-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, NCjeXYLsvpH5IqhfyRETrXL3f0IKI5NCGnWmsLwmeip7j8wn5j208AYimsStM4AC H9P8va1QLQu0B0aK94gthA== 0001012870-01-500793.txt : 20010516 0001012870-01-500793.hdr.sgml : 20010516 ACCESSION NUMBER: 0001012870-01-500793 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 1 CONFORMED PERIOD OF REPORT: 20010331 FILED AS OF DATE: 20010515 FILER: COMPANY DATA: COMPANY CONFORMED NAME: INTERWOVEN INC CENTRAL INDEX KEY: 0001042431 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-PREPACKAGED SOFTWARE [7372] IRS NUMBER: 943221352 STATE OF INCORPORATION: CA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 000-27389 FILM NUMBER: 1634362 BUSINESS ADDRESS: STREET 1: 1195 W FREMONT AVE STREET 2: STE 2000 CITY: SUNNYVALE STATE: CA ZIP: 94087 BUSINESS PHONE: 4087742000 MAIL ADDRESS: STREET 1: 1195 W FREMONT AVE STREET 2: STE 2000 CITY: SUNNYVALE STATE: CA ZIP: 94087 10-Q 1 d10q.txt FORM 10-Q PERIOD ENDED 03/31/2001 - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q [X]Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the quarterly period ended March 31, 2001 or [_]Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the transition period from to Commission File Number 000-27389 INTERWOVEN, INC. (Exact name of Registrant as specified in its charter) Delaware 77-0523543 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification Number) 1195 West Fremont Avenue, Suite 2000, 94087 Sunnyvale, CA (Zip Code) (Address of principal executive offices) (408) 774-2000 (Registrant's telephone number including area code) Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [_] There were 102,883,442 shares of the Company's Common Stock outstanding on May 7, 2001. - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- TABLE OF CONTENTS
Page No. ---- PART I FINANCIAL INFORMATION Item 1--Financial Statements: Unaudited Condensed Consolidated Balance Sheets as of March 31, 2001 and December 31, 2000................................................ 3 Unaudited Condensed Consolidated Statements of Operations for the Three Months Ended March 31, 2001 and 2000........................... 4 Unaudited Condensed Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2001 and 2000........................... 5 Notes to Unaudited Condensed Consolidated Financial Statements........ 6 Item 2--Management's Discussion and Analysis of Financial Condition and Results of Operations................................................... 11 Item 3--Quantitative and Qualitative Disclosures about Market Risk....... 27 PART II OTHER INFORMATION Item 1--Legal Proceedings................................................ 28 Item 2--Changes in Securities and Use of Proceeds........................ 28 Item 3--Defaults upon Senior Securities.................................. 28 Item 4--Submission of Matters to a Vote of Securities Holders............ 28 Item 5--Other Information................................................ 28 Item 6--Exhibits and Reports on Form 8-K................................. 28 SIGNATURE................................................................ 29
2 PART I FINANCIAL INFORMATION Item 1. Financial Statements INTERWOVEN, INC. UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS (In thousands)
March December 31, 31, 2001 2000 -------- ------------ ASSETS ------ Current assets: Cash and cash equivalents............................. $105,767 $ 75,031 Short-term investments................................ 111,025 147,253 Accounts receivable, net of allowance for doubtful accounts of $883 and $564, respectively.............. 44,212 36,806 Prepaid expenses...................................... 6,656 7,392 Other current assets.................................. 3,666 2,860 -------- -------- Total current assets................................ 271,326 269,342 Property and equipment, net............................. 17,051 14,889 Intangible assets, net.................................. 218,770 238,502 Restricted cash......................................... 605 605 Other assets............................................ 870 871 -------- -------- $508,622 $524,209 ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY ------------------------------------ Current liabilities: Accounts payable...................................... $ 6,271 $ 9,918 Accrued liabilities................................... 27,289 25,411 Deferred revenue...................................... 38,193 34,529 -------- -------- Total current liabilities........................... 71,753 69,858 -------- -------- Stockholders' equity: Common stock, 500,000 shares authorized, 102,507 and 102,171 shares issued and outstanding.................. 27 27 Additional paid-in capital.............................. 540,459 539,969 Deferred stock-based compensation....................... (21,482) (27,627) Accumulated other comprehensive income.................. 199 -- Accumulated deficit..................................... (82,334) (58,018) -------- -------- Total stockholders' equity.......................... 436,869 454,351 -------- -------- $508,622 $524,209 ======== ========
The accompanying notes are an integral part of these condensed consolidated financial statements. 3 INTERWOVEN, INC. UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands, except per share amounts)
Three months ended March 31, ----------------- 2001 2000 -------- ------- Revenues: License.................................................. $ 39,033 $ 9,388 Services................................................. 21,511 4,472 -------- ------- Total revenues......................................... 60,544 13,860 -------- ------- Cost of revenues: License.................................................. 490 66 Services................................................. 16,116 4,654 -------- ------- Total cost of revenues................................. 16,606 4,720 -------- ------- Gross profit 43,938 9,140 -------- ------- Operating expenses: Research and development................................. 8,923 2,208 Sales and marketing...................................... 28,545 9,669 General and administrative............................... 5,770 1,960 Amortization of deferred stock-based compensation........ 4,575 833 Amortization of acquired intangible assets............... 22,072 52 -------- ------- Total operating expenses............................... 69,885 14,722 -------- ------- Loss from operations....................................... (25,947) (5,582) Interest income and other, net............................. 2,779 2,537 -------- ------- Net loss before provision for income taxes................. (23,168) (3,045) Provision for income taxes................................. 1,148 -- -------- ------- Net loss................................................... $(24,316) $(3,045) ======== ======= Basic and diluted net loss per share....................... $ (0.25) $ (0.03) ======== ======= Shares used in computing basic and diluted net loss per share..................................................... 98,406 87,040 ======== =======
The accompanying notes are an integral part of these condensed consolidated financial statements. 4 INTERWOVEN, INC. UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands)
Three months ended March 31, ------------------- 2001 2000 -------- --------- Cash flows from operating activities: Net loss................................................. $(24,316) $ (3,045) Adjustments to reconcile net loss to net cash provided by (used in) operating activities: Depreciation........................................... 1,756 382 Amortization of deferred stock based compensation...... 4,575 833 Amortization of acquired intangible assets............. 22,072 52 Provisions for doubtful accounts....................... 400 (13) Changes in assets and liabilities: Accounts receivable.................................... (7,806) (6,910) Prepaid expenses and other assets...................... (70) (203) Accounts payable....................................... (3,647) 494 Accrued liabilities.................................... 2,764 3,658 Deferred revenue....................................... 3,664 6,688 -------- --------- Net cash (used in) provided by operating activities.. (608) 1,936 -------- --------- Cash flows from investing activities: Purchase of property and equipment....................... (3,918) (1,467) Purchases of investments................................. (55,473) (127,814) Maturities of investments................................ 91,974 13,090 -------- --------- Net cash provided by (used in) investing activities.. 32,583 (116,191) -------- --------- Cash flows from financing activities: Proceeds from exercise of warrants into common stock..... -- 10 Proceeds from issuance of common stock through stock options................................................. 2,562 484 Proceeds from issuance of common stock for follow-on offering................................................ -- 152,662 -------- --------- Net cash provided by financing activities............ 2,562 153,156 -------- --------- Cumulative effect of foreign currency translation........ (74) -- Purchase price adjustment................................ (3,727) -- Net increase in cash and cash equivalents................ 30,736 38,901 Cash and cash equivalents at beginning of period......... 75,031 10,983 -------- --------- Cash and cash equivalents at end of period............... $105,767 $ 49,884 ======== =========
The accompanying notes are an integral part of these condensed consolidated financial statements. 5 INTERWOVEN, INC. NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS Note 1. Summary of Significant Accounting Policies: Basis of Presentation The interim unaudited condensed consolidated financial statements have been prepared on the same basis as the annual consolidated financial statements and, in the opinion of management, reflect all adjustments, which include only normal recurring adjustments, necessary to present fairly the Company's financial position, results of operations and cash flows as of March 31, 2001 and 2000 and for the three months ended March 31, 2001 and 2000. These unaudited condensed consolidated financial statements and notes thereto should be read in conjunction with the Company's audited financial statements and related notes included in the Company's 2000 Annual Report on Form 10-K/A. The results of operations for the three months ended March 31, 2001 are not necessarily indicative of results that may be expected for any other interim period or for the full fiscal year. Revenue recognition Revenue consists principally of fees for licenses of the Company's software products, maintenance, consulting, and training. The Company recognizes revenue using the residual method in accordance with Statement of Position 97- 2 (SOP 97-2), "Software Revenue Recognition," as amended by SOP 98-9, "Modification of SOP 97-2, Software Revenue Recognition with Respect to Certain Transactions." Under the residual method, revenue is recognized in a multiple element arrangement in which Company-specific objective evidence of fair value exists for all of the undelivered elements in the arrangement, but does not exist for one or more of the delivered elements in the arrangement. Company-specific objective evidence of fair value of maintenance and other services is based on the Company's customary pricing for such maintenance and/or services when sold separately. At the outset of the arrangement with the customer, the Company defers revenue for the fair value of its undelivered elements (e.g., maintenance, consulting, and training) and recognizes revenue for the remainder of the arrangement fee attributable to the elements initially delivered in the arrangement (i.e., software product) when the basic criteria in SOP 97-2 have been met. If such evidence of fair value for each element of the arrangement does not exist, all revenue from the arrangement is deferred until such time that evidence of fair value does exist or until all elements of the arrangement are delivered. Under SOP 97-2, revenue attributable to an element in a customer arrangement is recognized when persuasive evidence of an arrangement exists, delivery has occurred, the fee is fixed or determinable, collectibility is probable, and the arrangement does not require services that are essential to the functionality of the software. If at the outset of the customer arrangement, the Company determines that the arrangement fee is not fixed or determinable or that collectibility is not probable, revenue is recognized when the arrangement fee becomes due and payable. The Company's specific policies for recognition of license revenues and services are as follows: License revenues are recognized when persuasive evidence of an agreement exists, the product has been delivered, the license fee is fixed or determinable and collection of the fee is probable. In addition to the aforementioned items, when assessing probability of collection, the Company considers maturity of conducting business, history of collection, and product acceptance within each geographic sales region. Since January 1, 2001, the Company has recognized revenue upon the signing of the contract and shipment of the product in Northern Europe. The Company will continue to assess probability of collections on an individual agreement-by-agreement basis. The Company does not offer product return rights to resellers or end users. Services revenues consist of professional services and maintenance fees. Professional services primarily consist of software installation and integration, business process consulting and training. Professional services are predominately billed on a time and materials basis and revenues are recognized as the services are performed. Maintenance agreements are typically priced based on a percentage of the product license fee and have a one- 6 INTERWOVEN, INC. NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued) year term, renewable annually. Services provided to customers under maintenance agreements include technical product support and unspecified product upgrades. Deferred revenues from advanced payments for maintenance agreements are recognized ratably over the term of the agreement, which is typically one year. During the fourth quarter of 2000, the Company adopted Staff Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements," ("SAB No. 101"). The adoption of SAB No. 101 did not have a material effect on the Company's consolidated statement of financial position or results of operation. The Company expenses all manufacturing, packaging and distribution costs associated with software license sales as cost of goods sold. Comprehensive loss For the three months ended March 31, 2000, comprehensive loss was zero. For the three months ended March 31, 2001, comprehensive loss of $24.1 million consists of $273,000 net unrealized investment gain, $74,000 net cumulative translation loss, and $24.3 million net loss. Note 2. Net loss per share The Company computes net loss per share in accordance with SFAS No. 128, "Earnings per Share" and SEC Staff Accounting Bulletin ("SAB") No. 98. Under the provisions of SFAS No. 128 and SAB No. 98, basic net loss per share is computed using the weighted-average number of outstanding shares of common stock, excluding shares of restricted stock subject to repurchase summarized below. Diluted net loss per share is computed using the weighted-average number of shares of common stock outstanding and, when dilutive, potential common shares from options and unvested restricted stock using the treasury stock method and from convertible securities on an "as if converted" basis. The following table sets forth the computation of basic and diluted net loss per share for the periods indicated (in thousands, except per share amounts):
Three months ended March 31, ----------------- 2001 2000 -------- ------- Numerator: Net loss attributable to common stockholders.......... $(24,316) $(3,045) Denominator: Weighted average shares............................... 102,371 94,577 Weighted average unvested common stock subject to repurchase........................................... (3,965) (7,537) -------- ------- Denominator for basic and diluted calculation......... 98,406 87,040 -------- ------- Net loss per share: Basic and diluted..................................... $ (0.25) $ (0.03) ======== =======
Options to purchase 17,999,680 shares of common stock at a weighted-average exercise price of $11.57 for the three months ended March 31, 2001, and options to purchase 4,235,022 shares of common stock at a weighted-average exercise price of $30.46 for the three months ended March 31, 2000, have been excluded from the computation of diluted net earnings per share for the three months ended March 31, 2001 and 2000, respectively, as their effect would have been antidilutive. 7 INTERWOVEN, INC. NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued) 3,964,816 and 7,537,028 shares of common stock subject to repurchase at a weighted average price of $0.32 and $0.35 as of March 31, 2001 and 2000, respectively, have been excluded from the computation of diluted net loss per share for the three months ended March 31, 2001 and 2000, respectively, as their effect would have been antidilutive. Warrants to purchase 149,564 and 116,316 shares of common stock at a weighted-average exercise price of $2.125 for the three months ended March 31, 2001 and 2000, respectively, have been excluded from the computation of diluted net earnings per share for the three months ended March 31, 2001 and 2000, respectively, as their effect would have been antidilutive. Note 3. Follow-on offering In February 2000, the Company completed its follow-on offering of 12,000,000 shares of common stock at $40.25. The Company sold 4,000,000 shares in this offering and selling stockholders sold 8,000,000 shares. Net proceeds to the Company were $152.4 million. Note 4. Stock Split On June 1, 2000 the Company's Board of Directors approved a 2-for-1 stock split of the outstanding shares of common stock in the form of a stock dividend. These shares were distributed on July 13, 2000. On December 12, 2000 the Company's Board of Directors approved a 2-for-1 stock split of the outstanding shares of common stock in the form of a stock dividend. The shares were distributed on January 2, 2001. All share and per share information included in these consolidated financial statements have been retroactively adjusted to reflect these stock splits. Note 5. Recent Pronouncements In June 1998, the Financial Accounting Standards Board (FASB) issued Statement No. 133 (SFAS 133), "Accounting for Derivative Instruments and Hedging Activity", which was subsequently amended by Statement No. 137 (SFAS 137), "Accounting for Derivative Instruments and Hedging Activities: Deferral of Effective Date of FASB 133" and Statement No.138 (SFAS 138), "Accounting for Certain Derivative Instruments and Certain Hedging Activities: an amendment of FASB Statement No. 133". SFAS 137 requires adoption of SFAS 133 in years beginning after June 15, 2000. SFAS 138 establishes accounting and reporting standards for derivative instruments and addresses a limited number of issues causing implementation difficulties for numerous entities. The Statement requires the Company to recognize all derivatives on the balance sheet at fair value. Derivatives that are not hedges must be recorded at fair value through earnings. If the derivative qualifies as a hedge, depending on the nature of the exposure being hedged, changes in the fair value of derivatives are either offset against the change in fair value of hedged assets, liabilities, or firm commitments through earnings or are recognized in other comprehensive income until the hedged cash flow is recognized in earnings. The ineffective portion of a derivative's change in fair value is recognized in earnings. The Statement permits early adoption as of the beginning of any fiscal quarter. The Company adopted SFAS 133 effective January 1, 2001, and such adoption did not have a material impact on its consolidated financial statements. Note 6. Acquisitions On July 18, 2000, the Company acquired all of the outstanding capital stock of Neonyoyo in exchange for approximately $8.0 million in cash and approximately 2,174,000 shares of its common stock. In addition, the Company assumed options to purchase a total of 33,862 shares of its common stock in exchange for all issued and outstanding Neonyoyo options and agreed to pay cash upon the exercise of such assumed options. 8 INTERWOVEN, INC. NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued) On October 31, 2000, the Company acquired all of the outstanding capital stock of Ajuba Solutions, Inc. in exchange for approximately 360,000 shares of Interwoven common stock. In addition, the Company issued options to purchase a total of approximately 218,000 shares of its common stock in exchange for all issued and outstanding Ajuba options. The Company also paid approximately $650,000 to Ajuba in connection with the acquisition. On November 1, 2000, the Company acquired all of the outstanding capital stock of Metacode Technologies, Inc. in exchange for approximately 1,860,000 shares of its common stock. In addition, the Company issued options to purchase a total of 914,000 shares of its common stock in exchange for all issued and outstanding Metacode options and the Company also paid approximately $5.3 million to Metacode in connection with the acquisition. The amounts and components of the purchase price, and the allocation of the purchase price to assets acquired, were as follows (in thousands):
Ajuba Metacode Neonyoyo Solutions Technologies -------- --------- ------------ Components of purchase price Net cash..................................... $ 8,000 $ 650 $ 5,250 Equity....................................... 76,311 21,061 114,049 Incremental fair value of stock options assumed..................................... 6 2,094 30,613 Transaction costs............................ 1,967 1,105 2,601 ------- ------- -------- Total purchase price....................... $86,284 $24,910 $152,513 ======= ======= ======== Allocation of purchase price Tangible assets.............................. $ 1,091 $ 2,073 5,206 Intangible assets............................ Workforce................................... 582 1,480 1,700 Goodwill.................................... 75,983 25,733 143,473 Assumed liabilities......................... (25) (4,376) (566) In-process research and development......... 1,724 -- 100 Covenants not to compete.................... 6,929 -- -- Completed technology........................ -- -- 2,600 ------- ------- -------- Net assets acquired........................ $86,284 $24,910 $152,513 ======= ======= ========
The following unaudited pro forma financial data representing the results of operations had the entities been combined with Interwoven for the three months ended March 31, 2000 and 2001 includes the straight-line amortization of intangibles over a period of two to four years and excludes the charges for in-process research and development (in thousands, except per share amounts).
Three Months Ended March 31, ------------------ 2000 2001 -------- -------- Revenue................................................. $ 14,539 $ 60,544 Net loss................................................ $(34,548) $(24,316) Weighted average common shares.......................... 91,460 98,406 Net loss per share...................................... $ (0.38) $ (0.25)
The Company recorded deferred compensation of $288 million related to the assumption of the options and exchange of the Company's shares in the acquisitions. Amortization of the deferred compensation was $4.6 million for the quarter ended March 31, 2001. 9 INTERWOVEN, INC. NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued) The acquisition of Neonyoyo, Ajuba Solutions and Metacode Technologies were structured as tax-free acquisitions of stock. Therefore, the differences between the recognized fair values of acquired net assets and their historical tax bases are not deductible for tax purposes. A deferred tax liability has been recognized for the differences between assigned fair values of intangibles for book purposes and the tax bases of such assets. Note 7. Subsequent Event In April 2001, the Company announced an optional two-for-one exchange program of all Interwoven employee stock options that are currently outstanding for new options that will be granted under the Interwoven 1999 Equity Incentive Plan and 2000 Stock Incentive Plan. Until May 18, 2001, Interwoven employees will have an option to exchange all or part of their existing options for new option(s) with an exercise price per share of $14.63 and a four-year vesting period, beginning May 18, 2001, with a six-month "cliff". The Company will account for the exchanged options as a variable option plan whereby the accounting charge for the options will be reassessed and reflected in the income statement for each reporting period. 10 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations This report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, including statements regarding deferred compensation costs, expansion of our professional services organization, expected increases in expenses, and other expectations regarding future financial and operating results. All forward-looking statements included in this document are based on the information available to us on the date hereof, and we assume no obligation to update any such forward-looking statements. Actual results may differ materially from the results discussed in this report. Factors that might cause such a difference include, but are not limited to, those discussed in "Factors Affecting Future Results". Readers are urged to review and consider carefully the various disclosures made by us in this report and in our other reports filed with the Securities and Exchange Commission, including our 2000 Annual Report on Form 10-K/A, that advise interested parties of risks and uncertainties that affect our business. The following discussion and analysis of the financial condition and results of operations should be read in conjunction with our Financial Statements and Notes appearing elsewhere in this Form 10-Q. Overview Interwoven was incorporated in March 1995 to provide software products and services for web content management. Our products allow large teams of people across an enterprise to contribute and edit web content on a collaborative basis, reducing the time-to-web for critical eBusiness initiatives. From March 1995 through March 1997, we were a development stage company conducting research and development for our initial products. In May 1997, we shipped the first version of our principal product, TeamSite. We have subsequently developed and released enhanced versions of TeamSite and have introduced related products. As of March 31, 2001, we had sold our products and services to over 740 customers. We market and sell our products primarily through a direct sales force and augment our sales efforts through relationships with systems integrators and other strategic partners. We are headquartered in Sunnyvale, California and maintain additional offices in the metropolitan areas of Atlanta, Boston, Chicago, Dallas, Los Angeles, New York City, San Francisco, Seattle and Washington, D.C. In addition, we have offices in Australia, Brazil, Canada, France, Hong Kong, Germany, Japan, Mexico, Netherlands, Norway, United Kingdom, Singapore, Spain and Sweden. We had 968 employees as of March 31, 2001. We derive revenues from the license of our software products and from services we provide to our customers. To date, we have derived the majority of our license revenues from licenses of TeamSite. License revenues are recognized when persuasive evidence of an agreement exists, the product has been delivered, the license fee is fixed or determinable and collection of the fee is probable. In addition to the aforementioned items, when assessing probability of collection, we consider maturity of conducting business, history of collection, and product acceptance within each geographic sales region. Services revenues consist of professional services and maintenance fees. Professional services primarily consist of software installation and integration, business process consulting and training. We generally bill our professional services customers on a time and materials basis and recognize revenues as the services are performed. Maintenance agreements are typically priced based on a percentage of the product license fee, and typically have a one-year term that is renewable annually. Services provided to customers under maintenance agreements include technical product support and an unspecified number of product upgrades as released by us during the term of a maintenance agreement. Revenues from maintenance support agreements are recognized ratably over the term of the agreement. Consistent with authoritative guidance on revenue recognition, we assess the probability of collection on all software license agreements and defer revenue when collection is not probable. From inception through the fourth quarter of 2000, the limited collection history and infancy of our international sales infrastructure as well as uncertain product acceptance lead us to defer revenue until cash collection for sales occurring outside the United States. We now believe that a more mature sales infrastructure coupled with a history of collections in several geographic regions allows us to ascertain that collections are probable in Northern Europe. Therefore, 11 since January 1, 2001, we have recognized revenue upon the signing of the contract and shipment of the product in Northern Europe. We will continue to assess probability of collections on an individual agreement-by-agreement basis. Further, we will continually assess the appropriateness of revenue recognition on sales agreements in other geographic locations once we have developed an adequate infrastructure, collection history, and product acceptance within those geographic regions. We have incurred substantial costs to develop our technology and products, to recruit and train personnel for our engineering, sales and marketing and services organizations, and to establish our administrative organization. As a result, we have incurred net losses through the quarter ending March 31, 2001 and had an accumulated deficit of $82.3 million as of March 31, 2001. We anticipate that our cost of services revenues and operating expenses in absolute dollars will increase substantially in the future as we grow our services organization to support an increased level and expanded number of services offered, increase our sales and marketing operations, develop new distribution channels, fund greater levels of research and development, and improve our operational and financial systems. In addition, our limited operating history and the weakness of the current economic environment generally makes the prediction of future results of operations difficult and, accordingly, there can be no assurance that we will achieve or sustain profitability. We have generally made business decisions with reference to net profit metrics excluding non-cash charges, for example, acquisition and stock based compensation charges. We expect to continue to make acquisitions, incur stock based compensation and intangible amortization charges, which will increase our losses inclusive of these non-cash expenses. We acquired a total of four corporations in 1999 and 2000: Lexington Software Associates, Inc.; Neonyoyo Inc.; Ajuba Solutions Inc.; and Metacode Technologies, Inc. Under U.S. generally accepted accounting principles, we have accounted for the four business combinations using the purchase method of accounting and recorded the market value of our common stock and options issued in connection with them and the amount of direct transaction costs as the cost of acquiring these entities. That cost is allocated among the individual assets acquired and liabilities assumed, including various identifiable intangible assets such as goodwill, in-process research and development, acquired technology, acquired workforce and convenants not to compete, based on their respective fair values. We allocated the excess of the purchase cost over the fair value of the net assets to goodwill. The impact of purchase accounting on our operating results is significant. The impact of these mergers and acquisitions resulted in amortization of acquired intangible assets of $22.1 million for the quarter ended March 31, 2001. We have also recorded deferred compensation related to options assumed and shares issued to effect business combinations and options granted below fair market value associated with our initial public offering in October 1999, of which amortization was $4.6 million in the quarter ended March 31, 2001. The following table reflects the prospective impact of deferred compensation costs and the annual amortization of purchased intangibles attributable to our mergers and acquisitions that have closed in the past two years (in thousands):
Fiscal Year ------------------------------- 2001 2002 2003 2004 -------- ------- ------- ------ Intangible Assets........................... $ 88,244 $86,444 $63,272 $ 542 Stock Based Compensation.................... 15,308 7,645 3,464 1,209 -------- ------- ------- ------ $103,552 $94,089 $66,736 $1,751 ======== ======= ======= ======
In April 2001, we announced an optional two-for-one exchange program of all our employee stock options that are currently outstanding for new options that will be granted under our 1999 Equity Incentive Plan and 2000 Stock Incentive Plan. Until May 18, 2001, our employees will have an option to exchange all or part of their existing options for new option(s) with an exercise price per share of $14.63 and a four-year vesting period, beginning May 18, 2001, with a six-month "cliff". We will account for the exchanged options as a variable option plan whereby the accounting charge for the options will be reassessed and reflected in the income statement for each subsequent reporting period until the new options are exercised and vested. 12 Results of Operations Our license and services revenues have grown in each of the last eleven quarters, and in the three months ended March 31, 2001, except that our license revenues declined in the three months ended March 31, 1999 from that in the three months ended December 31, 1998. The decline in that period reflected the unusually high revenues in the prior period, due in part to a few large license sales in that period. The increase in services revenues in the three months ended March 31, 2001 reflects an increase in both professional services and maintenance fees, generated from a greater number of customers which licensed our products in prior periods, and it reflects an increase in the number of professional services staff and a higher effective staff utilization rate. As a result of our limited operating history and the emerging nature of the market for web content management software and services in which we compete, it is difficult for us to forecast our revenues or earnings accurately. It is possible that in some future periods our results of operations may not meet or exceed the management's projections, or expectations of public market analysts and investors. If this occurs, the price of our common stock is likely to decline. Factors that have caused our results to fluctuate in the past, and are likely to cause fluctuations in the future, include: . the size of customer orders and the timing of product and service deliveries; . variability in the mix of products and services sold; . our ability to retain our current customers and attract new customers; . the amount and timing of operating costs relating to expansion of our business, including our planned international expansion; . the announcement or introduction of new products or services by us or our competitors; . our ability to attract and retain personnel, particularly management, engineering and sales personnel and technical consultants; . our ability to upgrade and develop our systems and infrastructure to accommodate our growth; and . costs related to acquisition of technologies or businesses. As a result of these and other factors, we believe that period-to-period comparisons of our results of operations may not be meaningful and should not be relied upon as indicators of our future performance. 13 The following table lists, for the periods indicated, our statement of operations data as a percentage of total revenues:
Three months ended March 31, ----------- 2001 2000 ---- ---- Revenues: License......................................................... 64% 68% Services........................................................ 36 32 --- --- Total revenues................................................ 100 100 Cost of revenues: License......................................................... 1 0 Services........................................................ 26 34 --- --- Total cost of revenues........................................ 27 34 Gross profit...................................................... 73 66 Operating expenses: Research and development........................................ 15 16 Sales and marketing............................................. 47 70 General and administrative...................................... 10 14 Amortization of deferred stock-based compensation............... 8 6 Amortization of acquired intangible assets...................... 36 0 --- --- Total operating expenses...................................... 116 106 Loss from operations.............................................. (43) (40) Interest income and other, net.................................... 5 18 Net loss before provision for income taxes........................ (38) (22) Provision for income taxes........................................ 2 0 --- --- Net loss.......................................................... (40)% (22)% === ===
Three months ended March 31, 2000 and 2001 Revenues Total revenues increased 337% from $13.9 million for the three months ended March 31, 2000 to $60.5 million for the three months ended March 31, 2001. This increase reflects sales to a larger number of new customers and at a higher average sales price. The number of new customers increased from 255 in the three months ended March 31, 2000 to 741 in the three months ended March 31, 2001, and the average sales price of an initial production order increased from $301,000 for the three months ended March 31, 2000 to $335,000 for the three months ended March 31, 2001. Our ability to attract new customers was a result of our developing a larger and more experienced sales and marketing staff, which numbered 125 persons in the three months ended March 31, 2000 and 430 persons in the three months ended March 31, 2001. The increase in average sales price was a result of larger numbers of user seats being licensed in the average new order, expanded product configurations, and price increases between the comparable periods. License. License revenues increased 316% from $9.4 million for the three months ended March 31, 2000 to $39.0 million for the three months ended March 31, 2001. License revenues represented 68% and 64% of total revenues, respectively, in those periods. This increase in license revenues in absolute dollars reflects the same factors that caused total revenues to increase from period to period. Services. Services revenues increased 381% from $4.5 million for the three months ended March 31, 2000 to $21.5 million for the three months ended March 31, 2001. Services revenues represented 32% and 36% of 14 total revenues, respectively, in those periods. The increase in services revenues reflects a $9.6 million increase in professional services fees, a $1.6 million increase in maintenance fees and a $1.8 million increase in training fees. The increased professional services and maintenance fees were generated by an expanded number of customers who licensed our products. Cost of Revenues License. Cost of license revenues includes expenses incurred to manufacture, package and distribute our software products and related documentation, as well as costs of licensing third-party software sold in conjunction with our software products. Cost of license revenues increased 642% from $66,000 for the three months ended March 31, 2000 to $490,000 for the three months ended March 31, 2001. Cost of license revenues represented approximately 1% of license revenues in both periods. The increase in absolute dollars of cost of license revenues was attributable to an increase in royalties paid to third party software vendors as well as an increase in the volume of products shipped. We expect cost of license revenues to increase in absolute dollar amounts in the future. We expect cost of license revenues as a percentage of license revenue to vary from period to period depending upon the royalties to third party software vendors and amounts of license revenue recognized in each period. Services. Cost of services revenues consists primarily of salary and related costs of our professional services, training, maintenance and support personnel, as well as subcontractor expenses. Cost of services revenues increased 246% from $4.7 million for the three months ended March 31, 2000 to $16.1 million for the three months ended March 31, 2001. Cost of services revenues represented 104% and 75% of services revenues, respectively, in those periods. This increase in absolute dollars of cost of services revenues was primarily attributable to an increase in the number of in-house services personnel from 82 to 257, and a $1.6 million increase in subcontractor expenses. We expect our cost of services revenues to increase for the foreseeable future as we continue to expand our services staff and consulting organizations. Since services revenues have lower gross margins than license revenues, this expansion will reduce our gross margins if our license revenues do not increase significantly. We expect cost of services revenues as a percentage of services revenues to vary from period to period depending on whether the services are performed by our in-house staff or by subcontractors, and on the overall utilization rates of our in-house professional services staff. Furthermore, the utilization of in-house staff or sub-contractors is affected by the mix of services we provide. Gross Profit Gross profit increased 381% from $9.1 million for the three months ended March 31, 2000 to $43.9 million for the three months ended March 31, 2001. Gross profit represented 66% and 73% of total revenues, respectively, in those periods. This increase in absolute dollar amounts reflects increased license and services revenues from a growing customer base. The increase in gross profit percentage was a result of an improvement in gross margin of our professional services organization. We have made and we will continue to make investments in our professional services organization to increase the capacity of that organization to meet the demand for services from our customers. We expect gross profit as a percentage of total revenues to fluctuate from period to period primarily as a result of changes in the relative proportion of license and services revenues. Operating Expenses Research and Development. Research and development expenses consist primarily of personnel and related costs to support product development activities. Research and development expenses increased 304% from $2.2 million for the three months ended March 31, 2000 to $8.9 million for the three months ended March 31, 2001, representing 16% and 15% of total revenues in those periods, respectively. This increase in absolute dollar amounts was due to increases in the number of our product development personnel, which grew from 50 to 158 15 persons, to increased use of subcontractors, and higher associated wages, salaries and recruitment costs. The decrease in research and development expenses as a percentage of total revenues relates to a higher growth rate in total revenues, attributable to our increasing revenue base, as compared to the growth rate in research and development expenses. We believe that continued investment in research and development is critical to our strategic objectives, and we expect that the dollar amounts of research and development expenses will increase in future periods. We expect that the percentage of total revenues represented by research and development expenses will fluctuate from period to period depending primarily on when we hire new research and development personnel as well as the size and timing of product development projects. To date, all software development costs have been expensed in the period incurred. Sales and Marketing. Sales and marketing expenses consist primarily of salaries and related costs for sales and marketing personnel, sales commissions, travel and marketing programs. Sales and marketing expenses increased 195% from $9.7 million for the three months ended March 31, 2000 to $28.5 million for the three months ended March 31, 2001, representing 70% and 47% of total revenues, respectively, in those periods. This increase in absolute dollar amounts primarily relates to increases in sales and marketing personnel costs of $10.1 million, higher sales commissions and bonuses of $4.8 million and increased marketing-related costs of $2.1 million. The decrease in sales and marketing expenses as a percentage of total revenues relates to a higher growth rate in total revenues, attributable to our increasing revenue base, when compared to the growth rate in sales and marketing expenses. We expect that the dollar amounts of sales and marketing expenses will increase in future periods as we continue to invest heavily in order to expand our customer base and increase brand awareness. We also anticipate that the percentage of total revenues represented by sales and marketing expenses will fluctuate from period to period depending primarily on when we hire new sales personnel, the timing of new marketing programs and the levels of revenues in each period. General and Administrative. General and administrative expenses consist primarily of salaries and related costs for accounting, human resources, legal and other administrative functions, as well as provisions for doubtful accounts. General and administrative expenses increased 194% from $2.0 million for the three months ended March 31, 2000 to $5.8 million for the three months ended March 31, 2001, representing 14% and 10% of total revenues, respectively. This increase in dollar amounts was due to additional staffing of these functions to support expanded operations during the same period. The decrease in general and administrative expenses as a percentage of total revenues relates to a higher growth rate in total revenues, attributable to our increasing revenue base, when compared to the growth rate in general and administrative expenses. We expect general and administrative expenses to increase in absolute dollars as we add personnel to support expanding operations and incur additional costs related to the growth of our business. We expect that the percentage of total revenues represented by general and administrative expenses will fluctuate from period to period depending primarily on when we hire new general and administrative personnel to support expanding operations as well as the size and timing of expansion projects. Amortization of Deferred Stock-Based Compensation. We recorded deferred stock-based compensation of $7.3 million and $30.4 million for stock options granted in 1999 and stock options granted and assumed in 2000, respectively. In 2000, we recorded deferred stock-based compensation of $28.8 million in connection with granting of stock options and issuance of shares related to the acquisitions of Neonyoyo, Metacode Technologies and Ajuba Solutions. Amortization of deferred stock-based compensation was $833,000 and $4.6 million for the three months ended March 31, 2000 and 2001, respectively. Approximately $209,000, $128,000, $408,000 and $88,000 of deferred stock based compensation amortization relates to personnel in services, research and development, sales and marketing and general and administrative departments, respectively, for the three months ended March 31, 2000. Approximately $103,000, $2.5 million, $1.6 million and $349,000 of deferred stock based compensation amortization relates to personnel in services, research and development, sales and marketing and general and administrative departments, respectively, for the three months ended March 31, 2001. We expect amortization of deferred stock-based compensation to be $15.3 million and $7.6 million for fiscal year 2001 and 2002, respectively. Amortization of Acquired Intangible Assets. In July 1999, we recorded intangible assets of approximately $800,000 in connection with the acquisition of Lexington Software Associates Incorporated. Goodwill related to 16 this transaction approximated $300,000 and intangible assets related to the workforce of Lexington Software approximated $500,000 of the purchase price. The total purchase price for this acquisition was approximately $800,000. In July 2000, we recorded intangible assets of approximately $85.4 million in connection with the acquisition of Neonyoyo. Goodwill related to this transaction approximated $77.9 million and intangible assets related to workforce and covenants not to compete of Neonyoyo approximated $7.5 million of the purchase price. The total purchase price for this acquisition was approximately $88.2 million. The purchase price was allocated to the tangible and intangible assets acquired and liabilities assumed based upon their respective fair values at the acquisition date. In October 2000, we recorded intangible assets of approximately $27.2 million in connection with the acquisition of Ajuba Solutions, Inc. including goodwill in the amount of approximately $25.7 million and intangible assets related to workforce of approximately $1.5 million of the purchase price. The total purchase price for this acquisition was approximately $24.9 million. In November 2000, we recorded intangible assets of approximately $147.8 million in connection with the acquisition of Metacode Technologies, Inc. including goodwill of approximately $143.5 million, intangible assets related to workforce of Metacode of approximately $1.7 million and completed technology of approximately $2.6 million of the purchase price. The total purchase price for this acquisition was approximately $152.5 million. Amortization of acquired intangible assets was $52,000 and $22.1 million for the three months ended March 31, 2000 and 2001, respectively. We expect amortization of acquired intangible assets to be $88.2 million and $86.4 million for fiscal year 2001 and 2002, respectively. These acquisitions were accounted for as purchase business combinations. In conjunction with these acquisitions, we recorded $247.4 million in goodwill and $13.8 million in other intangible assets. As of March 31, 2001, our stock price has declined significantly since the respective valuation dates of the shares issued in connection with each acquisition. Subsequent to March 31, 2001, our stock price has been volatile. Due to these changes, along with changes in the markets in which we compete and in the United States and global economics, we have begun an analysis to evaluate our product offerings and cost containment strategies. In connection with our analysis we also will evaluate whether the respective fair values of our goodwill and other intangible assets may be less than their respective carrying values. This process will include an analysis of estimated cash flows that we expect to generate from future operations for purposes of determining whether an impairment of goodwill and other intangible assets has occurred. If, as a result of our analysis, we determine that there has been an impairment of goodwill and other intangibles assets, the carrying value of these assets will be written down to their fair values as a charge against our operating results in the period that the determination is made. A significant impairment would harm our financial position and operating results if it were recorded. Interest Income and Other, Net. Interest income and other, net, increased from $2.5 million for the three months ended March 31, 2000 to $2.8 million for the three months ended March 31, 2001 due to increased interest income earned on proceeds from our initial public offering in October 1999 and our subsequent public offering in February 2000. Provision for Income Taxes. A provision of $1.1 million was recorded for state, federal and foreign taxes in the first quarter of 2001. The provision was calculated by applying an effective tax rate of 33% to net income before non-deductible acquisition, intangibles amortization and stock-based compensation charges. Liquidity and Capital Resources Net cash provided by operating activities was $1.9 million in the three months ended March 31, 2000 and net cash used in operating activities was $608,000 in the three months ended March 31, 2001. Net cash provided by operating activities in the prior period reflected decreasing net losses offset in part by an increase in accounts receivable, accrued liabilities and deferred revenue. Net cash used in operating activities in the current period primarily reflected net losses. During the three months ended March 31, 2000 and March 31, 2001 investing activities have included purchases of property and equipment, principally computer hardware and software for our growing number of 17 employees. Cash used to purchase property and equipment was $1.5 million and $3.9 million during the three months ended March 31, 2000 and March 31, 2001, respectively. We expect that capital expenditures will increase with our anticipated growth in operations, infrastructure and personnel. As of March 31, 2001 we had no material capital expenditure commitments. During the three months ended March 31, 2000 and March 31, 2001, our investing activities included purchases and maturities of short-term and long- term investments. Net purchases of investments approximated $114.7 million during the three months ended March 31, 2000 and net maturities of investment was $36.5 million during the three months ended March 31, 2001. As of March 31, 2001, we have not invested in derivative securities. We expect that, in the future, cash in excess of current requirements will continue to be invested in high credit quality, interest-bearing securities. Net cash provided by financing activities in the three months ended March 31, 2000 and 2001 was $153.1 million and $2.6 million, respectively. Net cash provided by financing activities primarily reflects the proceeds of issuance of common stock in each of these periods. At March 31, 2001, our sources of liquidity consisted of $216.8 million in cash, cash equivalents and investments and $199.6 million in working capital. We have a $5.0 million line of credit with Silicon Valley Bank, which bears interest at the bank's prime rate, which was 8.00% at March 31, 2001. At March 31, 2001, the line of credit was unused. The line of credit is secured by all of our tangible and intangible assets, and maintains minimum quarterly unrestricted cash, cash equivalents and short-term investments, among other things. We intend to maintain the line of credit. As of March 31, 2001, we were in compliance with all related financial covenants and restrictions under the line of credit. We believe that the current cash, cash equivalents, investments and funds available under existing credit facilities and the net proceeds from the sale of the common stock in our initial public offering and follow-on offering, will be sufficient to meet our working capital requirements for at least the next 12 months. Thereafter, we may require additional funds to support our working capital requirements or for other purposes and may seek to raise additional funds through public or private equity financing or from other sources. There can be no assurance that additional financing will be available on acceptable terms, if at all. If adequate funds are not available or are not available on acceptable terms, we may be unable to develop or enhance our products, take advantage of future opportunities, or respond to competitive pressures or unanticipated requirements, which could have a material adverse effect on our business, financial condition and operating results. 18 FACTORS AFFECTING FUTURE RESULTS The risks and uncertainties described below are not the only risks we face. These risks are the ones we consider to be significant to your decision whether to invest in our common stock at this time. We might be wrong. There may be risks that you in particular view differently than we do, and there are other risks and uncertainties that we do not presently know or that we currently deem immaterial, but that may in fact harm our business in the future. If any of these events occur, our business, results of operations and financial condition could be seriously harmed, the trading price of our common stock could decline and you may lose all or part of your investment. In addition to other information in this Form 10-Q, the following factors should be considered carefully in evaluating Interwoven and our business. Our operating history is limited, so it will be difficult for you to evaluate our business in making an investment decision. We were incorporated in March 1995 and have a limited operating history. We are still in the early stages of our development, which makes the evaluation of our business operations and our prospects difficult. We shipped our first product in May 1997. Since that time, we have derived substantially all of our revenues from licensing our TeamSite product and related products and services. In evaluating our common stock, you should consider the risks and difficulties frequently encountered by early stage companies in new and rapidly evolving markets, particularly those companies whose businesses depend on the Internet. These risks and difficulties, as they apply to us in particular, include: . potential fluctuations in operating results and uncertain growth rates; . limited market acceptance of our products; . concentration of our revenues in a single product or family of products; . our dependence on an increasing number of large orders; . our need to expand our direct sales forces and indirect sales channels; . our need to manage rapidly expanding operations; . our need to attract, train and retain qualified personnel; . our need to establish and maintain strategic relationships with other companies, some of whom may in the future become our competitors; . our need to expand internationally; . our ability to integrate acquired businesses and technologies; . delay or deferral of customer implementations of our products; . the size and timing of individual license transactions; . the appropriate mix of products and services sold; . our ability to develop and market new products and control costs; and . changes in the economy and foreign exchange rates. One or more of the foregoing factors may cause our operating expenses to be disproportionately high during any given period or may cause our net revenue and operating results to fluctuate significantly. Based upon the preceding factors, we may experience a shortfall in revenue or earnings or otherwise fail to meet public market expectations, which could materially adversely affect our business, financial condition and the market price of our common stock. 19 If we do not increase our license revenues significantly, we will fail to achieve and sustain operating profitability. We have incurred net losses from operations in each quarter since our inception through the quarter ended September 30, 2000. Our net losses amounted to $6.3 million in 1998, $15.7 million in 1999, $32.1 million in 2000 and 24.3 million for the three months ended March 31, 2001. As of March 31, 2001, we had an accumulated deficit of approximately $82.3 million. We plan to expand our sales and marketing, research and development, and professional services organizations. As a result, if we are to sustain operating profitability on a quarterly and annual basis, we will need to increase our revenues significantly, particularly our license revenues. We cannot predict when we will become profitable, if at all. Our operating results fluctuate widely and are difficult to predict, so we may fail to satisfy the expectations of investors or market analysts and our stock price may decline. Our quarterly operating results have fluctuated significantly in the past, and we expect them to continue to fluctuate unpredictably in the future. The main factors affecting these fluctuations are: . the discretionary nature of our customer's purchase and budget cycles; . the size and complexity of our license transactions; . potential delays in recognizing revenue from license transactions; . timing of new product releases; . sales force capacity; . seasonal variations in operating results; and . variations in the fiscal or quarterly cycles of our customers. It is possible that in some future periods our results of operations may not meet or exceed the forecasts periodically disclosed by management or the expectations of public market analysts and investors. If this occurs, the price of our common stock is likely to decline. Further, we anticipate that our sequential percentage rate of revenue growth will decline in future quarters in part because of the difficulty of maintaining high growth rates calculated off progressively larger base revenue numbers. Since large orders are increasingly important to us, our quarterly results are subject to wide fluctuation. We derive a significant portion of our license revenues from relatively large orders. We expect the percentage of larger orders as related to total orders to increase. This dependence on large orders makes our net revenue and operating results more likely to vary from quarter to quarter because the loss of any particular large order is significant. As a result, our operating results could suffer if any large orders are delayed or cancelled in any future period. We expect that we will continue to depend upon a small number of large orders for a significant portion of our license revenues. We face significant competition, which could make it difficult to acquire and retain customers and inhibit any future growth. We expect the competition in the market in which we operate to persist and intensify in the future. Competitive pressures may seriously harm our business and results of operations if they inhibit our future growth, or require us to hold down or reduce prices, or increase our operating costs. Our competitors include, but are not limited to: . potential customers that use in-house development efforts; 20 . developers of software that directly addresses the need for web content management, such as Documentum, Eprise, Filenet, Intranet Solutions, Rational Software and Vignette. We also face potential competition from our strategic partners or from other companies, such as Microsoft, Oracle or IBM, that may in the future decide to enter our market. Many of our existing and potential competitors have longer operating histories, greater name recognition, larger customer bases and significantly greater financial, technical and marketing resources than we do. Many of these companies can also leverage extensive customer bases and adopt aggressive pricing policies to gain market share. Potential competitors may bundle their products in a manner that discourages users from purchasing our products. Barriers to entering the web content management software market are relatively low. Although we believe the number of our competitors is increasing, we believe there may be consolidation in the web content management software industry. We expect that the general downturn of stock prices in the Internet and technology industries since March 2000 will result in significant acceleration of this trend, with fewer but more financially sound competitors surviving that are better able to compete with us for our current and potential customers. If we fail to establish and maintain strategic relationships, the market acceptance of our products, and our profitability, may suffer. To offer products and services to a larger customer base our direct sales force depends on strategic partnerships and marketing alliances to obtain customer leads, referrals and distribution. If we are unable to maintain our existing strategic relationships or fail to enter into additional strategic relationships, our ability to increase our sales and reduce expenses will be harmed. We would also lose anticipated customer introductions and co-marketing benefits. Our success depends in part on the success of our strategic partners and their ability to market our products and services successfully. We also rely on our strategic partnerships to aid in the development of our products. Should our strategic partners not regard us as significant for their own businesses, they could reduce their commitment to us or terminate their respective relationships with us, pursue other partnerships or relationships, or attempt to develop or acquire products or services that compete with our products and services. Even if we succeed in establishing these relationships, they may not result in additional customers or revenues. Because the market for our products is new, we do not know whether existing and potential customers will purchase our products in sufficient quantity for us to achieve profitability. The market for web content management software in which we sell is new and rapidly evolving. We expect that we will continue to need intensive marketing and sales efforts to educate prospective clients about the uses and benefits of our products and services. Various factors could inhibit the growth of the market and market acceptance of our products and services. In particular, potential customers that have invested substantial resources in other methods of conducting business over the Internet may be reluctant to adopt a new approach that may replace, limit or compete with their existing systems. We cannot be certain that a viable market for our products will continue to expand. The recent economic downturn may reduce our sales and may cause us to experience operating losses. In recent months many signs have pointed to widespread economic slowdowns in the markets we serve. Capital spending in general and capital spending on web initiatives in particular may decline. This trend could harm our sales if it results in order cancellations or delays, and the longer the trend continues the more harm our sales will suffer. In addition, since many of our customers may be suffering adverse effects of the general economic slowdown, we may find that collecting accounts receivable from existing or new customers will take longer than we expect or that some accounts receivable will become uncollectable. 21 Acquisitions may harm our business by being more difficult than expected to integrate, by diverting management's attention or by subjecting us to unforeseen accounting problems. As part of our business strategy, we may seek to acquire or invest in additional businesses, products or technologies that we feel could complement or expand our business. If we identify an appropriate acquisition opportunity, we might be unable to negotiate the terms of that acquisition successfully, finance it, develop the intellectual property acquired from it or integrate it into our existing business and operations. We may also be unable to select, manage or absorb any future acquisitions successfully. Further, the negotiation of potential acquisitions, as well as the integration of an acquired business, especially if it involved our entering a new market, would divert management time and other resources and put us at a competitive disadvantage. We may have to use a substantial portion of our available cash, including proceeds from public offerings, to consummate an acquisition. On the other hand, if we consummate acquisitions through an exchange of our securities, our stockholders could suffer significant dilution. In addition, we cannot assure you that any particular acquisition, even if successfully completed, will ultimately benefit our business. In connection with our acquisitions, we may be required to write off software development costs or other assets, incur severance liabilities, amortization expenses related to goodwill and other intangible assets, or incur debt, any of which could harm our business, financial condition, cash flows and results of operations. The companies we acquire may not have audited financial statements, detailed financial information, or adequate internal controls. There can be no assurance that an audit subsequent to the completion of an acquisition will not reveal matters of significance, including with respect to revenues, expenses, contingent or other liabilities, and intellectual property. Any such write off could harm our financial results. We may be required to write off all or a portion of the value of assets we acquired in our recent business combinations. Accounting principles require companies like us to review the value of assets from time to time to determine whether those values have been impaired. Because our stock price has declined in recent periods, and the stock prices of other companies comparable to us and to companies we acquired have declined in recent periods, we have begun a process of determining whether the value on our balance sheet that those acquired companies represent should be adjusted downward. This process would include an analysis of estimated cash flows expected from future operations. If as a result of this analysis we determine there has been an impairment of goodwill and other intangible assets, the carrying value of those assets will be written down to fair value as a charge against operating results in the period that the determination is made. Any significant impairment would harm our operating results for the period, our financial position, and the price of our stock. Our lengthy sales cycle makes it particularly difficult for us to forecast revenue, requires us to incur high costs of sales, and aggravates the variability of quarterly fluctuations. The time between our initial contact with a potential customer and the ultimate sale, which we refer to as our sales cycle, typically ranges between three and nine months depending largely on the customer. If we do not shorten our sales cycle, it will be difficult for us to reduce sales and marketing expenses. In addition, as a result of our lengthy sales cycle, we have only a limited ability to forecast the timing and size of specific sales. This makes it more difficult to predict quarterly financial performance, or to achieve it, and any delay in completing sales in a particular quarter could harm our business and cause our operating results to vary significantly. We rely heavily on sales of one product, so if it does not continue to achieve market acceptance we will continue to experience operating losses. Since 1997, we have generated substantially all of our revenues from licenses of, and services related to, our TeamSite product. We believe that revenues generated from TeamSite will continue to account for a large portion of our revenues for the foreseeable future. A decline in the price of TeamSite, or our inability to increase license sales of TeamSite, would harm our business and operating results more seriously than it would if we had 22 several different products and services to sell. In addition, our future financial performance will depend upon successfully developing and selling enhanced versions of TeamSite. If we fail to deliver product enhancements or new products that customers want it will be more difficult for us to succeed. We depend on our direct sales force to sell our products, so future growth will be constrained by our ability to hire, train and retain sales personnel. We sell our products primarily through our direct sales force, and we expect to continue to do so in the future. Our ability to sell more products is limited by our ability to hire, train and retain direct sales personnel, and we believe that there is significant competition for direct sales personnel with the advanced sales skills and technical knowledge that we need. Some of our competitors may have greater resources to hire or retain personnel with that skill and knowledge. If we are not able to hire or retain experienced and competent sales personnel, our business would be harmed. Furthermore, because we depend on our direct sales force, any turnover in our sales force can significantly harm our operating results. Sales force turnover tends to slow sales efforts until replacement personnel can be recruited and trained to become productive. See "--We must attract and retain qualified personnel, which is particularly difficult for us because we compete with other Internet-related software companies and are located in the San Francisco Bay area, where competition for personnel is extremely intense." If we do not continue to develop our indirect sales channel, we will be less likely to increase our revenues. If we do not develop indirect sales channels, we may miss sales opportunities that might be available through these channels. For example, domestic and international resellers may be able to reach new customers more quickly or more effectively than our direct sales force. Our investment of resources to develop indirect sales channels may not succeed in establishing a channel that can market our products effectively and provide timely and cost- effective customer support and services. In addition, we may not be able to manage conflicts across our sales channels, and our focus on increasing sales through our indirect channel may divert management resources and attention from direct sales. We must attract and retain qualified personnel, which is particularly difficult for us because we compete with other Internet-related software companies and are located in the San Francisco Bay area, where competition for personnel is extremely intense. Our success depends on our ability to attract and retain qualified, experienced employees. We compete for experienced engineering, sales and consulting personnel with Internet professional services firms, software vendors, consulting and professional services companies. It is also particularly difficult to recruit and retain personnel in the San Francisco Bay area, where we are located. Although we provide compensation packages that include incentive stock options, cash incentives and other employee benefits, the volatility and current market price of our common stock may make it difficult for us to attract, assimilate and retain highly qualified employees in the future. In addition, our customers generally purchase consulting and implementation services. While we have recently established relationships with some third-party service providers, we continue to be the primary provider of these services. It is difficult and expensive to recruit, train and retain qualified personnel to perform these services, and we may from time to time have inadequate levels of staffing to perform these services. As a result, our growth could be limited due to our lack of capacity to provide those services, or we could experience deterioration in service levels or decreased customer satisfaction, any of which would harm our business. If we do not improve our operational systems on a timely basis, we will be more likely to fail to manage our growth properly. We have expanded our operations rapidly in recent years. We intend to continue to expand our operational systems for the foreseeable future to pursue existing and potential market opportunities. This rapid growth places a significant demand on management and operational resources. In order to manage our growth, we need to 23 implement and improve our operational systems, procedures and controls on a timely basis. If we fail to implement and improve these systems in a timely manner, our business will be seriously harmed. Difficulties in introducing new products and upgrades in a timely manner will make market acceptance of our products less likely. The market for our products is characterized by rapid technological change, frequent new product introductions and Internet-related technology enhancements, uncertain product life cycles, changes in customer demands and evolving industry standards. We expect to add new content management functionality to our product offerings by internal development, and possibly by acquisition. Content management technology is more complex than most software, and new products or product enhancements can require long development and testing periods. Any delays in developing and releasing new products could harm our business. New products or upgrades may not be released according to schedule or may contain defects when released. Either situation could result in adverse publicity, loss of sales, delay in market acceptance of our products or customer claims against us, any of which could harm our business. If we do not develop, license or acquire new software products, or deliver enhancements to existing products on a timely and cost-effective basis, our business will be harmed. Stock based compensation charges and amortization of goodwill and other intangibles will reduce our reported net income. Under U.S. generally accepted accounting principles that apply to us, we have accounted for the four business combinations since our inception using the purchase method of accounting. Under purchase accounting, we recorded the market value of our common shares issued in connection with mergers and acquisitions with the fair value of the stock options assumed, which became options to purchase our common shares and the amount of direct transaction costs as the cost of acquiring these entities. That cost is allocated to the individual assets acquired and liabilities assumed, including various identifiable intangible assets such as goodwill, in-process research and development, acquired technology, acquired workforce and covenants not to compete, based on their respective fair values. We have also recorded deferred compensation related to options assumed and shares issued to effect business combinations as well as options granted below fair market value associated with our initial public offering in October 1999. The amortization of intangibles and deferred stock based compensation resulted in expenses of approximately $885,000 and $26.6 million, for the quarters ended March 31, 2000 and 2001. The future amortization expense related to the acquisitions and deferred stock based compensation may be accelerated as management assesses the value and useful life of the intangible assets. Our stock option repricing program will require us to record a compensation charge on a quarterly basis as a result of variable plan accounting treatment, which will lower our earnings. As of May 7, 2001, provided all employees exchange their options under the program, the magnitude of this charge would be approximately $11.2 million amortized quarterly until all options are either exercised, forfeited or cancelled. Our products might not be compatible with all major platforms, which could limit our revenues. Our products currently operate on the Microsoft Windows NT, Microsoft Windows 2000, Linux, IBM AIX, Hewlett Packard UX and Sun Solaris operating systems. In addition, our products are required to interoperate with leading web content authoring tools and web application servers. We must continually modify and enhance our products to keep pace with changes in these applications and operating systems. If our products were to be incompatible with a popular new operating system or Internet business application, our business would be harmed. In addition, uncertainties related to the timing and nature of new product announcements, introductions or modifications by vendors of operating systems, browsers, back-office applications, and other Internet- related applications, could also harm our business. 24 We have limited experience conducting operations internationally, which may make it more difficult than we expect to continue to expand overseas and may increase the costs of doing so. To date, we have derived the majority of our revenues from sales to North American customers. We have recently expanded our international operations. There are many barriers to competing successfully in the international arena, including: . costs of customizing products for foreign countries; . development of foreign language graphical user interface for development; . restrictions on the use of software encryption technology; . dependence on local vendors; . compliance with multiple, conflicting and changing governmental laws and regulations; . longer sales cycles; . revenue recognition criteria; . foreign exchange fluctuations; . import and export restrictions and tariffs; and . negotiating and executing sales in a foreign language. As a result of these competitive barriers, we cannot assure you that we will be able to market, sell and deliver our products and services in international markets. If our services revenue does not grow substantially, our total revenue is likely to grow at a slower rate. Our services revenue represents a significant component of our total revenue--32% and 36% of total revenue for the quarters ended March 31, 2000 and 2001, respectively. We anticipate that services revenue will continue to represent a significant percentage of total revenue in the future. To a large extent, the level of services revenue depends upon our ability to license products which generate follow-on services revenue. Additionally, services revenue growth depends on ongoing renewals of maintenance and service contracts. Moreover, as third-party organizations such as systems integrators become proficient in installing or servicing our products, our services revenues could decline. Our ability to increase services revenues will depend in large part on our ability to increase the capacity of our professional services organization, including our ability to recruit, train and retain a sufficient number of qualified personnel. We might not be able to protect and enforce our intellectual property rights, a loss of which could harm our business. We depend upon our proprietary technology, and rely on a combination of patent, copyright and trademark laws, trade secrets, confidentiality procedures and contractual provisions to protect it. We currently do not have any issued United States or foreign patents, but we have applied for several U.S. patents. It is possible that patents will not be issued from our currently pending patent applications or any future patent application we may file. We have also restricted customers access to our source code and required all employees to enter into confidentiality and invention assignment agreements. Despite our efforts to protect our proprietary technology, unauthorized parties may attempt to copy aspects of our products or to obtain and use information that we regard as proprietary. In addition, the laws of some foreign countries do not protect our proprietary rights as effectively as the laws of the United States, and we expect that it will become more difficult to monitor use of our products as we increase our international presence. In addition, third parties may claim that our products infringe theirs. 25 Our failure to deliver defect-free software could result in losses and harmful publicity. Our software products are complex and have in the past and may in the future contain defects or failures that may be detected at any point in the product's life. We have discovered software defects in the past in some of our products after their release. Although past defects have not had a material effect on our results of operations, in the future we may experience delays or lost revenue caused by new defects. Despite our testing, defects and errors may still be found in new or existing products, and may result in delayed or lost revenues, loss of market share, failure to achieve acceptance, reduced customer satisfaction, diversion of development resources and damage to our reputation. As has occurred in the past, new releases of products or product enhancements may require us to provide additional services under our maintenance contracts to ensure proper installation and implementation. Moreover, third parties may develop and spread computer viruses that may damage the functionality of our software products. Any damage to or interruption in the performance of our software could also harm our business. Defects in our products may result in customer claims against us that could cause unanticipated losses. Because customers rely on our products for business critical processes, defects or errors in our products or services might result in tort or warranty claims. It is possible that the limitation of liability provisions in our contracts will not be effective as a result of existing or future federal, state or local laws or ordinances or unfavorable judicial decisions. We have not experienced any product liability claims like this to date, but we could in the future. Further, although we maintain errors and omissions insurance, this insurance coverage may not be adequate to cover us. A successful product liability claim could harm our business. Even defending a product liability suit, regardless of its merits, could harm our business because it entails substantial expense and diverts the time and attention of key management personnel. We have various mechanisms in place to discourage takeover attempts, which might tend to suppress our stock price. Provisions of our certificate of incorporation and bylaws that may discourage, delay or prevent a change in control include: . we are authorized to issue "blank check" preferred stock, which could be issued by our board of directors to increase the number of outstanding shares and thwart a takeover attempt; . we provide for the election of only one-third of our directors at each annual meeting of stockholders, which slows turnover on the board of directors; . we limit who may call special meetings of stockholders; . we prohibit stockholder action by written consent, so all stockholder actions must be taken at a meeting of our stockholders; and . we require advance notice for nominations for election to the board of directors or for proposing matters that can be acted upon by stockholders at stockholder meetings. The location of our facilities subjects us to the risk of earthquakes and power outages. Our corporate headquarters, including most of our research and development operations, are located in the Silicon Valley area of Northern California, a region known for seismic activity. Additionally, California has experienced power outages in the recent past. A significant disaster, such as an earthquake or a prolonged power outage, could have a material adverse impact on our business, operating results, and financial condition by disrupting our employees' productivity or damaging our facilities. 26 Fluctuations in the exchange rates of foreign currency may harm our business. We are exposed to adverse movements in foreign currency exchange rates because we translate foreign currencies into U.S. Dollars for reporting purposes. Historically, these risks were minimal for us, but as our international revenue and operations have grown and continue to grow, the adverse currency fluctuations could have a material adverse impact on our financial results. Historically, our primary exposures have related to operating expenses and sales in Australia, Asia and Europe that were not U.S. Dollar denominated. The increasing use of the Euro as a common currency for members of the European Union could affect our foreign exchange exposure. Item 3. Quantitative and Qualitative Disclosures about Market Risk We develop products in the United States and market our products in North America, and, to a lesser extent in Europe and the Pacific Rim. As a result, our financial results could be affected by factors such as changes in foreign currency exchange rates or weak economic conditions in foreign markets. Since a majority of our revenue is currently denominated in U.S. Dollars, a strengthening of the Dollar could make our products less competitive in foreign markets. Our interest income and expense is sensitive to changes in the general level of U.S. interest rates, particularly since the majority of our financial investments are in cash equivalents and investments. Due to the nature of our financial investments, we believe that there is no material risk exposure. Interest Rate Risk The primary objective of our investment activities is to preserve principal while at the same time maximizing yields without significantly increasing risk. To achieve this objective, we maintain our portfolio of cash equivalents and short-term and long-term investments in a variety of securities, including both government and corporate obligations and money market funds. As of March 31, 2001, our entire portfolio matures in one year or less. For a tabular presentation of interest rate risk sensitive instruments by year of maturity, including the market value and average interest rates for the Company's investment portfolio as of December 31, 2000, see the Company's 2000 Form 10- K/A filed with the Securities and Exchange Commission in March 2001. We did not hold derivative financial instruments as of March 31, 2001, and have never held such instruments in the past. In addition, we had no outstanding debt as of March 31, 2001. Foreign Currency Risk Currently the majority of our sales and expenses are denominated in U.S. Dollars, as a result we have experienced no significant foreign exchange gains and losses to date. While we do expect to effect some transactions in foreign currencies in 2001, we do not anticipate that foreign exchange gains or losses will be significant. We have not engaged in foreign currency hedging activities to date. 27 PART II OTHER INFORMATION Item 1. Legal Proceedings Not applicable. Item 2. Changes in Securities and Use of Proceeds Not applicable. Item 3. Defaults upon Senior Securities Not applicable. Item 4. Submission of Matters to a Vote of Securities Holders Not applicable. Item 5. Other Information Not applicable. Item 6. Exhibits and Reports on Form 8-K (b) Reports on Form 8-K: A Form 8-K/A Amendment to Form 8-K dated October 30, 2000 was filed by the Registrant on January 16, 2001 to report under Item 2: Acquisition or Disposition of Assets its earlier-reported acquisition of Ajuba Solutions, Inc. and Metacode Technologies, Inc. and to report under Item 7: Financial Statements and Exhibits financial statements of businesses acquired and pro forma financial information. A Current Report on Form 8-K dated January 23, 2001 was filed by the Registrant on January 24, 2001 to report under Item 5: Other Events the filing of its quarterly earnings release and other financial and operating information and Item 7: Financial Statements and Exhibits with respect to a press release exhibit. 28 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. INTERWOVEN, INC. Dated: May 14, 2001 By: /s/ David M. Allen ---------------------------------- David M. Allen Senior Vice President and Chief Financial Officer (Principal Financial and Accounting Officer) 29 -----END PRIVACY-ENHANCED MESSAGE-----