner and to
materially conform to the specifications set forth in a customer's signed
contract. In the event there is a failure of such warranties, the Company
generally will correct or provide a reasonable work around or replacement
product. The Company's warranty accrual as of June 30, 2003 and March 31, 2003
was not significant and, to date, the Company's product and service warranty
expenses have not been significant.
The Company has two letters of credit that collateralize certain operating
lease obligations of the Company and total approximately $768,000 at June 30,
2003 and March 31, 2003, respectively. The Company collateralizes these letters
of credit with cash deposits made with certain of its financial institutions and
has classified these cash deposits as other assets on the Company's balance
sheet as of June 30, 2003 and March 31, 2003. The Company's landlords are able
to withdraw on each respective letter of credit in the event that the Company is
found to be in default of its obligations under each of its operating leases.
The Company generally does not enter into indemnification agreements that
contingently require the Company to make payments directly to a party that is
indemnified by the Company (an "Indemnified Party"). The Company's
indemnification agreements generally defend and indemnify an Indemnified Party
against adverse situations such as, for example, defense against plaintiffs in a
lawsuit brought by a third party. In all such cases the Company would make
payments to such third party and/or attorneys if such a third party were
successful in such litigation. Historically, the expenses relating to or arising
from the Company's indemnification agreements have not been significant.
14
VIRAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
June 30, 2003
(unaudited)
3. Stockholders' Equity
Warrant issued to Landlord
In December 2002, the Company entered into an amendment for its
headquarters' operating lease (see Note 2) and issued an immediately
exercisable, non-forfeitable warrant to purchase 200,000 shares of common stock
at $0.57 per share. The warrant expires in December 2005. The value of the
warrant was estimated to be $86,000 and was based upon a Black-Scholes valuation
model with the following assumptions: risk free interest rate of 1.9%, no
dividend yield, volatility of 130%, expected life of three years, exercise price
of $0.57 and fair market value of $0.57. The non-cash amortization of the
warrant's value is being recorded as rent expense over the life of the lease.
During the three months ended June 30, 2003, the Company recorded $3,000 as rent
expense related to this warrant.
Voluntary Stock Option Cancellation and Re-grant Program
In February 2002, the Company offered a voluntary stock option cancellation
and re-grant program to its employees. The plan allowed employees with stock
options at exercise prices of $5.00 per share and greater to cancel a portion or
all of these unexercised stock options effective February 6, 2002, if they so
chose, provided that should an employee participate, any option granted to that
employee within the six months preceding February 6, 2002 was also automatically
cancelled. On February 6, 2002, 2,678,250 shares with a weighted-average
exercise price of $9.54 per share were cancelled pursuant to this program. As a
result of this program, the Company was required to grant its employees stock
options on August 7, 2002 at the closing market price as of that date. On August
7, 2002, the Company issued 2,538,250 shares at $0.59 per share to employees
that participated in the Company's Voluntary Stock Option Cancellation and
Re-grant Program.
4. Segment Reporting
The Company has two reportable segments: the sale of software and related
software support services including revenues from U.S. government agencies
("software") and the sale of its application and professional services which
includes set-up fees, professional services fees, video processing fees, and
application hosting fees ("application and professional services"). The
Company's Chief Operating Decision Maker ("CODM") is the Company's Chief
Executive Officer who evaluates performance and allocates resources based upon
total revenues and gross profit (loss). Discreet financial information for each
segment's profit and loss and each segment's total assets is not provided to the
Company's CODM, nor is it tracked by the Company.
15
VIRAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
June 30, 2003
(unaudited)
Information on the Company's reportable segments for the three months ended
June 30, 2003 and 2002 are as follows (in thousands):
Three Months Ended
June 30,
------------------------
2003 2002
------ ------
Software:
Total revenues ....................... $2,021 $2,250
Total cost of revenues ............... 334 386
------ ------
Gross profit ......................... $1,687 $1,864
====== ======
Application and Professional Services:
Total revenues ....................... $ 906 $ 985
Total cost of revenues ............... 767 960
------ ------
Gross profit ......................... $ 139 $ 25
====== ======
5. Income Taxes
The Company has not recorded a provision for federal and state or foreign
income taxes for the three months ended June 30, 2003 or 2002 because the
Company has experienced net losses since inception, which have resulted in
deferred tax assets. The Company has recorded a valuation allowance against all
deferred tax assets as a result of uncertainties regarding the realization of
the balances, which only may occur through future taxable profits.
6. Subsequent Events (Unaudited)
Definitive Agreement with Autonomy Corporation plc and Related Restructuring
In July 2003, the Company and Autonomy Corporation plc entered into a
definitive agreement under which Autonomy will acquire the Company. Under the
terms of the definitive agreement, upon completion of the acquisition, Autonomy
will pay to the Company's stockholders $1.10 per share in cash for each share of
the Company's common stock outstanding and will assume any outstanding options
to purchase the Company's common stock.
The merger is subject to a number of conditions including, among other
things, approval of the Company's stockholders and regulatory approvals and
clearance. The transaction is currently expected to be completed in the quarter
ending September 30, 2003. There can be no assurance that the transaction will
be consummated. In the event that the proposed transaction fails to close, under
certain circumstances, the Company may be required to pay Autonomy a termination
fee of $1,250,000 and reimbursement of expenses of up to $350,000.
As described in Note 2 above, appropriate levels of the Company's
management approved and committed the Company to certain restructuring programs.
However, the Company had not notified the significant majority of the
individuals affected by these programs as of June 30, 2003. In conjunction with
the signing of the definitive agreement with Autonomy in July 2003, the Company
expects that it will notify the remaining individuals to be affected by these
restructuring programs and expects to incur and pay employee severance costs of
approximately $1,000,000 during the three months ended September 30, 2003 . The
impact of the expected severance costs to the Company's software segment and
application services and professional services segment is expected to be
approximately $28,000 and $18,000, respectively.
16
VIRAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
June 30, 2003
(unaudited)
NASDAQ SmallCap Market Transfer
In July 2003, the Company received a response from NASDAQ's compliance
department stating that its appeal was dismissed and that the Company had the
option of transferring to The NASDAQ SmallCap Market or being delisted from the
exchange. The Company submitted an application for transfer to The NASDAQ
SmallCap Market, which was accepted and the Company transferred to and began
trading on The NASDAQ SmallCap Market in July 2003. The Company expects that it
will have at least 180 days to regain compliance with NASDAQ's listing
requirements while trading on The NASDAQ SmallCap Market. The Company may be
eligible to transfer back to The NASDAQ National Market if its bid price
maintains the $1.00 per share requirement for 30 consecutive trading days and it
has maintained compliance with all other continued listing requirements for The
NASDAQ National Market.
17
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following discussion and analysis of our financial condition and
results of operations should be read in conjunction with the "Selected
Consolidated Financial Data", the condensed consolidated financial statements
and related notes contained herein. This discussion contains forward-looking
statements within the meaning of Section 27A of the Securities Act and Section
21E of the Exchange Act. We may identify these statements by the use of words
such as "believe", "expect", "anticipate", "intend", "plan", "will acquire", and
similar expressions. These forward-looking statements involve several risks and
uncertainties. Our actual results may differ materially from those set forth in
these forward-looking statements as a result of a number of factors, including
those described under the caption "Risk Factors" herein. These forward-looking
statements speak only as of the date of this report, and we caution you not to
rely on these statements without also considering the risks and uncertainties
associated with these statements and our business as addressed elsewhere in this
report.
Virage, Inc. is a provider of video and rich media communication software
products, professional services and application services. We sell these products
and services to corporations, media and entertainment companies, government
agencies, and universities worldwide.
Recent Events
Definitive Agreement with Autonomy Corporation plc and Related Restructuring
In July 2003, we entered into a definitive agreement with Autonomy
Corporation plc under which Autonomy will acquire us. Under the terms of the
definitive agreement, upon completion of the acquisition, Autonomy will pay to
our stockholders $1.10 per share in cash for each share of our common stock
outstanding and will assume any outstanding options to purchase our common
stock.
The merger is subject to a number of conditions including, among other
things, approval of our stockholders and regulatory approvals and clearance. We
currently expect the transaction to be completed in the quarter ending September
30, 2003. There can be no assurance that the transaction will be consummated. In
the event that the proposed transaction fails to close, under certain
circumstances, we may be required to pay Autonomy a termination fee of
$1,250,000 and reimbursement of expenses of up to $350,000.
During the three months ended June 30, 2003, appropriate levels of our
management approved and committed us to restructuring programs to better align
our operating expenses with anticipated revenues. As of June 30, 2003, we had
accrued employee severance costs of $35,000 as only limited individuals who
performed general and administrative duties were notified about the specific
actions of these restructuring programs. We expect we will notify the remaining
individuals to be affected by these restructuring programs during the three
months ending September 30, 2003. We expect to incur employee severance costs of
approximately $1,000,000 during the three months ending September 30, 2003 and
expect to pay the majority of all employee severance related to these programs
during the same period.
In addition, at June 30, 2003 we had an accrual balance of $1,386,000
related to restructuring costs for excess facility capacity, and potential cash
payments and potential forfeiture of cash-based collateral in conjunction with
an operating lease amendment described in the notes to our condensed
consolidated financial statements contained elsewhere in this quarterly report.
We expect to pay out the excess facility charges accrued as of June 30, 2003
over the life of the operating lease, which runs through September 2006. We
expect to sublease our excess space and forfeit certain cash-based collateral
and pay out cash payments related to our Lease Amendment over the course of the
next six months.
18
The following table depicts our restructuring activity during the three
months ended June 30, 2003 (in thousands):
Balance at Expenditures Balance at
Category March 31, 2003 Additions Cash Non-cash Adjustments June 30, 2003
-------- -------------- --------- ---- -------- ----------- -------------
Excess facilities $1,515 $ -- $ 129 $ -- $ -- $1,386
Employee severance -- 35 -- -- -- 35
------ ----- ------ -------- -------- ------
Total ........ $1,515 $ 35 $ 129 $ -- $ -- $1,421
====== ===== ====== ======== ======== ======
Excess Facilities: Excess facilities and other exit costs relate to lease
obligations and closure costs associated with offices we have vacated as a
result of our cost reduction initiatives and the restructuring of our San Mateo
office lease (refer to the discussion regarding our lease amendment in the notes
to our condensed consolidated financial statements contained elsewhere in this
quarterly report). Cash expenditures for excess facilities and other exit costs
during the three months ended June 30, 2003 represent the contractual ongoing
lease payments. It is management's best estimate that we will not be able to
recoup the losses from our lease rental payments recorded as excess facilities,
which continues through September 2006. The current commercial real estate
market in Northern California is poor for sublessors looking for tenants, and
while we will make every attempt to secure a sublease, we believe that we will
be unable to sublease this additional space at a rate that is consistent with
the minimum rate provided for in our lease amendment. We have made a number of
estimates, such as length of time required to engage a sublessee and an assumed
sublease rate, in deriving the accounting for our lease amendment and excess
facility space. Our assumptions and estimates are based upon the best
information that we have at the time any charges are derived. There are a number
of external factors outside of our control that could prove our assumptions and
estimates materially inaccurate and require us to record additional charges in
future periods. We monitor all of these external factors and the impact on its
assumptions and estimates as part of our on-going financial processes.
Employee Severance: Accrued employee severance, which includes severance
payments, related taxes, outplacement and other benefits, totaled approximately
$35,000 as of June 30, 2003. As of June 30, 2003, only limited individuals who
performed general and administrative duties were notified about the specific
actions of our restructuring programs. We expect we will notify the remaining
individuals to be affected by these restructuring programs during the three
months ending September 30, 2003. As a result, we expect to incur employee
severance costs of approximately $1,000,000 during the three months ending
September 30, 2003 and expect to pay the majority of all employee severance
related to these programs during the same period.
Critical Accounting Policies & Estimates
The discussion and analysis of our financial position and results of
operations are based upon our consolidated financial statements, which have been
prepared in accordance with generally accepted accounting principles in the
United States. The preparation of these consolidated financial statements
requires us to make estimates and judgments that affect the reported amounts of
assets, liabilities, revenues, and expenses, and related disclosure of
contingent assets and liabilities. We base our estimates on historical
experience and on various other assumptions that are believed to be reasonable
under the circumstances, the results of which form the basis for making
judgments about the carrying values of assets and liabilities that are not
readily apparent from other sources. Estimates and assumptions are reviewed as
part of our management's on-going financial processes. Actual results may differ
from these estimates under different assumptions and conditions.
We believe our critical accounting policies and estimates include accounting
for revenue recognition, provisions for revenue adjustments and doubtful
accounts, and the accounting and related estimates for our commitments and
contingencies.
Revenue Recognition
We enter into arrangements for the sale of licenses of software products
and related maintenance contracts, application services and professional
services offerings. Service revenues include revenues from maintenance
contracts, application services, and professional services, including
professional services performed directly for and via subcontract for the U.S.
Government.
19
Our revenue recognition policy is in accordance with the American Institute
of Certified Public Accountants' ("AICPA") Statement of Position No. 97-2 ("SOP
97-2"), "Software Revenue Recognition", as amended by Statement of Position No.
98-4, "Deferral of the Effective Date of SOP 97-2, "Software Revenue
Recognition"" ("SOP 98-4"), and Statement of Position No. 98-9, "Modification of
SOP No. 97-2 with Respect to Certain Transactions" ("SOP 98-9") and is also
consistent with the Securities and Exchange Commission's Staff Accounting
Bulletin No. 101, "Revenue Recognition in Financial Statements." For each
arrangement, we determine whether evidence of an arrangement exists, delivery
has occurred, the fee is fixed or determinable, and collection is probable. If
any of these criteria are not met, revenue recognition is deferred until such
time as all criteria are met. We consider all arrangements with payment terms
longer than normal not to be fixed and determinable. Our normal payment terms
are generally considered to be "net 30 days" to "net 60 days." For arrangements
involving extended payment terms, revenue recognition generally occurs when
payments become due provided all other revenue recognition criteria are met. No
customer has the right of return and arrangements generally do not have
acceptance criteria. If right of return or customer acceptance does exist within
an arrangement, revenue is deferred until the earlier of the end of the right of
return/acceptance period or until written notice of acceptance/cancellation of
right of return is received from the customer.
Arrangements consisting of license and maintenance. For those contracts
that consist solely of license and maintenance, the Company recognizes license
revenues based upon the residual method after all elements other than
maintenance have been delivered as prescribed by SOP 98-9. Revenue is recognized
on a per copy basis for licensed software when each copy of the license
requested by the customer is delivered. The Company recognizes maintenance
revenues over the term of the maintenance contract as vendor specific objective
evidence of fair value for maintenance exists. In accordance with paragraph ten
of SOP 97-2, vendor specific objective evidence of fair value of maintenance is
determined by reference to the price the customer will be required to pay when
it is sold separately (that is, the renewal rate). Customers that enter into
maintenance contracts have the ability to renew such contracts at the renewal
rate. Maintenance contracts are typically one year in duration.
Revenue is recognized on licensed software on a per user or per server
basis for a fixed fee when the product master is delivered to the customer.
There is no right of return or price protection for sales to domestic and
international distributors, system integrators, or value added resellers
(collectively, "resellers"). In situations where the reseller has a purchase
order or other contractual agreement from the end user that is immediately
deliverable upon, we recognize revenue on the shipment to the reseller, if other
criteria in SOP 97-2 are met, since we have no risk of concessions. We defer
revenue on shipments to resellers if the reseller does not have a purchase order
or other contractual agreement from an end user that is immediately deliverable
upon or other criteria in SOP 97-2 are not met. We recognize royalty revenues
upon receipt of the quarterly reports from the vendors.
When licenses and maintenance are sold together with professional services
such as consulting and implementation, license fees are recognized upon
shipment, provided that (1) the criteria in the previous paragraphs have been
met, (2) payment of the license fee is not dependent upon the performance of the
professional services, (3) the services do not include significant alterations
to the features and functionality of the software and (4) the services are
deemed "perfunctory" both in level of effort to perform and in magnitude of
dollars based upon the Company's objective evidence of fair value for the
services relative to the fair value of other elements provided for in the total
arrangement fee.
Should professional services be essential to the functionality of the
licenses in a license arrangement that contains professional services or should
an arrangement not meet the criteria mentioned above, both the license revenues
and professional service revenues are recognized in accordance with the
provisions of the AICPA's Statement of Position No. 81-1, "Accounting for
Performance of Construction Type and Certain Production Type Contracts" ("SOP
81-1"). When reliable estimates are available for the costs and efforts
necessary to complete the implementation services and the implementation
services do not include contractual milestones or other acceptance criteria, we
account for the arrangements under the percentage of completion contract method
pursuant to SOP 81-1 based upon input measures such as hours or days. When such
estimates are not available, the completed contract method is utilized. When an
arrangement includes contractual milestones, we recognize revenues as such
milestones are achieved provided the milestones are not subject to any
additional acceptance criteria. For arrangements that include customer
acceptance clauses that we do not have an established history of meeting or
which are not considered to be routine, we recognize revenue when the
arrangement has been completed and accepted by the customer provided all other
criteria for revenue recognition have been met.
20
Application services. Application services revenues consist primarily of
web design and integration fees, video processing fees and application hosting
fees. Web design and integration fees are recognized ratably over the contract
term, which is generally six to twelve months. We generate video processing fees
for each hour of video that a customer deploys. Processing fees are recognized
as encoding, indexing and editorial services are performed and are based upon
time-based rates of video content. Application hosting fees are generated by and
based upon the number of video queries processed, subject in most cases to
monthly minimums. We recognize revenues on transaction fees that are subject to
monthly minimums based upon the monthly minimum rate since we have no further
obligations, the payment terms are normal and each month is a separate
measurement period.
Professional Services. We provide professional services such as consulting,
implementation and training services to our customers. Revenues from such
services, when not sold in conjunction with product licenses, are generally
recognized as the services are performed provided that we have indications the
customer is satisfied with and/or will pay for the services and all other
revenue recognition criteria are met.
Included as part of our service revenues are services performed for U.S.
Government Defense and other security agencies, either from direct arrangements
or subcontracts with other U.S. Government contractors. We generally perform
these services in conjunction with existing or potential software license sales.
Should software be included as part of the arrangement, we account for any
software license fee according to our revenue recognition accounting policy for
multiple-element arrangements described above.
Virtually all of our services with such U.S. Government entities are
performed under various firm-fixed-price, time-and-material, and
cost-plus-fixed-fee reimbursement contracts. Revenues on firm-fixed-price
contracts are generally recognized according to SOP 81-1 based upon costs
incurred in relation to total estimated costs from input measures such as hours
or days. Revenues on time-and-material contracts are recognized to the extent of
billable rates multiplied by hours worked plus materials expense incurred.
Revenues for cost-plus-fixed-fee contracts are recognized as costs are incurred,
including a proportionate amount of the fee earned.
Customer billings that have not been recognized as revenue in accordance
with the above policies are shown on the balance sheet as deferred revenue.
Allowance for Revenue Adjustments and Doubtful Accounts
If we determine that payment from the customer is not probable at the time
all other revenue recognition criteria (as described above) have been met, we
defer revenues until payment from the customer is received. We also make
judgments as to our ability to collect outstanding receivables (that have not
been deferred) and provide an allowance for the portion of receivables when
collection becomes doubtful. We also provide an allowance for returns and
revenue adjustments in the same period as the related revenues are recorded.
Allowances are made based upon a specific review of all significant outstanding
invoices. Allowances recorded offset our gross accounts receivable balance.
Restructuring Costs
During the three months ended June 30, 2003 and 2002, we undertook plans to
restructure our operations in order to reduce operating expenses. Our
restructuring expenses have included excess facilities, employee severance,
asset write-downs and other exit costs. Given the significance of, and timing of
the execution of such activities, this process is complex and involves periodic
reassessments of estimates made at the time the original decisions were made.
Our restructuring expenses involved significant estimates made by management
using the best information available at the time that the estimates were made,
some of which were based upon information provided by third parties. We
continually evaluate the adequacy of the remaining liabilities under our
restructuring initiatives. Although we believe that these estimates accurately
reflect the costs of our restructuring plans, actual results may differ, thereby
requiring us to record additional provisions or reverse a portion of such
provisions.
21
As discussed in Note 2 of the notes to our condensed consolidated financial
statements included elsewhere in this quarterly report, we have recorded
significant restructuring expenses in connection with our abandonment of certain
leased facilities. These excess facility costs were estimated to include
remaining lease liabilities, forfeiture of certain collateral pursuant to our
lease amendment and brokerage fees offset by estimated sublease income.
Estimates related to sublease costs and income are based on assumptions
regarding the period required to sublease the facilities and the likely sublease
rates. These estimates are based on market trend information analyses provided
by commercial real estate brokerage firms retained by us. We review these
estimates each reporting period and, to the extent that our assumptions change,
adjustments to the restructuring accrual are recorded. If the real estate market
continues to worsen and we are not able to sublease the properties as early as,
or at the rates estimated, the accrual will be increased, which would result in
additional restructuring costs in the period in which such determination is
made. If the real estate market strengthens and we are able to sublease the
properties earlier or at more favorable rates than projected, the accrual may be
decreased, which would increase net income in the period in which such
determination is made.
Commitments and Contingencies
In the normal course of business, we are subject to commitments and
contingencies, including operating leases, restructuring liabilities, and legal
proceedings and claims that cover a wide range of matters, including
securities-related litigation and other claims. We also may be subject to
termination fees or expense reimbursements to Autonomy in certain circumstance
where their acquisition of us is not consummated. We record accruals for such
contingencies based upon our assessment of the probability of occurrence and,
where determinable, an estimate of the liability. We consider many factors in
making these assessments including past history and the specifics of each
matter. We believe that there are no claims or actions pending or threatened
against us that would have a material adverse effect on our operating results.
Further, we review our assessment of the likelihood of loss on any outstanding
contingencies as part of our management's on-going financial processes. However,
actual results may differ from these estimates under different assumptions and
conditions.
From time to time, we may become involved in litigation claims arising from
our ordinary course of business. We provide further detail about one of these
claims in the notes to our consolidated financial statements included elsewhere
in this quarterly report. We believe that there are no claims or actions pending
or threatened against us, the ultimate disposition of which would have a
material adverse effect on the our consolidated financial position, results of
operations or cash flows.
Results of Operations
The following table sets forth consolidated financial data for the periods
indicated, expressed as a percentage of total revenues.
Three Months Ended
June 30,
-------------------------
2003 2002
------- -------
Revenues:
License revenues ............... 44% 50%
Service revenues ............... 56 50
---- ----
Total revenues ......... 100 100
---- ----
Cost of revenues:
License revenues ............... 5 6
Service revenues ............... 33 36
---- ----
Total cost of revenues . 38 42
---- ----
Gross profit ..................... 62 58
Operating expenses:
Research and development ....... 57 74
Sales and marketing ............ 71 114
General and administrative ..... 38 35
Stock-based compensation ....... 9 11
---- ----
Total operating expenses 175 234
---- ----
Loss from operations ............. (113) (176)
Interest and other income ........ 2 6
---- ----
Net loss ......................... (111)% (170)%
==== ====
22
We incurred a net loss of $3,259,000 during the three months ended June 30,
2003. As of June 30, 2003, we had an accumulated deficit of $110,303,000. We
expect to continue to incur operating losses for the foreseeable future. In view
of the rapidly changing nature of our market and our limited operating history,
we believe that period-to-period comparisons of our revenues and other operating
results are not necessarily meaningful and should not be relied upon as
indications of future performance. Our historic revenue growth rates are not
necessarily sustainable or indicative of our future growth.
Revenues
The following table sets forth a breakdown of our revenues for the three
months ended June 30, 2003, with changes expressed in whole dollar amounts and
percentages versus results from the same period in the prior fiscal year (all
amounts presented are in thousands, except percentages):
Three Months Ended June 30, Increase/(Decrease)
-------------------------- -------------------
2003 2002 Amount Percent
------ ------ ------ -------
License revenues ............ $1,276 $1,611 $(335) (21)%
Customer support revenues ... 745 639 106 17%
Professional service revenues 511 522 (11) (2)%
Application service revenues 395 463 (68) (15)%
------ ------ -----
Total service revenues .... 1,651 1,624 27 2%
------ ------ -----
Total revenues .......... $2,927 $3,235 $(308) (10)%
====== ====== ===== =====
Total revenues decreased to $2,927,000 for the three months ended June 30,
2003 from $3,235,000 for the three months ended June 30, 2002, a decrease of
$308,000 or 10%. This decrease was a result of decreases in license,
professional service, and application service revenues, and was slightly offset
by increases in customer support revenues. International revenues decreased to
$463,000, or 16% of total revenues, during the three months ended June 30, 2003,
from $714,000, or 22% of total revenues, during the three months ended June 30,
2002. There were no customers who accounted for more than 10% of total revenues
during the three months ended June 30, 2003 or 2002.
License revenues decreased to $1,276,000 for the three months ended June
30, 2003 from $1,611,000 for the three months ended June 30, 2002, a decline of
$335,000 or 21%. This decrease was a result of lower sales of our platform
products and was offset, in part, by increased revenues from our application
products. We believe the lower sales performance for our platform business
during the three months ended June 30, 2003 continued to result from weak
technology spending by our target markets in the United States and abroad,
causing delays in the closure of deals for our platform license products or a
reduction in the size of those deals. The decline in platform license revenues
was offset, in part, by increased revenues from our application products,
particularly VS Webcasting. Our VS Webcasting product continues to be our
strongest performing application product, although we do, to a lesser extent,
continue to experience some demand for our VS Publishing and VS Production
applications.
23
Service revenues increased to $1,651,000 during the three months ended June
30, 2003 from $1,624,000 during the three months ended June 30, 2002, an
increase of $27,000. Customer support increased by 17% during the three months
ended June 30, 2003 in comparison to the three months ended June 30, 2002. Our
customer support revenues increased in comparison to the prior year's quarter,
despite a decline in our license revenues during the current quarter. This was a
result of existing customers renewing their support agreements with us during
the current and prior quarters. These renewals, combined with the significant
majority of our new customers also purchasing support contracts, resulted in our
customer support revenues increasing during the current quarter in comparison to
the same period in the prior year. Professional and application service revenues
declined two percent and 15%, respectively, in the three months ended June 30,
2003 in comparison to the three months ended June 30, 2002. Professional service
revenues typically correlate with fluctuations in our license business as
consulting contracts are frequently signed upon the purchase of our software.
Consistent with the decrease in our license revenues during the three months
ended June 30, 2003, we generated lower professional service revenues from our
commercial customers. These decreases were partially offset by an increase in
revenues earned from defense related entities of the U.S. Government, which
comprised 10% of our total revenues during the three months ended June 30, 2003
(none during the three months ended June 30, 2002). Our application service
revenues declined modestly during the three months ended June 30, 2003 as a
result of lower revenues generated from our application and video hosting
services. We focused our efforts and resources on our enterprise software and
related services businesses during the past 12 months and, as a result, we
significantly downsized our application services business infrastructure and
sales efforts. As a result, we had fewer customers engaging such hosting
services during the three months ended June 30, 2003 in comparison to June 30,
2002.
Cost of Revenues
The following table sets forth a breakdown of our different cost of
revenues for the three months ended June 30, 2003 and 2002, with changes
expressed in whole dollar amounts and percentages versus results from the same
period in the prior fiscal year (all amounts presented are in thousands, except
percentages):
Three Months Ended June 30, Increase/(Decrease)
--------------------------- -------------------
2003 2002 Amount Percent
------ ------- ------ -------
Cost of license revenues ............... $ 153 $ 187 $ (34) (18)%
Cost of customer support revenues ...... 181 199 (18) (9)%
Cost of professional service revenues .. 417 539 (122) (23)%
Cost of application service revenues ... 350 421 (71) (17)%
------ ------- -----
Total cost of service revenues ....... 948 1,159 (211) (18)%
------ ------- -----
Total cost of revenues ............. $1,101 $ 1,346 $(245) (18)%
====== ======= ===== =======
License gross profit ................... 88% 88%
Customer support gross profit .......... 76% 69%
Professional service gross profit (loss) 18% (3)%
Application service gross profit ....... 11% 9%
Total service gross profit ........... 43% 29%
Total gross profit ................. 62% 58%
====== =======
Cost of license revenues consists primarily of royalty fees for third-party
software products integrated into our products. Our cost of service revenues
includes personnel expenses, related overhead, communication expenses and
capital equipment depreciation costs for maintenance and support activities and
application and professional services. Total cost of revenues decreased to
$1,101,000, or 38% of total revenues, in the three months ended June 30, 2003
from $1,346,000, or 42% of total revenues, in the three months ended June 30,
2002. The decrease in total cost of revenues was due to a reduction in license
royalties payable as a result of a smaller amount of revenues during the three
months ended June 30, 2003, as well as our restructuring efforts during the past
twelve months. We generally expect that increases or decreases in the dollar
amount of our total cost of revenues will correlate with increases or decreases
in the dollar amount of our total revenues. However, our total cost of revenues
is highly variable and has, in the past, been inconsistent with our
expectations.
24
Cost of license revenues decreased to $153,000, or 12% of license revenues,
in the three months ended June 30, 2003 from $187,000, or 12% of license
revenues, in the three months ended June 30, 2002. The decrease was primarily
due to fewer shipments of products upon which we incur a unit-based royalty to
certain technology providers.
Cost of service revenues decreased to $948,000, or 57% of service revenues,
in the three months ended June 30, 2003 from $1,159,000, or 71% of service
revenues, in the three months ended June 30, 2002. Decreases in cost of customer
support services, professional services and application services all contributed
to lower cost of service expenses and were a result of our restructuring efforts
undertaken during the past twelve months, including headcount reductions,
facility consolidations and equipment write-downs.
Operating Expenses
The following table sets forth a breakdown of our different operating
expenses for the three months ended June 30, 2003 and 2002, with changes
expressed in whole dollar amounts and percentages versus results from the same
period in the prior fiscal year (all amounts presented are in thousands, except
percentages):
Increase/(Decrease)
Three Months Ended June 30, vs. Prior Year
--------------------------- -------------------
2003 2002 Amount Percent
---- ---- ------ -------
Research and development . $1,654 $2,382 $ (728) (31)%
Sales and marketing ...... 2,095 3,685 (1,590) (43)%
General and administrative 1,120 1,142 (22) (2)%
Stock-based compensation . 270 371 (101) (27)%
------ ------- -------
Total operating expenses $5,139 $7,580 $(2,441) (32)%
====== ====== ======= ====
Research and Development Expenses. Research and development expenses
consist primarily of personnel and related costs for our development efforts.
Our research and development expenses decreased to $1,654,000, or 57% of
revenues, in the three months ended June 30, 2003 from $2,382,000, or 74% of
revenues, in the three months ended June 30, 2002. The decrease was primarily
due to our restructuring efforts during fiscal 2003 whereby headcount reductions
and facility consolidations resulted in decreases of $467,000 and $248,000,
respectively, during the three months ended June 30, 2003 in comparison to the
three months ended June 30, 2002. To date, we have not capitalized any software
development costs as they have been insignificant after establishing
technological feasibility.
Sales and Marketing Expenses. Sales and marketing expenses consist of
personnel and related costs for our direct sales force, pre-sales support and
marketing staff, and discretionary marketing programs including trade shows,
telemarketing campaigns and seminars. Sales and marketing expenses decreased to
$2,095,000, or 71% of total revenues, in the three months ended June 30, 2003
from $3,685,000, or 114% of total revenues, in the three months ended June 30,
2002. The decrease was primarily due to our restructuring efforts during fiscal
2003, resulting in reductions in headcount and facility related expenses that
saved $1,162,000 and $245,000, respectively, during the three months ended June
30, 2003 in comparison to the three months ended June 30, 2002.
General and Administrative Expenses. General and administrative expenses
consist primarily of personnel and related costs for general corporate
functions, including finance, accounting, legal, human resources, facilities,
costs of our external audit firm and costs of our outside legal counsel. General
and administrative expenses decreased modestly in absolute dollars to
$1,120,000, or 38% of total revenues, in the three months ended June 30, 2003
from $1,142,000,or 35% of total revenues, in the three months ended June 30,
2002. The decrease in absolute dollars was primarily due to our restructuring
efforts during fiscal 2003, resulting in payroll and related expense savings of
$212,000 and facility-related cost savings of $51,000 in the three months ended
June 30, 2003 in comparison to the three months ended June 30, 2002. These
decreases were almost entirely offset by an increase in professional service
expenses, particularly legal and accounting fees payable in connection with the
pending acquisition of us by Autonomy, of $264,000 during the three months ended
June 30, 2003 in comparison to June 30, 2002.
25
Stock-Based Compensation Expense. We follow the intrinsic value method of
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees" ("APB Opinion No. 25"), in accounting for our employee stock options
because the alternative fair value accounting provided for under the FASB's
Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation" ("FAS 123"), requires use of option valuation models that were not
developed for use in valuing employee stock options. Under APB Opinion No. 25,
compensation expense is based on the difference, if any, on the date of grant,
between the estimated fair value of the Company's common stock and the exercise
price. Stock based compensation expense represents the amortization of this
deferred compensation for stock options granted to our employees. We recognized
stock-based compensation expense of $270,000 and $371,000 in the three months
ended June 30, 2003 and 2002, respectively, in connection with the granting of
stock options to our employees. Our stock-based compensation expense decreased
in the three months ended June 30, 2003 in comparison to the three months ended
June 30, 2002 as the options for which deferred compensation originated have
become fully vested or employees have departed from the Company.
Interest and Other Income. Interest and other income includes interest
income from cash, cash equivalents and short-term investments. Interest and
other income, net, decreased to $54,000 in the three months ended June 30, 2003
from $190,000 in the three months ended June 30, 2002. The decreases were a
result of lower interest rates and lower average cash balances during the three
months ended June 30, 2003.
Provision for Income Taxes. We have not recorded a provision for federal
and state or foreign income taxes during the three months ended June 30, 2003 or
2002 because we have experienced net losses since inception, which have resulted
in deferred tax assets. We have recorded a valuation allowance for the entire
deferred tax asset as a result of uncertainties regarding the realization of the
asset balance through future taxable profits.
Liquidity and Capital Resources
As of June 30, 2003, we had cash, cash equivalents and short-term
investments of $13,923,000, a decrease of $2,394,000 from March 31, 2003 and our
working capital, defined as current assets less current liabilities, was
$8,569,000, a decrease of $2,492,000 in working capital from March 31, 2003. The
decrease in our cash, cash equivalents, and short-term investments and our
working capital is primarily attributable to cash used in operating activities.
Our operating activities resulted in net cash outflows of $2,506,000 and
$5,205,000 for the three months ended June 30, 2003 and 2002, respectively. The
cash used in these periods was primarily attributable to net losses of
$3,259,000 and $5,501,000 in the three months ended June 30, 2003 and 2002,
respectively, offset by depreciation and non-cash, stock-based charges.
Investing activities resulted in cash inflows of $5,887,000 and $2,560,000
for the three months ended June 30, 2003 and 2002, respectively. Our investing
inflows were primarily from the maturity of our short-term investments and our
outflows were primarily for the purchase of short-term investments and capital
equipment. We expect that we will continue to invest in short-term investments
and purchase capital equipment as we replace older equipment with newer models.
Financing activities provided net cash inflows of $144,000 and $161,000
during the three months ended June 30, 2003 and 2002, respectively. These
inflows were from the proceeds of our employee stock plans during each period.
At June 30, 2003, we have contractual and commercial commitments not
included on our balance sheet primarily for our San Mateo, California facility
that we have an obligation to lease through September 2006. For the remainder of
the fiscal year ended March 31, 2004, our total commitments amount to
$2,610,000. Future full fiscal year commitments are as follows: $1,972,000 in
2005, $1,715,000 in 2006 and $1,057,000 in 2007 ($7,354,000 in total commitments
as of June 30, 2003). The aforementioned amounts include estimates of expected
fair market rental rates in fiscal years ending March 31, 2004 to March 31, 2007
and the payments of cash and forfeiture of other collateral of $1,000,000 for
the year ending March 31, 2004, pursuant to the Lease Amendment described in the
notes to our condensed consolidated financial statements included elsewhere in
this quarterly report.
26
Our management believes we have adequate cash to sustain operations at
least through fiscal 2004 and is managing our business in the short-term to
control the amount of cash used and in the long-term to manage towards
profitability utilizing existing assets. During fiscal 2003, we continued to
reduce operating expenses by renegotiating our lease commitments, reducing
purchases of other services and making workforce reductions. During fiscal 2004,
we executed additional workforce reduction measures. We are committed to the
successful execution of our operating plan and will take further restructuring
actions as necessary to align our revenue and reduce expenses.
Although we believe our existing cash, cash equivalents and investments
will be sufficient to meet our anticipated cash needs for working capital and
capital expenditures for the next 12 months, higher than anticipated expenses
and lower than anticipated receipts may result in lower cash, cash equivalents
and investments balances than presently anticipated and we may find it necessary
to obtain additional equity or debt financing. We may not be able to obtain
adequate or favorable financing when necessary to fund our business. Failure to
raise capital when needed could harm our business. If we raise additional funds
through the issuance of equity securities, the percentage of ownership of our
stockholders would be reduced. Furthermore, these equity securities might have
rights, preferences or privileges senior to our common stock.
27
Risk Factors
The occurrence of any of the following risks could materially and adversely
affect our business, financial condition and operating results. In this case,
the trading price of our common stock could decline and you might lose all or
part of your investment.
Risks Related to Our Business
If the proposed merger with Autonomy Corporation plc is not completed, our
business and stock price may be adversely affected.
On July 10, 2003, we announced a definitive acquisition agreement by
Autonomy Corporation plc. The acquisition is subject to a number of
contingencies, including approval by a majority vote of our stockholders,
receipt of regulatory approvals and other customary closing conditions.
Therefore, there is a risk that the merger will not be completed or that it will
not be completed in the expected time period. If the merger is not completed, we
could be subject to a number of risks that may adversely affect our business and
stock price, including:
o the trading price of our common stock likely will decline as we
believe the current trading price reflects a market assumption that
the acquisition will be completed;
o we have and will continue to incur significant expenses related to the
acquisition prior to its closing, including fees paid to an investment
bank for a fairness opinion for the merger, and legal and accounting
fees, that must be paid even if the merger is not completed; and
o if the merger agreement is terminated under certain circumstances, we
may be obligated to pay Autonomy a $1,250,000 termination fee and up
to $350,000 for reimbursable expenses.
If completion of the merger is substantially delayed, we could be subject
to a number of risks that may adversely affect our business and stock price,
including:
o the trading price of our common stock might not exceed $1.10 to the
extent that the trading price reflects a market assumption that the
merger will be completed; and
o we could suffer repercussions from the limitations on our ability to
conduct our business that we are bound by (until the merger is
completed or the merger agreement is terminated) in the merger
agreement.
In connection with the proposed acquisition, we have mailed and/or will
mail to our stockholders and filed with the SEC a definitive proxy statement
which will contain important information about Virage, the proposed merger and
related matters. We urge all interested and affected parties to read the
definitive proxy statement.
The uncertainty created by the proposed acquisition of us by Autonomy could have
an adverse effect on our revenue and results of operations.
Due to our agreement to be acquired by Autonomy, we are and will continue
to be operating in a state of uncertainty about our future until the proposed
transaction is either completed or the acquisition agreement is terminated. As a
result of this uncertainty, customers may decide to delay, defer, or cancel
purchases of our products pending resolution of the proposed transaction. If
these decisions represent a significant portion of our anticipated revenue, our
results of operations and quarterly revenues could be adversely impacted.
28
The announcement of the sale of our Company to Autonomy could impair existing
relationships with our suppliers, customers, strategic partners and employees,
which could have an adverse effect on our business and financial results.
The recent public announcement that we have entered into a definitive
agreement to be acquired by Autonomy could substantially impair important
business relationships because of uncertainty regarding our future strategic
direction and the distraction completing these transactions will create.
Impairment of these business relationships could reduce revenues or increase
expenses, either of which could harm our financial results. Specific examples of
situations in which we could experience problems include the following:
o suppliers, distributors or customers could decide to cancel or
terminate existing arrangements, or fail to renew those arrangements,
as a result of the pending acquisition by Autonomy;
o our employees may be distracted by concerns about the pending merger
with Autonomy and therefore may not meet critical deadlines in their
assigned tasks or otherwise perform effectively;
o our management personnel may be distracted from day-to-day operations
by the time demands associated with these significant corporate
transactions and therefore may be unable to timely identify and
address business issues as they arise; and
o other current or prospective employees may experience uncertainty
about their future roles with us, which could adversely affect our
ability to attract and retain key management, sales, marketing and
technical personnel.
If the proposed acquisition by Autonomy is completed, shares of Virage common
stock will no longer represent equity interests in Virage's business.
If the proposed merger with Autonomy is completed, each share of Virage
common stock will be converted into the right to receive $1.10 in cash and will
no longer represent an equity interest in Virage. Because of this conversion,
stockholders will not be able to share in any potential future growth of
Virage's business.
We have not been profitable and if we do not achieve profitability, our business
may fail. If we need additional financing we may not obtain the required
financing on favorable terms and conditions.
We have experienced operating losses in each quarterly and annual period
since we were formed and we expect to incur significant losses in the future. As
of June 30, 2003, we had an accumulated deficit of $110,303,000. We have made
efforts to reduce our expenses over the past several quarters, but it is
possible that we could incur increasing research and development, sales and
marketing and general and administrative expenses at some point in the future,
particularly in connection with the proposed acquisition by Autonomy. Our
revenues have been relatively flat to slightly down for the past five quarters
and any inability to increase our revenues significantly in the future will
result in continuing losses and a deteriorating cash position, which will harm
our business. In addition, our cash, cash equivalent and short-term investment
resources (collectively, "cash resources") totaled $13,923,000 as of June 30,
2003 and we used $2,506,000 in our operating activities during the three months
ended June 30, 2003. We anticipate that our operating activities will use a
substantial portion of our remaining cash resources over the next 12 months.
Absent a significant interim improvement in our operating results or a
successful effort to raise additional capital, this will leave us with a
deteriorated cash position in comparison to our cash position as of June 30,
2003 and this may affect our ability to transact future strategic operating and
investing activities, which may harm our business and cause our stock price to
fall. In addition, we may experience reluctance on the part of prospects to
purchase from us if they believe our financial viability is in question. The
current business environment is not conducive to raising additional financing.
If we require additional financing, the terms of such financing may heavily
dilute the ownership interests of current investors, and cause our stock price
to fall significantly or we may not be able to secure financing upon acceptable
terms at all. Accordingly, our stock price and business' viability is heavily
dependent upon our ability to grow our revenues and manage our costs in order to
preserve cash resources.
29
Failure to comply with NASDAQ's listing standards could result in our delisting
by NASDAQ from The NASDAQ Small Cap and/or National Market and severely limit
the ability to sell any of our common stock.
Our stock is currently traded on The NASDAQ SmallCap Market. Under NASDAQ's
listing maintenance standards, if the closing bid price of our common stock is
under $1.00 per share for 30 consecutive trading days, NASDAQ may choose to
notify us that it may delist our common stock. For at least the prior 12 months
until the announcement of our agreement to be acquired by Autonomy, our common
stock price predominantly traded below $1.00 per share. There can be no
assurance that our stock will continue to trade above the $1.00 per share
listing requirement, that we will comply with other non-bid price related
listing criteria or that our common stock will remain eligible for trading on
The NASDAQ SmallCap Market or The NASDAQ National Market. If our stock were
delisted, the ability of our stockholders to sell any of our common stock at all
would be severely, if not completely, limited.
Our revenues, cost of revenues, expense and cash balance/cash usage forecasts
are based upon the best information we have available, but our operating results
have historically been volatile and there are a number of risks that make it
difficult for us to foresee or accurately evaluate factors that may impact our
forecasts.
Our quarterly and annual operating results have varied significantly in the
past and are likely to vary significantly in the future. We believe that
period-to-period comparisons of our results of operations are not meaningful and
should not be relied upon as indicators of future performance. Our operating
results have in past quarters fallen below securities analyst expectations and
will likely fall below their expectations in some future quarter or quarters.
We have limited visibility into future demand, and our limited operating
history makes it difficult for us to foresee or accurately evaluate factors that
may impact such future demand. Our visibility over our potential sales is
typically limited to the current quarter and our visibility for even the current
quarter is rather limited. In order to provide a revenue forecast for the
current quarter, we must make assumptions about conversion of sales prospects
into current quarter revenues. Such assumptions may be materially incorrect due
to the pending acquisition of us by Autonomy, competition for the customer
order, pricing pressures, sales execution issues, customer selection criteria or
length of the customer selection cycle, the failure of sales contracts to meet
our revenue recognition criteria, our inability to timely perform professional
services, our inability to hire and retain qualified personnel, our inability to
develop new markets domestically and internationally, the strength of
information technology spending, and other factors that may be beyond our
control. In addition, our application products are relatively early in their
product life cycles and we cannot predict how the market for these products will
develop. Our assumptions about conversion of potential application product sales
and/or our potential platform product sales into current quarter revenues could
be materially incorrect. We are reliant on third party resellers for a
significant portion of our license revenues and we have limited visibility into
the status of orders from these third parties.
For quarters beyond the current quarter, we have very limited visibility
into potential sales opportunities, and thus we have a lower confidence level in
any revenue forecast or forward-looking guidance. In developing a revenue
forecast for such quarters, we assess any customer indications about future
demand, general industry trends, marketing lead development activities,
productivity goals for the sales force and expected growth in sales personnel,
and any demand for products that we may have. Because visibility into outlying
quarters is so limited, we have not provided guidance beyond the current quarter
for the past several quarters.
Our cost of sales and expense forecasts are based upon our budgets and
spending forecasts for each area of the Company. Circumstances we may not
foresee could increase cost and expense levels beyond the levels forecasted.
Such circumstances may include the pending acquisition of us by Autonomy,
competitive threats in our markets which we may need to address with additional
sales and marketing expenses, severance for involuntary reductions in headcount
should we determine cost cutting measures are necessary, write-downs of
equipment and/or facilities in the event of unforeseen excess capacity, legal
claims, employee turnover, additional royalty expenses should we lose a source
of current technology, losses of key management personnel, unknown defects in
our products, and other factors we cannot foresee. In addition, many
expenditures are planned or committed in advance in anticipation of future
revenues, and if our revenues in a particular quarter are lower than we
anticipate, we may be unable to reduce spending in that quarter. As a result,
any shortfall in revenues or a failure to improve gross profit margin would
likely hurt our quarterly and/or annual operating results.
30
Our cash balance and cash usage forecasts are typically limited to the
current quarter and are based upon a number of factors including our revenue and
expense forecasts, which are also subject to a number of risks described above.
In addition, in deriving our cash forecasts, we make a number of assumptions
that are subject to other uncertainties including our expected cash payments to
employees, vendors and other parties, expected cash receipts from customers and
interest earned on our cash and investment balances. Such assumptions may be
materially incorrect due to the pending acquisition of us by Autonomy,
unexpected payments that are required to be made to employees or vendors,
delayed payments from our customers, unfavorable fluctuations in interest rates
and other factors that may be beyond our control.
The failure of any significant contracts to meet our policies for recognizing
revenue may prevent us from achieving our revenue objectives for a quarter or a
fiscal year, which would hurt our operating results.
Our sales contracts are typically based upon standard agreements that meet
our revenue recognition policies. However, our future sales may include site
licenses, professional services or other transactions with customers who may
negotiate special terms and conditions that are not part of our standard sales
contracts. In addition, customers may insist on an extended payment schedule or
may delay payments to us, which may require us to recognize from sales to those
customers' when amounts become due or are collected, rather than upon delivery
of our software to the customer. If these special terms and conditions cause
sales under these contracts to not qualify under our revenue recognition
policies, we would defer revenues to future periods when all revenue recognition
criteria are met, which may impair our revenues and operating results.
In addition, customers that license our products may require consulting,
implementation, maintenance and training services and obtain them from our
internal professional services, customer support and training organizations.
When we provide significant services in connection with a software license
arrangement, our revenue recognition policy may require us to recognize the
software license fee as the implementation services are performed. Customers may
opt to defer the implementation of significant services, which will cause us to
recognize revenues from the license as we perform the services or we may be
required to defer revenues from the license until the completion of the
services. Either of these scenarios may impair our revenues and operating
results.
We have allocated significant product development, sales and marketing resources
toward the deployment of our application products, we face a number of risks
that may impede market acceptance of these products and such risks may
ultimately prove our business model invalid, thereby hurting our financial
results.
We have invested significant resources into developing and marketing our
application products and do not know whether our business model and strategy
will be successful. The market for these products is in a relatively early stage
and one of our key assumptions about the market is that digital video will
continue to develop as a more relevant communication medium. We cannot predict
how the market for our applications will develop, and part of our strategic
challenge will be to convince enterprise customers of the productivity, improved
communications, cost savings and other benefits of our application products. Our
future revenues and revenue growth rates will depend in large part on our
success in delivering these products effectively and creating market acceptance
for these products. If we fail to do so, our products and services will not
achieve widespread market acceptance, and we may not generate significant
revenues to offset our development and sales and marketing costs, which will
hurt our business. Additionally, our future success will continue to depend upon
our ability to develop new products or product enhancements that address future
needs of our target markets and to respond to these changing standards and
practices.
In addition, resources may be required to fund development of our
application products' feature-sets beyond what we have planned due to
unanticipated marketplace demands. We may determine that we are unable to fund
these additional feature-sets due to financial constraints and may halt the
development of a product at a stage that the marketplace perceives as immature.
We may also encounter that the marketplace for an application product is not as
robust as we had expected and we may react to this by leaving the development of
a product at an early stage or combining key features of one or more of our
application products into a single product. Either of these product development
scenarios may impede market acceptance of any of our application products and
therefore hurt our financial results.
31
The length of our sales and deployment cycle is uncertain, which may cause our
revenues and operating results to vary significantly from quarter to quarter and
year to year.
During our sales cycle, we spend considerable time and expense providing
information to prospective customers about the use and benefits of our products
and services without generating corresponding revenues. Our expense levels are
relatively fixed in the short-term and based in part on our expectations of
future revenues. Therefore, any delay in our sales cycle could cause significant
variations in our operating results, particularly because a relatively small
number of customer orders represent a large portion of our revenues.
Some of our largest sources of revenues are government entities and large
corporations that often require long testing and approval processes before
making a decision to license our products. In general, the process of entering
into a licensing arrangement with a potential customer may involve lengthy
negotiations. As a result, our sales cycle has been and may continue to be
unpredictable. In the past, our sales cycle has ranged from one to 12 months.
Our sales cycle is also subject to delays as a result of customer-specific
factors over which we have little or no control, including budgetary constraints
and internal approval procedures. In addition, because our technology must often
be integrated with the products and services of other vendors, there may be a
significant delay between the use of our software and services in a pilot system
and our customers' volume deployment of our products and services.
Our application products are aimed toward a broadened business user base
within our key markets. These products are relatively early in their product
life cycles and we are relatively inexperienced with their sales cycle. We
cannot predict how the market for our application products will develop and part
of our strategic challenge will be to convince targeted users of the
productivity, improved communications, cost savings and other benefits.
Accordingly, it is likely that delays in our sales cycles with these application
products will occur and this could cause significant variations in our operating
results.
We expect the market price of our common stock to be volatile.
The market price of our common stock has experienced significant swings in
price over short periods of time. We believe that factors such as the
announcement of our definitive agreement to be acquired by Autonomy and other
announcements related to our business, fluctuations in our operating results,
failure to meet securities analysts' expectations, our ability to remain an
active listing on The NASDAQ SmallCap Market or The NASDAQ National Market,
general conditions in the software and high technology industries and the
worldwide economy, announcements of technological innovations, new systems or
product enhancements by us or our competitors, acquisitions, changes in
governmental regulations, developments in patents or other intellectual property
rights and changes in our relationships with customers and suppliers could cause
the price of our common stock to continue to fluctuate substantially.
Historically, there has been a relatively small number of buyers and sellers of
our common stock and trading volume of our common stock is relatively low in
comparison to many companies listed on The NASDAQ SmallCap Market or The NASDAQ
National Market and other well-known stock exchanges. This low trading volume
contributes to the volatility of our stock. In addition, in recent years the
stock market in general, and the market for small capitalization and high
technology stocks in particular, has experienced extreme price fluctuations. Any
of these factors could adversely affect the market price of our common stock.
32
Our revenues may be harmed if general economic conditions do not improve.
Our revenues are dependent on the health of the economy (in particular, the
robustness of information technology spending) and the growth of our customers
and potential future customers. The economic environment has not been favorable
to companies involved in information technology infrastructure for several
quarters. In addition, potential conflicts with rogue countries and the threat
of terrorist actions create a great deal of uncertainty for businesses and this
uncertainty generally results in businesses delaying investments in such areas
as information technology. If the economic trend continues, our customers and
potential customers may continue to delay or reduce their spending on our
software and service solutions. When economic conditions for information
technology products weaken, sales cycles for sales of software products and
related services tend to lengthen and companies' information technology and
business unit budgets tend to be reduced. We believe that global economic
conditions have become progressively weaker over the past 24 months and believe
that this has contributed to our decline in revenues for our current quarter in
comparison to other quarters over the past couple of years. If global economic
conditions continue to weaken or if potential conflicts continue or worsen, our
revenues could continue to suffer and our stock price could decline further.
Our restructuring efforts may not result in the intended benefits. We may be
required to record additional restructuring charges and this may adversely
affect the morale and performance of our personnel we wish to retain and may
also adversely affect our ability to hire new personnel.
During the past several quarters, as well as during our quarter ending
September 30, 2003, we have taken steps to better align the resources required
to operate efficiently in the prevailing market. Through these steps, we reduced
our headcount and incurred charges for employee severance, excess facility
capacity and excess equipment. While we believe that these steps help us achieve
greater operating efficiency, we have limited history with such measures and the
results of these measures are less than predictable. We monitor our expenses
closely and benchmark our expenses against expected revenues. Should our
revenues not meet internal or external expectations or other circumstances arise
that require us to better align resources required to operate efficiently in the
prevailing market such as our pending acquisition by Autonomy, additional
restructuring efforts will be required. We believe workforce reductions,
management changes and facility consolidation create anxiety and uncertainty and
may adversely affect employee morale. These measures could adversely affect our
employees that we wish to retain and may also adversely affect our ability to
hire new personnel. They may also affect customers and/or vendors, which could
harm our ability to operate as intended and which would harm our business.
As we have better aligned our resources over the past several quarters, we
have consolidated our operations into facility space that is less than our
current facility commitment, resulting in excess operating lease capacity. We
consolidated our space in March 2003 and recorded charges related to our excess
space as of the date we cease to use the space. This charge was our best
estimate based upon a number of assumptions and estimates that could prove
inaccurate including length of period that it will take to sublease our excess
space, assumed sublease rate and other collateral we expect to forfeit to our
landlord upon commencement of a sublease. In addition, should we continue to
have excess operating lease capacity and we are unable to find a sublessee at a
rate equivalent to our operating lease rate, we would be required to record
additional charges for the rental payments that we owe to our landlord relating
to any excess facility capacity, which would harm our operating results. Our
management reviews our facility requirements and assesses whether any excess
capacity exists as part of our on-going financial processes.
We have experienced rapid growth followed by substantial downsizing and we may
encounter difficulties in managing these size changes, which could adversely
impact our results of operations
We have experienced a period of rapid growth in our business and related
expenses, followed by a period of rapid and substantial downsizing of our
workforce and related expenses. These periods have placed a serious strain on
our managerial, administrative and financial personnel and our internal
infrastructure. To manage the changes these periods of expansion and contraction
of our business and personnel have brought to our operations and personnel, we
will be required to continue to improve existing and implement new operational,
financial and management controls, reporting systems and procedures. We may not
be able to install adequate management information and control systems in an
efficient and timely manner and our current or planned personnel systems,
procedures and controls may not be adequate to support our future operations. If
we are unable to manage further growth or reductions effectively, we may not be
able to capitalize on attractive business opportunities.
33
The prices we charge for our products and services may decrease or our pricing
assumptions may be incorrect, either of which may impact our ability to develop
a sustainable business.
The prices we charge for our products and services may decrease as a result
of competitive pricing pressures, promotional programs and customers who
negotiate price reductions. In addition, some of our competitors have provided
their services without charge in order to gain market share or new customers and
key accounts. The prices at which we sell and license our products and services
to our customers depend on many factors, including:
o purchase volumes;
o competitive pricing;
o the specific requirements of the order;
o the duration of the licensing arrangement;
o the general worldwide economic conditions and demand for our products
there from, and
o the level of sales and service support.
Our applications products are intended to increase both our revenues and
the average size of our customers' orders. These products have pricing models
based upon a number of assumptions about the market for our products. If our
assumptions are incorrect or our pricing does not work as intended, we may not
be able to increase the average size of our customer orders or reduce the costs
of selling and marketing for our products and, therefore, we may not be able to
develop a profitable and sustainable business.
Our sales and marketing costs are a high percentage of the revenues from
our orders, due partly to the expense of developing leads and relatively long
sales cycles involved in selling products that are not yet considered
"mainstream" technology investments. For the three months ended June 30, 2003
and 2002, sales and marketing expenses were 71% and 114% of our total revenues,
respectively.
Our service revenues have substantially lower gross profit margins than our
license revenues, and an increase in service revenues relative to license
revenues could harm our gross margins.
Our service revenues, which include fees for our application services as
well as professional services such as consulting, implementation, maintenance
and training, were 56% and 50% of our total revenues for the three months ended
June 30, 2003 and 2002, respectively. Our service revenues have substantially
lower gross profit margins than our license revenues. Our cost of service
revenues for the three months ended June 30, 2003 and 2002 were 57% and 71% of
service revenues, respectively. An increase in the percentage of total revenues
represented by service revenues could adversely affect our overall gross profit
margins.
Service revenues as a percentage of total revenues and cost of service
revenues as a percentage of total revenues have varied significantly from
quarter to quarter due to a number of factors including our swings in headcount
and related costs and restructuring charges. Recently, we have experienced an
increase in the percentage of license customers requesting professional
services. We expect that the amount and profitability of our professional
services will depend in large part on:
o the software solution that has been licensed;
o the complexity of the customers' information technology environments;
o the resources directed by customers to their implementation projects;
o the size and complexity of customer implementations; and
o the extent to which outside consulting organizations provide services
directly to customers.
The relative amount of service revenues as compared to license revenues has
also varied based on customer demand for our application services. Our
application services require a relatively fixed level of investment in staff,
facilities and equipment. In the past, we have operated our application service
business at a loss due to fixed investments that exceeded actual levels of
revenues realized. We have reduced the application service fixed investments.
However, there is no assurance that the current level of application service
revenues will continue to allow us to recover our fixed costs and make a
positive gross profit margin.
34
Service revenues from contracts with federal government agencies comprised
10% of total revenues during the three months ended June 30, 2003 (none during
the three months ended June 30, 2002). Contract costs for service revenues to
federal government agencies, including indirect expenses, are subject to audit
and subsequent adjustment by negotiation between U.S. Government representatives
and us. Service revenues are recorded in amounts expected to be realized upon
final settlement and in accordance with our revenue recognition policies. While
historically we have had no adverse impact related to our revenues from such an
audit and believes that the results of any future audit will have no material
effect on our financial position or results of operations, there can be no
assurance that no adjustment will be made and that, if made, such adjustment
will not have a material effect on our financial position or results of
operations (including our gross profit margin).
Because competition for qualified personnel is intense, we may not be able to
recruit or retain personnel, which could impact the development and acceptance
of our products and services.
Our future success depends to a significant extent on the continued
services of our senior management and other key personnel such as senior
development staff, product marketing staff and sales personnel. The loss of key
employees would likely have an adverse effect on our business. If one or more of
our senior management team were to resign, the loss could result in loss of
sales, delays in new product development and diversion of management resources.
We may also be required to create additional performance and retention
incentives in order to retain our employees including the granting of additional
stock options to employees at or below current prices or issuing incentive cash
bonuses. Such incentives may either dilute our existing stockholder base or
result in unforeseen operating expenses, which may cause our stock price to
fall. For example, in February 2002, we introduced a Voluntary Stock Option
Cancellation and Re-grant Program in which a number of our employees cancelled
stock options that had significantly higher exercise prices in comparison to
where our common stock price currently trades. These employees received
2,538,250 shares at $0.59 per share in August 2002. This may cause dilution to
our existing stockholder base, which may cause our stock price to fall.
We may need to hire sales, development, marketing and administrative
personnel in the foreseeable future. We may be unable to attract or assimilate
other highly qualified employees in the future particularly given our pending
transaction with Autonomy, continued operating losses and weakening cash
position. We have in the past experienced, and we expect to continue to
experience, difficulty in hiring highly skilled employees with appropriate
qualifications. In addition, new hires frequently require extensive training
before they achieve desired levels of productivity. We may fail to attract and
retain qualified personnel, which could have a negative impact on our business.
If requirements relating to accounting treatment for employee stock options are
changed, we may be forced to change our business practices.
We currently account for the issuance of stock options under follow
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees." If proposals currently under consideration by administrative and
governmental authorities are adopted, we may be required to treat the value of
the stock options granted to employees as compensation expense. Such a change
could have a negative effect on our earnings. In response to a requirement to
expense the value of stock options, we could decide to decrease the number of
employee stock options granted to our employees. Such a reduction could affect
our ability to retain existing employees and attract qualified candidates, and
increase the cash compensation we would have to pay to them.
35
Recently enacted and proposed changes in securities laws and regulations will
increase our costs.
The Sarbanes-Oxley Act ("the Act") of 2002 that became law in July 2002
requires changes in some of our corporate governance and securities disclosure
and/or compliance practices. The Act also requires the SEC to promulgate new
rules on a variety of subjects, in addition to rule proposals already made, and
The NASDAQ SmallCap Market and The NASDAQ National Market have proposed
revisions to their requirements for companies like Virage. We believe these
developments will increase our legal and accounting compliance costs. We also
expect these developments to make it more difficult and more expensive for us to
obtain director and officer liability insurance, and we may be required to
accept reduced coverage or incur substantially higher costs to obtain coverage.
These developments could make it more difficult for us to attract and retain
qualified members of our board of directors, or qualified executive officers. We
are presently evaluating and monitoring regulatory developments and cannot
reliably estimate the timing or magnitude of additional costs we will incur as a
result of the Act or other, related legislation.
If the protection of our intellectual property is inadequate or third party
intellectual property is unavailable or if others bring infringement or other
claims against us, we may incur significant costs or lose customers.
We depend on our ability to develop and maintain the proprietary aspects of
our technology. Policing unauthorized use of our products is difficult and
software piracy may become a problem. We license our proprietary rights to third
parties, who may not abide by our compliance guidelines. To date, we have not
sought patent protection of our proprietary rights in any foreign jurisdiction,
and the laws of some foreign countries do not protect our proprietary rights to
as great an extent as do the laws of the United States. Our efforts to protect
our intellectual property rights may not be effective to prevent
misappropriation of our technology or may not prevent the development by others
of products competitive with those developed by us.
In addition, other companies may obtain patents or other proprietary rights
that would limit our ability to conduct our business and could assert that our
technologies infringe their proprietary rights. We could incur substantial costs
to defend any litigation, and intellectual property litigation could force us to
cease using key technology, obtain a license, or redesign our products. From
time to time, we have received notices claiming that our technology infringes
patents held by third parties and, in addition, may become involved in
litigation claims arising from our ordinary course of business. We believe that
there are no claims or actions pending or threatened against us, the ultimate
disposition of which would have a material adverse effect on us. However, in the
event any claim against us is successful, our operating results would be
significantly harmed.
Furthermore, we license technology from third parties, which may not
continue to be available on commercially reasonable terms, if at all. For
example, our proposed transaction with Autonomy has caused one of our vendors to
claim we are in default with our technology licensing agreement with them.
Although we do not believe that we are substantially dependent on any licensed
technology, some of the software we license from third parties could be
difficult for us to replace. The loss of any of these licenses could result in
delays in the licensing of our products until equivalent technology, if
available, is developed or licensed for potentially higher fees and integrated.
In the event of any such loss, costs could be increased and delays could be
incurred, thereby harming our business. The use of additional third-party
software would require us to negotiate license agreements with other parties,
which could result in higher royalty payments and a loss of product
differentiation. In addition, the effective implementation of our products
depends upon the successful operation of third-party licensed products in
conjunction with our products, and therefore any undetected errors in these
licensed products could prevent the implementation or impair the functionality
of our products, delay new product introductions and/or damage our reputation.
36
Interruptions to our business or internal infrastructure from unforeseen,
adverse events or circumstances will disrupt our business and our operating
results will suffer.
The worldwide socio-political environment has changed dramatically since
September 11, 2001 and potential conflicts with rogue countries or threatened
acts of terrorism create a great deal of global uncertainty. Our customers,
potential customers and vendors are located worldwide and generally within major
international metropolitan areas. In addition, the significant majority of our
operations are conducted at offices within a 60-mile radius of the major
metropolitan cities of San Francisco, New York City, Boston and London. Our
business also requires that certain personnel, including our officers, travel in
order to perform their jobs appropriately. A terrorist attack or military
conflict or adverse biological event (such as the recent outbreak of SARS
globally, and in particular, in Asia and Canada) could reduce our ability to
travel or could limit our ability to enter foreign countries, either of which
would diminish our effectiveness in closing international customer
opportunities. Should a major catastrophe occur within the vicinity of any of
our operations, our customers' and/or potential customers' operations and/or
vendors' operations, our operations may be adversely impacted and our business
may be harmed.
Our communications and network infrastructure are a critical part of our
business operations. Our application services business is dependent upon
providing our customers with fast, efficient and reliable services. To meet our
customers' requirements, we must protect our network against damage from any and
all sources, including among other things:
o human error;
o physical or electronic security breaches;
o computer viruses;
o fire, earthquake, flood and other natural disasters;
o power loss;
o telecommunications failure; and
o sabotage and vandalism.
We have communications hardware and computer hardware operations located at
third party facilities in Santa Clara, California and Palo Alto, California. We
do not have complete backup systems for these operations. A problem with, or
failure of, our communications hardware or operations could result in
interruptions or increases in response times on the Internet sites of our
customers. Furthermore, if these third party partners fail to adequately
maintain or operate our communications hardware or do not perform our computer
hardware operations adequately, our services to our customers may not be
available. We have experienced system failures in the past. Any disruptions
could damage our reputation, reduce our revenues or otherwise harm our business.
Our insurance policies may not adequately compensate us for any losses that may
occur due to any failures or interruptions in our systems.
Defects in our software products or services could diminish demand for our
products or could subject us to liability claims and negative publicity if our
customers' systems, information or video content is damaged through the use of
our products and/or our application services.
Our software products and related services are complex and may contain
errors that may be detected at any point in the life of the product or service.
Our software products must operate within our customers' hardware and network
environment in order to function as intended. We cannot assure you that, despite
testing by us and our current and potential customers, errors will not be found
in new products or releases after shipment or in the related services that we
perform for our customers. If our customers' systems, information or video
content is damaged by software errors or services that we perform for them, our
business may be harmed. In addition, these errors or defects or the
incompatibility of our products to work within a customers' hardware and network
environment may cause severe customer service and public relations problems.
Errors, bugs, viruses, incompatibility or misimplementation of our products or
services may cause liability claims and negative publicity ultimately resulting
in the loss of market acceptance of our products and services. Our agreements
with customers that attempt to limit our exposure to liability claims may not be
enforceable in jurisdictions where we operate.
37
As we operate internationally, we face significant risks in doing business in
foreign countries.
We are subject to a number of risks associated with international business
activities, including:
o costs of customizing our products and services for foreign countries,
including localization, translation and conversion to international
and other foreign technology standards;
o compliance with multiple, conflicting and changing governmental laws
and regulations, including changes in regulatory requirements that may
limit our ability to enter or sell our products and services in
particular countries;
o import and export restrictions, tariffs and greater difficulty in
collecting accounts receivable; and
o foreign currency-related risks if a significant portion of our
revenues become denominated in foreign currencies.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
At June 30, 2003, the Company's cash and cash equivalents consisted
primarily of bank deposits and money market funds. The Company's short-term
investments consisted of commercial paper, municipal bonds, and federal agency
and related securities. The Company did not hold any derivative financial
instruments. The Company's interest income is sensitive to changes in the
general level of interest rates. In this regard, changes in interest rates can
affect the interest earned on cash and cash equivalents and short-term
investments.
Item 4. Controls and Procedures
Evaluation of disclosure controls and procedures
Our management evaluated, with the participation of our Chief Executive
Officer and our Acting Chief Financial Officer, the effectiveness of our
disclosure controls and procedures as of the end of the period covered by this
Quarterly Report on Form 10-Q. Based on this evaluation, our Chief Executive
Officer and our Acting Chief Financial Officer have concluded that our
disclosure controls and procedures are effective to ensure that information we
are required to disclose in reports that we file or submit under the Securities
Exchange Act of 1934 is recorded, processed, summarized and reported within the
time periods specified in Securities and Exchange Commission rules and forms.
Changes in internal control over financial reporting
There was no change in our internal control over financial reporting that
occurred during the period covered by this Quarterly Report on Form 10-Q that
has materially affected, or is reasonably likely to materially affect, our
internal control over financial reporting.
38
PART II: OTHER INFORMATION
Item 1. Legal Proceedings.
Securities class action lawsuits were filed, starting on August 22,
2001, in the United States District Court for the Southern District
of New York . The cases have been consolidated under the caption In
re Virage, Inc. Initial Public Offering Securities Litigation, No.
01-CV-7866 (SAS) (S.D.N.Y.), related to In re Initial Public
Offerings Securities Litigation, No. 21 MC 92 (SAS). The lawsuit is
brought purportedly on behalf of all persons who purchased our
common stock from June 28, 2000 through December 6, 2000. The
defendants are the Company, one of our current officers and one of
our former officers (the "Virage Defendants"); and investment
banking firms that served as underwriters for our initial public
offering. The operative amended complaint alleges liability under
Sections 11 and 15 of the Securities Act of 1933 and Sections 10(b)
and 20(a) of the Securities Exchange Act of 1934, on the grounds
that the registration statement for the IPO did not disclose that:
(1) the underwriters agreed to allow certain customers to purchase
shares in the IPO in exchange for excess commissions paid to the
underwriters; and (2) the underwriters arranged for certain
customers to purchase additional shares in the aftermarket at
predetermined prices. The complaint also appears to allege that
false or misleading analyst reports were issued. The complaint does
not claim any specific amount of damages. Similar allegations were
made in other lawsuits challenging over 300 other initial public
offerings and follow-on offerings conducted in 1999 and 2000. The
cases were consolidated for pretrial purposes. On February 19, 2003,
the Court ruled on all defendants' motions to dismiss. The Court
denied the motions to dismiss the claims under the Securities Act of
1933. The Court granted the motions to dismiss the claims under the
Securities Exchange Act of 1934.
We have decided to accept a settlement proposal presented to all
issuer defendants. In this settlement, plaintiffs will dismiss and
release all claims against the Virage Defendants, in exchange for a
contingent payment by the insurance companies collectively
responsible for insuring the issuers in all of the IPO cases, and
for the assignment or surrender of control over certain claims we
may have against the underwriters. The Virage Defendants will not be
required to make any cash payments in the settlement, unless the pro
rata amount paid by the insurers in the settlement exceeds the
amount of the insurance coverage, a circumstance which we do not
believe will occur. The settlement will require approval of the
Court, which cannot be assured, after class members are given the
opportunity to object to the settlement or opt out of the
settlement.
From time to time, we may become involved in litigation claims
arising from its ordinary course of business. We believe that there
are no claims or actions pending or threatened against it, the
ultimate disposition of which would have a material adverse effect
on our consolidated financial position, results of operations or
cash flows.
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Item 2. Changes in Securities and Use of Proceeds
(d) Use of Proceeds.
On July 5, 2000, we completed a firm commitment underwritten initial
public offering of 3,500,000 shares of our common stock, at a price
of $11.00 per share. Concurrently with our initial public offering,
we also sold 1,696,391 shares of common stock in a private placement
at a price of $11.00 per share. On July 17, 2000, our underwriters
exercised their over-allotment option for 525,000 shares of our
common stock at a price of $11.00 per share. The shares of the
common stock sold in the offering and exercised via our
underwriters' over-allotment option were registered under the
Securities Act of 1933, as amended, on a Registration Statement on
Form S-1 (File No. 333-96315). The Securities and Exchange
Commission declared the Registration Statement effective on June 28,
2000. The public offering was underwritten by a syndicate of
underwriters led by Credit Suisse First Boston, FleetBoston
Robertson Stephens Inc. and Wit SoundView Corporation, as their
representatives.
The initial public offering and private placement resulted in net
proceeds of $57,476,000, after deducting $3,099,000 in underwriting
discounts and commissions and $1,800,000 in costs and expenses
related to the offering. None of the costs and expenses related to
the offering or the private placement were paid directly or
indirectly to any director, officer, general partner of Virage or
their associates, persons owning 10 percent or more of any class of
equity securities of Virage or an affiliate of Virage. Proceeds from
the offering and private placement have been used for general
corporate purposes, including working capital and capital
expenditures. The remaining net proceeds have been invested in cash,
cash equivalents and short-term investments. The use of the proceeds
from the offering and private placement does not represent a
material change in the use of proceeds described in our prospectus.
Item 3. Defaults Upon Senior Securities
None.
Item 4. Submission of Matters to a Vote of Security Holders
None.
Item 5. Other Information
Through June 30, 2003, our common stock was traded on The NASDAQ National
Market and the bid price for our common stock had been under $1.00 per share
for over 30 consecutive trading days. Under NASDAQ's listing maintenance
standards, if the closing bid price of our common stock is under $1.00 per
share for 30 consecutive trading days, NASDAQ may choose to notify us that
it may delist our common stock from The NASDAQ National Market.
We received a NASDAQ letter on May 1, 2003 that stated we were not in
compliance with the NASDAQ's minimum bid price listing requirement and that
we had seven calendar days to do one of the following:
o Submit an application for transfer of our securities for trading to
The NASDAQ SmallCap Market;
o Request a hearing to appeal the delisting notice; or
o Have our securities delisted from The NASDAQ National Market.
We initiated an appeal process with NASDAQ whereby it requested an
in-person hearing with NASDAQ regulators to present relevant measures we
have taken in order to improve our operating results and, as a result,
bolster our stock price to levels required by NASDAQ. The hearing took
place in June 2003. We received a verdict letter from NASDAQ's compliance
department in July 2003.
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In July 2003, we received a response from NASDAQ's compliance department
stating that our appeal was dismissed and that we had the option of
transferring to The NASDAQ SmallCap Market or being delisted from the
exchange. We submitted an application for transfer to The NASDAQ SmallCap
Market, which was accepted and we transferred to and began trading on The
NASDAQ SmallCap Market in July 2003. We expect that we will have at least
180 days to regain compliance with NASDAQ's listing requirements while
trading on the NASDAQ SmallCap Market. We may be eligible to transfer back
to The NASDAQ National Market if our bid price maintains the $1.00 per share
requirement for 30 consecutive trading days and we have maintained
compliance with all other continued listing requirements for The NASDAQ
National Market.
Item 6. Exhibits and Report on Form 8-K.
(a) Exhibits
Exhibit 2.1+ Agreement and Plan of Merger with Autonomy Corporation
plc
Exhibit 31.1 Certification by Paul G. Lego Pusuant to Rule 13a-14(a)
Exhibit 31.2 Certification by Scott Gawel Pursuant to Rule 13a-14(a)
Exhibit 32.1 Certifications Pursuant to 18 U.S.C. Section 1350
+ Incorporated by reference to the Registrant's Current Report on Form
8-K filed on July 11, 2003
(b) Report on Form 8-K
1. We filed a current report on Form 8-K dated April 24, 2003, which
announced our results of operations for the three months and
fiscal year ended March 31, 2003.
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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.
VIRAGE, INC.
Date: August 7, 2003 By: /s/ Scott Gawel
----------------------------------------
Scott Gawel
Vice President, Finance &
Acting Chief Financial Officer
(Duly Authorized Officer and
Principal Financial Officer)
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