10-Q 1 f72738e10-q.txt CRITICAL PATH, INC. FORM 10-Q 1 -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- 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 [ ] 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: 000-25331 CRITICAL PATH, INC. A CALIFORNIA CORPORATION I.R.S. EMPLOYER NO. 91-1788300
532 FOLSOM STREET SAN FRANCISCO, CALIFORNIA 94105 415-808-8800 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. [X] Yes [ ] No As of April 30, 2000, the company had outstanding 74,591,239 shares of common stock, $0.001 par value per share. -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- 2 CRITICAL PATH, INC. INDEX
PAGE ---- PART I Item 1. Condensed Consolidated Financial Statements (Unaudited) Condensed Consolidated Balance Sheet........................ 1 Condensed Consolidated Statement of Operations.............. 2 Condensed Consolidated Statement of Cash Flows.............. 3 Notes to Condensed Consolidated Financial Statements........ 4 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations................................... 8 Supplemental Pro Forma Financial Data (Unaudited)........... 17 Item 3. Quantitative and Qualitative Disclosures About Market Risk........................................................ 18 PART II Item 1. Legal Proceedings........................................... 19 Item 6. Exhibits and Reports on Form 8-K............................ 20
The following Condensed Consolidated Financial Statements and Notes thereto of Critical Path, Inc. and discussions contain forward-looking statements. Our actual results may differ significantly from those projected in these forward-looking statements. The words "anticipate," "expect," "intend," "plan," "believe," "seek," and "estimate" and similar expressions are intended to identify forward-looking statements. Factors that might cause future results to differ materially from those projected in the forward-looking statements include, but are not limited to, difficulties of forecasting future results due to our limited operating history, evolving business strategy and the emerging nature of the market for our products and services, pending litigation and SEC investigation, turnover of senior management and other key personnel, difficulties of integrating acquired businesses, failure to expand our sales and marketing activities, potential difficulties associated with strategic relationships, investments and uncollected bills, risks associated with our international operations, foreign currency fluctuations, unplanned system interruptions and capacity constraints, software defects, and those discussed in "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Additional Factors That May Affect Future Operating Results" and elsewhere in this report. Readers are cautioned not to place undue reliance on these forward-looking statements. We have no obligation to publicly release the results of any revisions to these forward-looking statements to reflect events or circumstances after the date of this filing. i 3 PART I ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) CRITICAL PATH, INC. CONDENSED CONSOLIDATED BALANCE SHEET (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) ASSETS
DECEMBER 31, MARCH 31, 2000 2001 ------------ ----------- (UNAUDITED) Current assets Cash and cash equivalents................................. $ 216,542 $ 171,634 Restricted cash........................................... 215 158 Accounts receivable, net.................................. 38,938 29,485 Other current assets...................................... 10,252 9,457 ----------- ----------- Total current assets.............................. 265,947 210,734 Investments................................................. 10,610 10,136 Notes receivable from officers.............................. 2,702 2,237 Property and equipment, net................................. 85,304 80,764 Intangible assets, net...................................... 77,339 68,379 Other assets................................................ 8,953 10,544 ----------- ----------- Total assets...................................... $ 450,855 $ 382,794 =========== =========== LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities Accounts payable.......................................... $ 43,710 $ 33,292 Accrued expenses.......................................... 10,377 8,400 Deferred revenue.......................................... 15,720 16,939 Capital lease and other obligations, current.............. 9,363 8,575 ----------- ----------- Total current liabilities......................... 79,170 67,206 Convertible subordinated notes payable...................... 300,000 300,000 Capital lease and other obligations, long-term.............. 4,687 3,132 ----------- ----------- Total liabilities................................. 383,857 370,338 ----------- ----------- Commitments and contingencies Minority interest in consolidated subsidiary................ 649 -- ----------- ----------- Shareholders' equity Preferred Stock and paid-in-capital, $0.001 par value Shares authorized: 5,000 Shares issued and outstanding: none.................... -- -- Common Stock and paid-in-capital, $0.001 par value Shares authorized: 150,000 and 500,000, respectively Shares issued and outstanding: 74,135 and 74,295, respectively.......................................... 2,130,329 2,144,546 Notes receivable from shareholders........................ (1,205) (1,217) Unearned compensation..................................... (80,760) (78,275) Accumulated deficit, including other comprehensive income................................................. (1,982,015) (2,052,598) ----------- ----------- Total shareholders' equity........................ 66,349 12,456 ----------- ----------- Total liabilities and shareholders' equity........ $ 450,855 $ 382,794 =========== ===========
The accompanying notes are an integral part of these Condensed Consolidated Financial Statements. 1 4 CRITICAL PATH, INC. CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
THREE MONTHS ENDED ----------------------- MARCH 31, MARCH 31, 2000 2001 ----------- --------- (UNAUDITED) Net revenues Software license.......................................... $ 11,070 $ 5,550 Hosted messaging.......................................... 9,095 14,439 Professional service...................................... 2,493 3,417 Maintenance and support................................... 1,895 3,737 -------- -------- Total net revenues................................ 24,553 27,143 -------- -------- Cost of net revenues Software license.......................................... 1,007 291 Hosted messaging (excludes $493 and $385 in stock-based expenses).............................................. 11,880 17,938 Professional service (excludes $0 and $433 in stock-based expenses).............................................. 1,056 2,966 Maintenance and support (excludes $0 and $485 in stock-based expenses).................................. 1,404 2,586 Amortization of purchased technology...................... 2,114 5,672 Acquisition-related retention bonuses..................... 390 -- Stock-based expenses...................................... 493 1,303 -------- -------- Total cost of net revenues........................ 18,344 30,756 -------- -------- Gross profit (loss)......................................... 6,209 (3,613) -------- -------- Operating expenses Sales and marketing (excludes $5,249 and $6,600 in stock-based expenses).................................. 13,605 18,712 Research and development (excludes $477 and $1,097 in stock-based expenses).................................. 6,323 9,934 General and administrative (excludes $977 and $8,733 in stock-based expenses).................................. 6,766 13,293 Amortization of intangible assets......................... 47,699 4,133 Acquisition-related retention bonuses..................... 2,679 170 Stock-based expenses...................................... 6,703 16,430 -------- -------- Total operating expenses.......................... 83,775 62,672 -------- -------- Loss from operations........................................ (77,566) (66,285) Interest and other income, net.............................. 1,258 2,425 Interest expense............................................ (274) (5,067) Equity in net loss of joint venture......................... -- (776) -------- -------- Loss before income taxes.................................... (76,582) (69,703) Provision for income taxes.................................. (360) (343) -------- -------- Net loss.................................................... $(76,942) $(70,046) ======== ======== Net loss per share -- basic and diluted..................... $ (1.52) $ (0.97) Weighted average shares -- basic and diluted................ 50,570 72,137
The accompanying notes are an integral part of these Condensed Consolidated Financial Statements. 2 5 CRITICAL PATH, INC. CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS (IN THOUSANDS)
THREE MONTHS ENDED ---------------------- MARCH 31, MARCH 31, 2000 2001 --------- --------- (UNAUDITED) Operating Net loss.................................................. $(76,942) $(70,046) Provision for doubtful accounts........................... 330 1,642 Depreciation and amortization............................. 6,191 12,169 Amortization of intangible assets......................... 49,813 9,805 Amortization of stock-based costs and expenses............ 7,212 17,745 Equity in net loss of joint venture....................... -- 776 Accounts receivable....................................... (3,394) 8,310 Other assets.............................................. 2,401 (1,198) Accounts payable.......................................... (6,937) (5,132) Accrued expenses.......................................... 4,088 (1,625) Deferred revenue.......................................... (57) 1,332 -------- -------- Net cash used in operating activities............. (17,295) (26,222) -------- -------- Investing Notes receivable from officers............................ (100) -- Property and equipment purchases.......................... (11,046) (6,156) Investments in unconsolidated entities.................... 3,000 -- Payments for acquisitions, net of cash acquired........... (5,549) (9,898) Promissory note receivable................................ 10,000 -- Restricted cash........................................... -- 57 -------- -------- Net cash used in investing activities............. (3,695) (15,997) -------- -------- Financing Proceeds from issuance of Preferred Stock, net............ -- -- Proceeds from issuance of Common Stock, net............... 3,851 575 Proceeds from convertible debt offering, net.............. 290,250 -- Proceeds from payments of shareholder notes receivable.... -- -- Principal payments on lease obligations................... (823) (2,355) Purchase of Common Stock.................................. -- (51) -------- -------- Net cash provided by (used in) financing activities...................................... 293,278 (1,831) -------- -------- Net change in cash and cash equivalents..................... 272,288 (44,050) Effect of exchange rates on cash and cash equivalents....... (168) (858) Cash and cash equivalents at beginning of period............ 75,932 216,542 -------- -------- Cash and cash equivalents at end of period.................. $348,052 $171,634 ======== ========
The accompanying notes are an integral part of these Condensed Consolidated Financial Statements. 3 6 CRITICAL PATH, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) NOTE 1 -- BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES The Company Critical Path, Inc. was incorporated in California on February 19, 1997. In connection with the Annual Shareholders meeting held in June 2000, the shareholders approved the re-incorporation of Critical Path, Inc. in Delaware, as well as an increase in the authorized shares of Common Stock from 150 million to 500 million. In January 2001, the Company amended its articles of incorporation to increase the authorized shares to 505 million; however the Company has not yet been re-incorporated in Delaware. Critical Path, along with its subsidiaries (collectively referred to herein as the "Company") provides Internet messaging infrastructure solutions for corporate enterprises and service providers worldwide. The unaudited condensed Consolidated Financial Statements ("Financial Statements") of Critical Path, Inc. and Subsidiaries furnished herein reflect all adjustments that are, in the opinion of management, necessary to present fairly the financial position and results of operations for each interim period presented. All adjustments are normal recurring adjustments. The Financial Statements should be read in conjunction with the condensed consolidated financial statements and notes thereto, together with management's discussion and analysis of financial condition and results of operations, presented in the Company's 2000 Annual Report on Form 10-K and as amended on Form 10-K/A. The results of operations for the interim periods presented herein are not necessarily indicative of the results to be expected for the entire year. Basis of Presentation The consolidated financial statements include the accounts of the Company, and its wholly and majority owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation. Segment and geographic information The Company does not currently manage its business in a manner that requires it to report financial results on a segment basis. The Company currently operates in one segment: Internet messaging infrastructure products and services and management uses one measure of profitability. Revenue information on a product basis has been disclosed in our statement of operations. Included in software license revenue is InScribe Messaging revenue of approximately $8.0 million and $2.6 million for the first quarters of 2000 and 2001, respectively. Included in hosted messaging revenue is InScribe Fax Messaging revenue of approximately $3.2 million for the first quarters of 2000 and 2001. NOTE 2 -- COMMITMENTS AND CONTINGENCIES Securities Class Actions. Beginning on February 2, 2001, a number of securities class action complaints were filed against the Company, certain of its current and former officers and directors and its independent accountants, in the United States District Court for the Northern District of California. The complaints have been filed as purported class actions by individuals who allege that they purchased the Company's Common Stock during a purported class period; the alleged class periods vary among the complaints and are in the process of being consolidated into a single action. The complaints generally allege that, in differing periods from December 1999 to February 1, 2001, the Company and other named defendants made false or misleading statements of material fact about the Company's financial statements, including its revenues, revenue recognition policies, business operations and prospects for the year 2000 and beyond. The complaints seek an unspecified amount in damages on behalf of persons who purchased the Company's Common Stock during certain periods. 4 7 CRITICAL PATH, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED) Derivative Actions. Beginning on February 5, 2001, the Company has been named as a nominal defendant in a number of derivative actions, purportedly brought on its behalf, filed in the Superior Court of the State of California. The derivative complaints allege that certain of the Company's current and former officers and directors breached their fiduciary duties to the Company, were unjustly enriched by their sales of the Company's Common Stock, engaged in insider trading in violation of California law or published false financial information in violation of California law. The plaintiffs seek unspecified damages on the Company's behalf from each of the defendants. Because of the nature of derivative litigation, any recovery in the action would inure to the Company's benefit. Securities and Exchange Commission Investigation In February 2001, the Securities and Exchange Commission (the "SEC") issued a formal order of investigation of the Company and certain unidentified individuals associated with the Company with respect to non-specified accounting matters, financial reports, other public disclosures and trading activity in the Company's securities. While the Company does not know the current status of the investigation or any possible actions that may be taken against the Company as a result, any SEC action against us could harm the Company's business. The uncertainty associated with substantial unresolved lawsuits and the SEC investigation could seriously harm the Company's business and financial condition. In particular, the lawsuits or the investigation could harm its relationships with existing customers and its ability to obtain new customers. The continued defense of the lawsuits and conduct of the investigation could also result in the diversion of management's time and attention away from business operations, which could harm the Company's business. Negative developments with respect to the lawsuits or the investigation could cause the Company's stock price to decline significantly. In addition, although the Company is unable to determine the amount, if any, that it may be required to pay in connection with the resolution of these lawsuits or the investigation by settlement or otherwise, the size of any such payment could seriously harm the Company's financial condition. NOTE 3 -- SHAREHOLDERS' EQUITY WARRANTS Vectis Group, LLC In March 2001, the Company entered into an agreement with Vectis Group, LLC ("Vectis Group") to engage Vectis Group to act as an advisor to the Company with respect to various strategic alternatives the Company is currently exploring. As part of the agreement, Vectis Group agreed to provide consulting services to the Company in exchange for a monthly retainer fee and warrants to purchase 500,000 shares of the Company's Common Stock with an exercise price of $2.00 per share, issuable upon execution of the agreement. Using the Black-Scholes option-pricing model and assuming a term of three years, the term of the agreement, and expected volatility of 215%, the initial and final fair value of the warrant on the effective date of the agreement approximated $732,000, which was recognized upon the execution of the agreement in March 2001, as the relationship is terminable at any time. 5 8 CRITICAL PATH, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED) NOTE 4 -- OTHER COMPREHENSIVE LOSS The components of other comprehensive loss are as follows:
MARCH 31, -------------------- 2000 2001 -------- -------- Net loss............................................... $(76,942) $(70,046) Unrealized investment gains (losses)................... (2,717) 302 Foreign currency translation adjustments............... (168) (839) -------- -------- Other comprehensive loss............................... $(79,827) $(70,583) ======== ========
Accumulated other comprehensive loss consists of unrealized gains (losses) on available-for-sale securities, net of tax, and cumulative translation adjustments, as presented on the accompanying consolidated balance sheet. NOTE 5 -- NET LOSS PER SHARE Net loss per share is calculated as follows:
THREE MONTHS ENDED -------------------------- MARCH 31, MARCH 31, 2000 2001 ----------- ----------- (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) Net loss............................................... $(76,942) $(70,046) Weighted average shares outstanding.................... 53,495 74,268 Weighted average common shares issued subject to repurchase agreements................................ (1,857) (526) Shares held in escrow related to acquisitions.......... (1,068) (1,605) -------- -------- Shares used in computation of basic and diluted loss per share............................................ 50,570 72,137 ======== ======== Basic and diluted loss per share....................... (1.52) (0.97) ======== ========
For the three-month period ended March 31, 2001, approximately 33.4 million potential common shares were excluded from the determination of diluted net loss per share, as the effect of such shares on a weighted average basis is anti-dilutive. NOTE 6 -- SUBSEQUENT EVENT Restructuring In the first quarter of 2001, the Company began developing a strategic plan that involved reorganizing Critical Path's product and service offerings around a group of core products deemed most imperative to its ability to serve the Internet messaging infrastructure market. In the second quarter, implementation of the plan has commenced and, accordingly, certain products and services that have been determined to be non-core to the Company's strategy are being strategically exited. The strategic plan also includes an initiative to reduce operating costs through a reduction of approximately 450 personnel and a consolidation of approximately two-thirds of the Company's office space in keeping with the Company's increased focus on core messaging products and services. The Company is currently implementing these actions and anticipates it will incur one-time charges of approximately $15.0 to $25.0 million related to losses on disposal of assets of non-core products and services, early termination of office lease commitments, and employee severance payments. As a result of these strategic initiatives, the Company anticipates that it will realize future annual cost savings of 6 9 CRITICAL PATH, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED) approximately $30.0 to $50.0 million. The non-core products and services comprised approximately 37% of total revenues in the first quarter of 2001 and 26% of total revenues during fiscal year 2000. It is expected that these products and services will not be a part of the Company's revenue stream by the fourth quarter of 2001. 7 10 CRITICAL PATH, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion and analysis of Critical Path, Inc., and Subsidiaries should be read with the Condensed Consolidated Financial Statements and Notes thereto of Critical Path, Inc. included herein, as well as our 2000 Annual Report on Form 10-K and as amended on Form 10-K/A. The following discussion contains forward-looking statements. Our actual results may differ significantly from those projected in these forward-looking statements. The words "anticipate," "expect," "intend," "plan," "believe," "seek," and "estimate" and similar expressions are intended to identify forward-looking statements. Factors that might cause future results to differ materially from those projected in the forward-looking statements include, but are not limited to, difficulties of forecasting future results due to our limited operating history, evolving business strategy and the emerging nature of the market for our products and services, pending litigation and SEC investigation, turnover of senior management and other key personnel, difficulties of integrating acquired businesses, failure to expand our sales and marketing activities, potential difficulties associated with strategic relationships, investments and uncollected bills, risks associated with our international operations, foreign currency fluctuations, unplanned system interruptions and capacity constraints, software defects, and those discussed in "Additional Factors That May Affect Future Operating Results" and elsewhere in this report. Readers are cautioned not to place undue reliance on these forward-looking statements. We have no obligation to publicly release the results of any revisions to these forward-looking statements to reflect events or circumstances after the date of this filing. OVERVIEW Critical Path, Inc. is a global provider of Internet messaging infrastructure products and services. We provide solutions to manage the flow of mission-critical information through an integrated portfolio of messaging, directory, and security solutions. Our technology provides the messaging infrastructure to support customers' new and existing eBusiness initiatives. Our primary sources of revenue come from providing a wide range of messaging, directory and collaboration licensed products and services. Critical Path was founded in 1997 and is headquartered in San Francisco, with offices worldwide. RESULTS OF OPERATIONS In view of the rapidly evolving nature of the our business, prior acquisitions, organizational restructuring, and limited operating history, we believe that period-to-period comparisons of revenues and operating results, including gross profit margin and operating expenses as a percentage of total net revenues, are not meaningful and should not be relied upon as indications of future performance. At March 31, 2001, we had 1011 employees, in comparison with 1041 employees at December 31, 2000 and 921 employees at March 31, 2000. We do not believe that our historical growth rates for revenue, expenses, or personnel are indicative of future results. Net Revenues We derive most of our revenues through the sale of our Internet messaging infrastructure solutions. These solutions include both licensed software products and hosted messaging services. In addition, we receive revenues from professional services and maintenance and support services. Software license revenue is derived from perpetual and term licenses for our messaging, directory, collaborative and enterprise application integration technologies. Hosted messaging services relate to fees for our hosted messaging and collaboration services. These are primarily based upon monthly contractual per unit rates for the services involved, which are recognized on a ratable monthly basis over the term of the contract. Professional services revenue is derived from fees primarily related to training, installation and configuration services and revenue is recognized as services are performed. Maintenance and support revenue is derived from fees related to post- 8 11 contract customer support agreements associated with software product licenses and revenue is recognized ratably over the term of the agreement. Software License. We recognized $5.6 million in license revenues during the first quarter of 2001, as compared to $11.1 million in the same quarter in 2000. This significant decrease from 2000 was attributed to several factors which affected our operations in the first quarter of 2001. Delays in information technology spending were experienced across many industries due to macroeconomic conditions and these were exacerbated by circumstances at Critical Path. Many of our customers who were evaluating our products during the early part of the quarter delayed making decisions until they could gain a level of comfort in Critical Path as we emerge from this management transition. Additionally, our sales organization was distracted by the termination and resignation of much of its leadership in the quarter and its focus on rebuilding, causing a reduction in effectiveness. Hosted Messaging. We recognized $14.4 million in hosted messaging revenues during the first quarter of 2001, as compared to $9.1 million in same quarter in 2000. This increase in 2001 resulted primarily from the completion of the acquisition of RemarQ Communities in 2000. Additionally, we continued to penetrate the hosted messaging market throughout the latter half of 2000. Professional Service. We recognized $3.4 million in professional service revenues during the first quarter of 2001, as compared to $2.5 million in same quarter in 2000. This increase in 2001 resulted primarily from the completion of the PeerLogic, Inc. acquisition in 2000. Through the addition of PeerLogic we experienced a significant increase in professional service revenues, however this increase was partially offset in the first quarter by the decrease in license product sales. Maintenance and Support. We recognized $3.7 million in maintenance and support revenues during the first quarter of 2001, as compared to $1.9 million in same quarter in 2000. This increase in 2001 resulted primarily from the completion of the PeerLogic, Inc. acquisition in 2000. Through the addition of PeerLogic we experienced a significant increase in maintenance service revenues from new and existing maintenance contracts. Additionally, maintenance and support revenue has increased from the first quarter of 2000 as a result of the significant increase in license product sales throughout 2000. Critical Path's international operations accounted for approximately 30% of net revenues in the first quarter of 2001. Revenues from international operations accounted for approximately 50% of net revenues in the first quarter of 2000. This significant decrease in the percentage of international revenues related primarily to a reduction in enterprise information technology spending during the first quarter of 2001, as it impacted the sale of our license products in the international markets. Cost of Net Revenues Software License. Cost of net software license revenues consists primarily of product media duplication, manuals and packaging materials, personnel and facility costs, and third-party royalties. The overall decrease in cost of net software license revenue was the result of reduced software license revenue and an overall reduction in royalties paid to third parties. Hosted Messaging. Cost of net hosted messaging revenues consists primarily of costs incurred in the delivery and support of messaging services, including depreciation of capital equipment used in network infrastructure, amortization of purchased technology, Internet connection charges, accretion of acquisition- related retention bonuses, personnel costs incurred in operations, and other direct and allocated indirect costs. We added several new hosted messaging clusters to our data centers during 2000, expanding the capacity of our hosting network to manage current customer requirements and future growth. Additional costs were incurred during the latter half of 2000 to add technology platforms for new service offerings. As a result of these significant acquisitions of equipment and operations resources, depreciation and other costs have increased substantially in comparison with the first quarter of 2000. Professional Service. Cost of net professional service revenues consists primarily of personnel costs including custom engineering, installation and training services for both hosted and licensed solutions, and 9 12 other direct and allocated indirect costs. As a result of the 2000 acquisitions, additional costs were incurred in the first quarter of 2001 on professional service resources in comparison with the first quarter of 2000. Maintenance and Support. Cost of net maintenance and support revenues consists primarily of personnel costs related to the customer support functions for both hosted and licensed solutions, and other direct and allocated indirect costs. As a result of the 2000 acquisitions, additional costs were incurred in the first quarter of 2001 on customer support resources in comparison with the first quarter of 2000. Cost of net service revenues was primarily impacted by the increased compensation and other personnel costs resulting from the additional headcount added through our acquisitions completed during the end of the first quarter and duration of 2000, and through our continued efforts to enhance our portfolio of product and service offerings. Operations, customer support, and professional services staff increased to 349 employees at March 31, 2001 from 304 employees at March 31, 2000. Operating Expenses Sales and Marketing. Sales and marketing expenses consist primarily of compensation for sales and marketing personnel, advertising, public relations, other promotional costs, and, to a lesser extent, related overhead. Increases in marketing and promotional expenses, incentive compensation payments to sales personnel, and increases in compensation associated with additional headcount added through our acquisitions completed during the end of the first quarter and duration of 2000, resulted in the increase in sales and marketing expenses from the first quarter of 2000 to the first quarter of 2001. Sales and marketing staff increased to 286 employees at March 31, 2001 from 282 employees at March 31, 2000. Research and Development. Research and development expenses consist primarily of compensation for technical staff, payments to outside contractors, depreciation of capital equipment associated with research and development activities, and, to a lesser extent, related overhead. This significant increase in research and development expenses, resulted primarily from increased compensation and other personnel costs from the additional headcount added through our acquisitions completed during the end of the first quarter and duration of 2000, causing the increase from the first quarter of 2000 to the first quarter of 2001. Research and development staff increased to 244 employees at March 31, 2001 from 209 employees at March 31, 2000. General and Administrative. General and administrative expenses consist primarily of compensation for personnel, fees for outside professional services, occupancy costs and, to a lesser extent, related overhead. The significant increase from the first quarter of 2000 to the first quarter of 2001 resulted primarily from increased compensation and other personnel costs from the additional headcount added through our acquisitions completed during the end of the first quarter and duration of 2000. Additionally, we incurred higher fees for outside professional services in the first quarter of 2001, in particular higher legal fees related to the investigation and significantly higher accounting fees related to the extended audit. General and administrative staff increased to 132 employees at March 31, 2001 from 126 employees at March 31, 2000. Amortization of Intangible Assets In connection with our 1999 and 2000 acquisitions, which were all accounted for using the purchase method of accounting, we recorded goodwill and other intangible assets, primarily for assembled workforce, customer base, and existing technology. During the fourth quarter of 2000, we recognized a $1.3 billion charge related to the impairment of certain goodwill and other intangible assets. As a result of this impairment charge amortization expense decreased significantly from the first quarter of 2000 to the first quarter of 2001. Based on the types of identifiable intangibles acquired, amortization expense of $5.7 million was allocated to cost of net revenues and the remaining amortization expense of $4.1 million was allocated to operating expenses. Acquisition-Related Retention Bonuses In connection with the numerous acquisitions completed in 1999 and 2000, we established various retention bonus programs that in the aggregate amounted to approximately $20.7 million in incentives for certain former employees of these companies to encourage their continued employment with Critical Path. 10 13 The significant decrease in acquisition-related retention bonus expense resulted from the completion during fiscal year 2000 of all but one of the acquisition-related retention bonus programs. Stock-Based Expenses Warrants. During 1999 and 2000, we issued warrants to purchase shares of our preferred and common stock pursuant to certain strategic agreements with ICQ, Inc., Qwest Communications Corporation, Worldsport Network Ltd., one of our lessors, and a major telecommunications company. These issuances allowed the warrantholders to purchase an aggregate of 7.1 million shares of our common stock in exchange for sub-branded advertising and various other services. During the first quarters of 2000 and 2001, we recognized stock-based expenses related to these warrants of approximately $4.0 million and $4.9 million, respectively. We believe that these warrant agreements could have a significant current and future impact on our results of operations. In March 2001, we entered into an agreement with Vectis Group, LLC ("Vectis Group") to engage Vectis Group to act as an advisor to Critical Path with respect to various strategic alternatives we are currently exploring. As part of the agreement, Vectis Group agreed to provide consulting services to us in exchange for a monthly retainer fee and warrants to purchase 500,000 shares of Critical Path common stock, issuable upon execution of the agreement. Using the Black-Scholes option-pricing model and assuming a term of three years, the term of the agreement, and expected volatility of 215%, the initial and final fair value of the warrant on the effective date of the agreement approximated $732,000, which was recognized upon the execution of the agreement in March 2001, as the relationship is terminable at anytime. Interest and Other Income (Expense) Interest and other income (expense) consists primarily of interest earnings on cash and cash equivalents as well as net realized gains (losses) on foreign exchange transactions. On March 30, 2000, we issued $300.0 million of five-year, 5.75% Convertible Subordinated Notes due April 1, 2005. As a result, interest income increased significantly between the first quarter of 2000 and the first quarter of 2001, due to higher cash balances available for investing. Interest income amounted to $1.1 million and $2.3 million in the first quarters of 2000 and 2001, respectively. We also recognized net gains from foreign currency transactions associated with our international operations in the amounts of $136,000 and $170,000 during the first quarter of 2001 and 2000, respectively. Interest Expense Interest expense consists primarily of the interest and amortization of related issuance costs related to the Convertible Subordinated Notes we issued in March 2000, and interest on certain capital leases. We incurred approximately $4.3 million in interest expense on the Convertible Subordinated Notes, and approximately $538,000 related to amortization of debt issuance costs during the first quarter of 2001. Interest expense on the Convertible Subordinated Notes and amortization of related debt issuance costs was insignificant during the first quarter of 2000. Interest on capital leases and other long-term obligations amounted to approximately $264,000 during the first quarter of 2001 and $258,000 during the first quarter of 2000. Additionally, amortization of stock-based charges associated with warrants issued in connection with certain financing arrangements in 1998 and 1999, amounted to $12,000 during the first quarter of 2001 and $16,000 during the first quarter of 2000. Equity in Net Loss of Critical Path Pacific In June 2000, we established a joint venture, Critical Path Pacific, with Mitsui and Co., Ltd., NTT Communications Corporation and NEC Corporation to deliver advanced Internet messaging solutions to businesses in Asia. We invested $7.5 million and hold a 40% ownership interest in the joint venture. This investment is being accounted for using the equity method. During the first quarter of 2001, we recorded equity in net loss of joint venture of approximately $776,000. 11 14 Provision for Income Taxes No current provision or benefit for U.S. federal or state income taxes has been recorded as we have incurred net operating losses for income tax purposes since our inception. No deferred provision or benefit for federal or state income taxes has been recorded as we are in a net deferred tax asset position for which a full valuation allowance has been provided due to uncertainty of realization. We recognized a provision for foreign income taxes during the first quarter of 2001 as certain of our European operations generated income taxable in certain European jurisdictions. LIQUIDITY AND CAPITAL RESOURCES During the first quarter of 2001 we have begun investing a portion of our cash in high grade, low risk investments with an average maturity of twelve months. As of March 31, 2001, our cash balance was $171.6 million and our working capital amounted to approximately $143.5 million. During the first quarter of 2001, we used approximately $44.9 million in cash. We expect, after incurring special one-time charges and realizing the expected quarterly cost savings in connection with our strategic restructuring, the implementation of certain worldwide cost control policies and procedures, and the potential increase in revenue volume once we move beyond the issues experienced in the first quarter, that we have sufficient cash to operate the duration of 2001. We used cash to fund operating activities during the first quarter of 2001 primarily due to our net loss adjusted for non-cash charges and acquisition-related retention bonus payments. Our cash disbursements related primarily to compensation for our employees. In addition, we used cash to fund various other operating costs, which are identified in the Results of Operations portion of this section. We used cash in investing activities during first quarter of 2001 to purchase property, equipment and other capital expenditures, however the cash used for those capital expenditures in 2001 has significantly reduced from 2000. The outlay in capital expenditures during the first quarter of 2001 was primarily related to the acquisition of the outstanding interest in CP Italia, a consolidated subsidiary, an investment banking fee related to the ISOCOR acquisition and the installation of additional network infrastructure equipment in our data centers. Additionally, we invested in licenses of new software platforms, leasehold improvements for our buildings, and furniture and equipment for new employees. We used cash from financing activities during the first quarter of 2001 to retire principal on capital lease obligations. These uses were offset by net proceeds from the sale of the Company's common stock. We received cash proceeds from financing activities during 2000 from the sale of $300.0 million in convertible subordinated notes, as well as from the exercise of employee stock options and the purchase of stock under our employee stock purchase plan. These cash proceeds were partially offset by payments to retire principal on capital lease obligations. ADDITIONAL FACTORS THAT MAY AFFECT FUTURE OPERATING RESULTS WE HAVE A HISTORY OF LOSSES, EXPECT CONTINUING LOSSES AND MAY NEVER ACHIEVE PROFITABILITY. As of March 31, 2001, we had an accumulated deficit, including other comprehensive income, of approximately $2.1 billion. We have not achieved profitability in any period, and expect to continue to incur net losses in accordance with generally accepted accounting principles for the foreseeable future. We expect that our operating expenses will decrease as a result of our strategic restructuring, however we will continue to spend resources on maintaining and strengthening our business and this may have a negative effect on operating results and financial condition in the near term. We have spent heavily on technology and infrastructure development. We may continue to spend substantial financial and other resources to develop and introduce new end-to-end Internet messaging infrastructure products and services, and improve our sales and marketing organizations, strategic relationships and operating infrastructure. In addition, in future periods we will continue to incur significant non-cash charges related to the ten acquisitions we completed in 1999 and 2000 and stock-based compensation. We expect that our cost of revenues, sales and marketing expenses, general and administrative expenses, 12 15 operations and customer support expenses, and depreciation and amortization expenses could continue to increase in absolute dollars and may increase as a percent of revenues. If revenues do not correspondingly increase, our operating results and financial condition could be harmed. Should we continue to incur net losses in future periods, we may not be able to retain employees, fund investments in capital equipment, sales and marketing programs, and research and development to successfully compete against our competitors. We may never obtain sufficient revenues to achieve profitability. If we do achieve profitability, we may not sustain or increase profitability in the future. This may, in turn, cause our stock price to decline. DUE TO OUR LIMITED OPERATING HISTORY, EVOLVING BUSINESS STRATEGY AND THE EMERGING NATURE OF THE INTERNET MESSAGING INFRASTRUCTURE MARKET, FUTURE REVENUES ARE UNPREDICTABLE, AND OUR QUARTERLY OPERATING RESULTS MAY FLUCTUATE. We cannot accurately forecast our revenues as a result of our limited operating history, evolving business strategy and the emerging nature of the Internet messaging infrastructure market. Forecasting is further complicated by rapid changes in our business due to the ten acquisitions we completed in 1999 and 2000, our current strategic restructuring, as well as significant fluctuations in license revenues as a percentage of total revenues from an insignificant percentage in 1999 to 38% in 2000 to 20% in the first quarter of 2001. Our revenues could fall short of expectations if we experience delays or cancellations of even a small number of orders. We often offer volume-based pricing, which may affect operating margins. A number of factors are likely to cause fluctuations in operating results, including, but not limited to: - Continued growth of the Internet in general and the use of messaging infrastructure products and services in particular; - Demand for outsourced messaging services; - Demand for licensing of messaging, directory, and other products; - Our ability to attract and retain customers and maintain customer satisfaction; - Our ability to attract and retain qualified personnel with Internet industry expertise, particularly sales and marketing personnel; - The reaction of our customers and potential customers to our ongoing integration of acquired businesses; - Our ability to upgrade, develop and maintain our systems and infrastructure; - The budgeting cycles of our customers and potential customers; - The amount and timing of operating costs and capital expenditures relating to expansion of business and infrastructure; - Our ability to effectively respond to the rapid technology change of the Internet messaging infrastructure market; - Technical difficulties or system outages; and - The announcement or introduction of new or enhanced services by competitors. In addition to the factors set forth above, operating results will be impacted by the extent to which we incur non-cash charges associated with stock-based arrangements with employees and non-employees. In particular, we have incurred and expect to continue to incur substantial non-cash charges associated with the grant of stock options to employees and non-employees and the grant of warrants to our customers and other parties with which we have commercial relationships. These grants of options and warrants also may be dilutive to existing shareholders. Our operating results also could be impacted by a decision to eliminate a product or service offering through termination, sale or other disposition or to sustain certain products and services at a minimum level where customer commitments prevent us from eliminating the offering altogether. Decisions to eliminate or 13 16 limit our offering of a product or service will involve the expenditure of capital, the realization of losses, a reduction in our workforce, facility consolidation, and/or the elimination of revenues along with the associated costs, any of which could harm our financial condition and operating results. As a result of the foregoing, period-to-period comparisons of operating results are not a good indication of future performance. It is likely that operating results in some quarters will be below market expectations. In this event, the price of our common stock is likely to decline. PENDING LITIGATION COULD SERIOUSLY HARM OUR BUSINESS. Since February 2001, various of our shareholders have filed separate lawsuits against us, our independent accountants and certain of our current and former officers and directors. The uncertainty associated with substantial unresolved lawsuits could seriously harm our business, financial condition and reputation. In particular, the lawsuits could harm our relationships with existing customers and our ability to obtain new customers. The continued defense of the lawsuits also could result in the diversion of our management's time and attention away from business operations, which could harm our business. Negative developments with respect to the lawsuits could cause our stock price to decline significantly. In addition, although we are unable to determine the amount, if any, that we may be required to pay in connection with the resolution of these lawsuits by settlement or otherwise, the size of any such payment could seriously harm our financial condition. Most of the lawsuits have been filed as purported class actions by persons who claim that they purchased our common stock during a purported class period. The complaints generally allege that we and the other named defendants made false or misleading statements of material fact about our financial statements, including our revenues, revenue recognition practices, business operations and prospects for the year 2000 and beyond. The complaints, in general, do not specify the amount of damages that plaintiffs seek. As a result, we are unable to estimate the possible range of damages that might be incurred as a result of the lawsuits. We have not set aside any financial reserves relating to potential damages associated with any of these lawsuits. LIMITATIONS OF OUR DIRECTOR AND OFFICER LIABILITY INSURANCE MAY HARM OUR BUSINESS. Our liability insurance for actions taken by officers and directors during the period from March 1999 to March 2001, the period during which events related to securities class action lawsuits against us and certain of our current and former executive officers are alleged to have occurred, provide only limited liability protection. If these policies do not adequately cover our expenses related to those lawsuits, our business and financial condition could be seriously harmed. Under California law, in connection with our charter documents and indemnification agreements we entered into with our executive officers and directors, we must indemnify our current and former officers and directors to the fullest extent permitted by law. The indemnification covers any expenses and liabilities reasonably incurred in connection with the investigation, defense, settlement or appeal of legal proceedings. THE PENDING SECURITIES AND EXCHANGE COMMISSION INVESTIGATION COULD HARM OUR BUSINESS. In February 2001, the Securities and Exchange Commission, or SEC, issued a formal order of investigation of us and certain unidentified individuals associated with us. The investigation relates to non-specified accounting matters, financial reports, other public disclosures and trading activity in our stock. While we do not know the current status of the investigation or any possible actions that may be taken against us as a result, any negative developments with respect to the investigation or any SEC action against us could harm our business and cause our stock price to decline significantly. WE MAY NOT BE ABLE TO MAINTAIN OUR LISTING ON THE NASDAQ NATIONAL MARKET. In connection with our listing on The NASDAQ National Market (NASDAQ) we must maintain compliance with several requirements related to the trading price of our stock, our financial condition and board of directors, among other issues. As a result of the turnover on our Board of Directors, we might not comply with The Nasdaq National Market's Audit Committee Rules, which require audit committees to be comprised of at least three independent directors on or before June 14, 2001, however, we do intend to satisfy 14 17 the Audit Committee Rules prior to June 14, 2001. In the event that we are not able to comply with this or any of the other requirements we may be delisted from the NASDAQ. Such action may negatively affect our standing with NASDAQ, which in turn would harm our business and its financial condition. WE HAVE EXPERIENCED AND MAY CONTINUE TO EXPERIENCE TURNOVER OF SENIOR MANAGEMENT AND KEY PERSONNEL, WHICH COULD HARM OUR BUSINESS AND OPERATIONS. We are currently engaged in a search for a Chief Executive Officer. Our success depends on our ability to recruit and hire a Chief Executive Officer. If we are not able to successfully recruit a Chief Executive Officer our business will be seriously harmed. Additionally, the loss of the services of key personnel could harm our business results. Our success depends on our ability to recruit, retain and motivate highly skilled sales and marketing, operational, technical and managerial personnel. Competition for these people is intense, and we may not be able to successfully recruit, train or retain qualified personnel. In the first quarter of 2001, we announced a series of changes in Critical Path management and the Board of Directors. In the early part of the second quarter of 2001, we announced a series of additional changes in Critical Path management and the Board of Directors. It is possible that this high turnover at our senior management levels will continue and that other senior executive officers also will resign. Additionally, our management team has not worked together for a significant length of time and may not be able to work together effectively to successfully implement our strategy. If the management team is unable to accomplish our business objectives, our ability to grow our business could be severely impaired. We do not have long-term employment agreements with any of our executive officers and key personnel. In addition, we do not maintain key person life insurance on our employees and have no plans to do so. The loss of the services of one or more of our current senior executive officers or key personnel could harm our business and affect our ability to successfully implement our business objectives. IF WE FAIL TO IMPROVE SALES AND MARKETING ACTIVITIES, WE MAY BE UNABLE TO IMPROVE OUR BUSINESS. Our ability to increase revenues will depend on our ability to successfully recruit, train and retain sales and marketing personnel. Competition for qualified personnel is intense and we may not be able to hire and retain personnel with relevant experience. The complexity and implementation of our Internet messaging infrastructure products and services require highly trained sales and marketing personnel to educate prospective customers regarding the use and benefits of our services. Current and prospective customers, in turn, must be able to educate their end-users. Any delays or difficulties encountered in our staffing efforts would impair our ability to attract new customers and enhance our relationships with existing customers. This in turn would adversely impact the timing and extent of revenues. Because we have experienced high turnover in our sales force and the majority of our current sales and marketing personnel have recently joined us and have limited experience working together, our sales and marketing organizations may not be able to compete successfully against the sales and marketing organizations of our competitors. If we do not successfully operate our sales and marketing activities, our business could suffer and our stock price could decline. IF WE DO NOT SUCCESSFULLY ADDRESS THE RISKS INHERENT IN THE EXPANSION OF OUR INTERNATIONAL OPERATIONS, OUR BUSINESS COULD SUFFER. We derived 30% of our revenue from international sales in the first quarter of 2001 and 38% of our revenue from international sales in 2000. We intend to continue to operate in international markets and to spend significant financial and managerial resources to do so. If revenues from international operations do not exceed the expense of establishing and maintaining these operations, our business, financial condition and operating results will suffer. We have limited experience in international operations and may not be able to compete effectively in international markets. We face certain risks inherent in conducting business internationally, including: - Difficulties and costs of staffing and managing international operations; - Fluctuations in currency exchange rates and imposition of currency exchange controls; 15 18 - Differing technology standards; - Difficulties in collecting accounts receivable and longer collection periods; - Unexpected changes in regulatory requirements including U.S. export restrictions on encryption technologies; - Political and economic instability; - Potential adverse tax consequences; and - Reduced protection for intellectual property rights in some countries. Any of these factors could harm our international operations and, consequently, our business and consolidated operating results. Specifically, failure to successfully manage international growth could result in higher operating costs than anticipated, or could delay or preclude altogether our ability to generate revenues in key international markets. WE MAY NEED ADDITIONAL CAPITAL AND RAISING ADDITIONAL CAPITAL MAY DILUTE EXISTING SHAREHOLDERS. We believe that existing capital resources will enable use to maintain current and planned operations through December 31, 2001. However, we may be required to raise additional funds due to unforeseen circumstances. If capital requirements vary materially from those currently planned, we may require additional financing sooner than anticipated. Such financing may not be available in sufficient amounts or on terms acceptable to us and may be dilutive to existing shareholders. THE TRADING PRICES AND VOLUMES OF OUR STOCK HAVE BEEN VOLATILE AND WE EXPECT THAT THIS VOLATILITY WILL CONTINUE. Our stock price and trading volumes have been highly volatile since our initial public offering on March 29, 1999. We expect that this volatility will continue in the future due to factors, including actual or anticipated fluctuations in results of operations and changes in or failure to meet market expectations. For example, in February 2001, after we announced a revision of our fourth quarter results of operations, our stock was suspended from trading on Nasdaq for a period of time, and subsequently the market price of our stock declined. In addition, the stock market itself is experiencing and may continue to experience significant price and volume fluctuations that have affected the market prices for the stocks of technology companies, particularly Internet companies. These broad market fluctuations may continue to result in a material decline in the market price of our common stock. OUR ARTICLES OF INCORPORATION AND BYLAWS CONTAIN PROVISIONS THAT COULD DELAY OR PREVENT A CHANGE IN CONTROL. Our articles of incorporation and bylaws contain provisions that could delay or prevent a change in control of our company. These provisions could limit the price that investors might be willing to pay in the future for shares of our common stock. Some of these provisions: - Authorize the issuance of preferred stock that can be created and issued by the board of directors without prior shareholder approval, commonly referred to as "blank check" preferred stock, with rights senior to those of common stock; - Prohibit shareholder action by written consent; and - Establish advance notice requirements for submitting nominations for election to the board of directors and for proposing matters that can be acted upon by shareholders at a meeting. In March 2001, we adopted a shareholder rights plan or "poison pill." This plan could cause the acquisition of our company by a party not approved by our board of directors to be prohibitively expensive. 16 19 SUPPLEMENTAL PRO FORMA FINANCIAL DATA (UNAUDITED) The following supplemental pro forma financial information presents Critical Path's condensed consolidated results of operations during the first quarter of 2001 and 2000, excluding the impact of certain special charges consisting of (i) amortization of intangible assets associated with purchase business combinations, (ii) accruals for employee retention bonuses associated with purchase business combinations, and (iii) stock-based compensation associated with outstanding options and warrants. This supplemental presentation is for informational purposes only, and is not intended to replace the consolidated operating results prepared and presented in accordance with generally accepted accounting principles.
THREE MONTHS ENDED ---------------------- MARCH 31, MARCH 31, 2000 2001 --------- --------- Net revenues Software license.......................................... $ 11,070 $ 5,550 Hosted messaging.......................................... 9,095 14,439 Professional service...................................... 2,493 3,417 Maintenance and support................................... 1,895 3,737 -------- -------- Total net revenues................................ 24,553 27,143 -------- -------- Cost of net revenues Software license.......................................... 1,007 291 Hosted messaging.......................................... 11,880 17,938 Professional service...................................... 1,056 2,966 Maintenance and support................................... 1,404 2,586 -------- -------- Total cost of net revenues........................ 15,347 23,781 -------- -------- Gross profit (loss)......................................... 9,206 3,362 -------- -------- Operating expenses Sales and marketing....................................... 13,605 18,712 Research and development.................................. 6,323 9,934 General and administrative................................ 6,766 13,293 -------- -------- Total operating expenses.......................... 26,694 41,939 -------- -------- Loss from operations........................................ (17,488) (38,577) Interest and other income (expense), net.................... 1,258 2,425 Interest expense............................................ (258) (5,051) Equity in net loss of joint venture......................... -- (776) -------- -------- Loss before income taxes.................................... (16,488) (41,979) Provision for income taxes.................................. (360) (343) -------- -------- Net loss.................................................... $(16,848) $(42,322) ======== ======== Net loss per share -- basic and diluted..................... $ (0.33) $ (0.59) Weighted average shares -- basic and diluted................ 50,570 72,137
17 20 QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK As of March 31, 2001, our investment portfolio consisted of available-for-sale securities, excluding those classified as cash equivalents, of $4.4 million. These securities consist of strategic equity investments in corporate partners, certain of which are publicly traded and marketable and certain of which are privately held. These securities are subject to equity price risk. Critical Path's long-term obligations consist of our $300.0 million five-year, 5.75% Convertible Subordinated Notes due April 2005, and certain fixed rate capital leases. We do not attempt to reduce or eliminate our market exposure on these securities. A significant portion of our worldwide operations has a functional currency other than the United States dollar. Accordingly, we are exposed to foreign currency exchange rate risk inherent in our sales commitments, anticipated sales, and assets and liabilities of these operations. Fluctuations in exchange rates may harm our results of operations and could also result in exchange losses. The impact of future exchange rates fluctuations cannot be predicted adequately. To date, we have not sought to hedge the risks associated with fluctuations in exchange rates. Information relating to quantitative and qualitative disclosure about market risk is set forth in "Management's Discussion and Analysis of Financial Condition and Results of Operations." 18 21 PART 2 -- OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS We are a party to lawsuits in the normal course of our business. Litigation in general, and securities and intellectual property litigation in particular, can be expensive and disruptive to normal business operations. Moreover, the results of complex legal proceedings are difficult to predict. Other than as described below, we are not a party to any other material legal proceedings. Securities Class Actions Beginning on February 2, 2001, a number of securities class action complaints were filed against us, certain of our current and former officers and directors and our independent accountants in the United States District Court for the Northern District of California. The complaints have been filed as purported class actions by individuals who allege that they purchased our common stock during a purported class period; the alleged class periods vary among the complaints and are in the process of being consolidated into a single action. The complaints generally allege that, in differing periods from December 1999 to February 1, 2001, we and other named the defendants made false or misleading statements of material fact about our financial statements, including our revenues, revenue recognition policies, business operations and prospects for the year 2000 and beyond. The complaints seek an unspecified amount in damages on behalf of persons who purchased Critical Path stock during certain periods. Derivative Actions Beginning on February 5, 2001, we have been named as a nominal defendant in a number of derivative actions, purportedly brought on our behalf, filed in the Superior Court of the State of California. The derivative complaints allege that certain of Critical Path's current and former officers and directors breached their fiduciary duties to us, engaged in abuses of their control of us, were unjustly enriched by their sales of our common stock, engaged in insider trading in violation of California law or published false financial information in violation of California law. The plaintiffs seek unspecified damages on our behalf from each of the defendants. Because of the nature of derivative litigation, any recovery in the action would inure to our benefit. SEC Investigation In February 2001, the Securities and Exchange Commission issued a formal order of investigation of Critical Path and certain unidentified individuals associated with Critical Path with respect to non-specified accounting matters, financial reports, other public disclosures and trading activity in our securities. While we do not know the current status of the investigation or any possible actions that may be taken against us as a result, any SEC action against us could harm our business. The uncertainty associated with substantial unresolved lawsuits and the SEC investigation could seriously harm our business and financial condition. In particular, the lawsuits or the investigation could harm our relationships with existing customers and our ability to obtain new customers. The continued defense of the lawsuits and conduct of the investigation could also result in the diversion of our management's time and attention away from business operations, which could harm our business. Negative developments with respect to the lawsuits or the investigation could cause our stock price to decline significantly. In addition, although we are unable to determine the amount, if any, that we may be required to pay in connection with the resolution of these lawsuits or the investigation by settlement or otherwise, the size of any such payment could seriously harm our financial condition. 19 22 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits 3.1* Amended and Restated Articles of Incorporation 3.2* Amendment to the Articles of Incorporation 3.3* Amended and Restated Bylaws 4.1* Form of Common Stock Certificate 4.2* Preferred Stock Rights Agreement, dated as of March 29, 2001 between Critical Path, Inc. and Computershare, including the Certificate of Determination, the form of Rights Certificate and the Summary of Rights attached thereto as Exhibits A, B and C, respectively.
--------------- * See Exhibit Index attached hereto, which is incorporated herein by reference. (b) Reports on Form 8-K On February 6, 2001, we filed a report on Form 8-K under Item 5, announcing an investigation undertaken by the Company's Board of Directors. On February 14, 2001, we filed a report on Form 8-K under Item 5, announcing a series of changes in the Company's management. On February 16, 2001, we filed a report on Form 8-K under Item 5, announcing the revision of the Company's fourth quarter results. On April 2, 2001, we filed a report on Form 8-K under Item 5, announcing the Company's Board of Directors had approved the adoption of a Shareholder Rights Plan. 20 23 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. Date: May 15, 2001 CRITICAL PATH, INC. By: /s/ LAWRENCE P. REINHOLD ------------------------------------ Lawrence P. Reinhold Executive Vice President, Chief Financial Officer (Duly Authorized Officer and Principal Financial and Accounting Officer) 21 24 INDEX TO EXHIBITS
EXHIBIT NUMBER EXHIBIT DESCRIPTION ------- ------------------- 3.1(1) Amended and Restated Articles of Incorporation 3.2(2) Amendment to the Articles of Incorporation 3.3(1) Amended and Restated Bylaws 4.1(3) Form of Common Stock Certificate 4.2(4) Preferred Stock Rights Agreement, dated as of March 29, 2001 between Critical Path, Inc. and Computershare, including the Certificate of Determination, the form of Rights Certificate and the Summary of Rights attached thereto as Exhibits A, B and C, respectively.
------------------------ (1) Incorporated by reference from Exhibits 3(i)(b) and 3(ii)(b) of Critical Path, Inc.'s Registration Statement on Form S-1 (File Number 333-71499) filed with the Securities and Exchange Commission on January 29, 1999. (2) Incorporated by reference from Exhibit 3.2 of Critical Path, Inc.'s Form 10-K for the year ended December 31, 2000. (3) Incorporated by reference from Exhibit 4.1 of Critical Path, Inc.'s Registration Statement on Form S-1, Amendment Number 1 (File Number 333-71499) filed with the Securities and Exchange Commission on February 24, 1999. (4) Incorporated by reference from Exhibit 4.5 of Critical Path, Inc.'s Form 8-A filed on May 7, 2001. 22