e10vq

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 þ No o

As of October 31, 2002, the company had outstanding 80,124,000 shares of common stock, $0.001 par value per share.

The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.

Note 1 — Basis of Presentation and Summary of Significant Accounting Policies

Critical Path, Inc. was incorporated in California on February 19, 1997. Critical Path, Inc., along with its subsidiaries (collectively referred to herein as “We,” “Critical Path” or the “Company”), provides messaging and collaboration solutions, from wireless, secure and unified messaging to basic email and personal information management, as well as identity management solutions that simplify user profile management and strengthen information security. The Company’s customers are corporate enterprises, carriers and service providers, postal authorities and government agencies.

The unaudited Condensed Consolidated Financial Statements (“Financial Statements”) of the Company furnished herein have been reviewed by independent accountants and 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 Annual Report on Form 10-K for the fiscal year ended December 31, 2001. The results of operations for the interim periods presented herein are not necessarily indicative of the results to be expected for the entire year.

With respect to the unaudited condensed consolidated financial information of the Company as of September 30, 2002 and for the three and nine-month periods ended September 30, 2001 and 2002 included herein, PricewaterhouseCoopers LLP reported that they have applied limited procedures in accordance with professional standards for a review of such information. However, their separate report dated November 5, 2002, appearing herein, states that they did not audit and they do not express an opinion on the unaudited condensed consolidated financial information. PricewaterhouseCoopers LLP is not subject to the liability provisions of Section 11 of the Securities Act of 1933 for their report on the unaudited condensed consolidated financial information because that report is not a report or a part of this Form 10-Q prepared or certified by PricewaterhouseCoopers LLP within the meaning of Sections 7 and 11 of the Act.

The condensed consolidated financial statements include the accounts of the Company, and its wholly-owned and majority-owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation. The equity method is used to account for investments in unconsolidated entities if the Company has the ability to exercise significant influence over financial and operating matters, but does not have the ability to control such entities. The cost method is used to account for equity investments in unconsolidated entities where the Company does not have the ability to exercise significant influence over financial and operating matters.

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 and communication products and services and management uses one measure of profitability. Revenue information on a product and service basis has been disclosed in our statements of operations.

Certain amounts previously reported have been reclassified to conform to the current period presentation.

In July 2002, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 146, Accounting for Costs Associated with Exit or Disposal Activities. This Statement addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force (“EITF”) Issue No. 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring). This Statement requires that a liability for costs associated with an exit or disposal activity be recognized and measured initially at fair value only when the liability is incurred. The provisions of this Statement are effective for exit or disposal activities that are initiated after December 31, 2002. The Company is currently assessing the impact of SFAS No. 146 on its financial statements.

In April 2002, the FASB issued SFAS No. 145, Rescission of FASB Statements No. 4, 44 and 64, Amendment of SFAS No. 13, and Technical Corrections. The provisions of SFAS No. 145 related to the rescission of SFAS No. 4 are effective for fiscal years beginning after May 15, 2002. Other provisions of SFAS No. 145 are effective for financial statements issued on or after May 15, 2002 and rescinds both SFAS No. 4, Reporting Gains and Losses from Extinguishment of Debt, and the amendment to SFAS No. 4, SFAS No. 64, Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements. Through this rescission, SFAS No. 145 eliminates the requirement that gains and losses from the extinguishment of debt be aggregated and, if material, classified as an extraordinary item, net of the related income tax effect. The Company early adopted the rules on accounting and reporting gains and losses from extinguishment of debt in the second quarter of fiscal 2002. Adoption resulted in the reclassification of certain gains on extinguishment of debt recorded in fiscal 2001.

In June 2001, the FASB issued SFAS No. 142, Goodwill and Other Intangible Assets. This Statement addressed financial accounting and reporting for intangible assets acquired individually or with a group of other assets (but not those acquired in a business combination) at acquisition and goodwill and other intangible assets subsequent to their acquisition. This Statement supersedes APB Opinion No. 17, Intangible Assets. Under the provisions of this Statement, if an intangible asset is determined to have an indefinite useful life, it shall not be amortized until its useful life is determined to be no longer indefinite. An intangible asset that is not subject to amortization shall be tested for impairment annually, or more frequently if events or changes in circumstances indicate that the asset might be impaired. Goodwill shall not be amortized. Goodwill shall be tested for impairment on an annual basis and between annual tests in certain circumstances at a level of reporting referred to as a reporting unit. Goodwill and intangible assets acquired after June 30, 2001 will be subject immediately to the nonamortization and amortization provisions of this Statement. The Company adopted the new rules on accounting for goodwill and other intangible assets in the first quarter of fiscal 2002. Adoption resulted in the identification of approximately $5.6 million in intangible assets related to acquired workforce and goodwill that will no longer be amortized. These assets were also tested upon implementation and found not to be impaired based upon estimates of the fair values of the two reporting units identified. See also Note 6 — Intangible Assets.

The Company is 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.

California. The complaint alleged breach of contract, unjust enrichment, common law fraud and violations of federal securities laws and seeks compensatory and punitive damages in an unnamed amount but in excess of $200 million. Litigation in this matter is ongoing. The Company filed a motion to have the case transferred to the Northern District of California and is awaiting the court’s review of such motion.

Securities and Exchange Commission Investigation. In 2001, the Securities and Exchange Commission (the “SEC”) investigated the Company and certain former officers, employees and directors with respect to non-specified accounting matters, financial reports, other public disclosures and trading activity in the Company’s securities. The SEC concluded its investigation of the Company in January 2002 with no imposition of fines or penalties and, without admitting or denying liability, the Company consented to a cease and desist order and an administrative order as to violation of certain non-fraud provisions of the federal securities laws. The investigation has also thus far resulted in charges being filed against five former officers and employees of the Company. We believe that the investigation of former officers and employees of the Company continues; while the Company continues to fully cooperate with any requests with respect to such investigation, we do not know the status of such investigation.

Derivative Actions in Northern District of California. Beginning on February 5, 2001, Critical Path was named as a nominal defendant in a number of derivative actions, purportedly brought on the Company’s behalf, filed in the Superior Court of the State of California and in the U.S. District Court for the Northern District of California. The derivative complaints alleged that certain of the Company’s former officers and directors breached their fiduciary duties, engaged in abuses of control, were unjustly enriched by 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 Company is currently working with plaintiffs’ counsel to finalize the settlement of this matter.

Securities Class Action in Southern District of New York. Beginning on July 18, 2001, a number of securities class action complaints were filed against the Company, and certain of its former officers and directors and underwriters connected with its initial public offering of common stock in the U.S. District Court for the Southern District of New York. The purported class action complaints were filed by individuals who allege that they purchased common stock at the initial public offering of common stock between March 26, 1999 and December 6, 2000. The complaints allege generally that the Prospectus under which such securities were sold contained false and misleading statements with respect to discounts and commissions received by the underwriters. The complaints have been consolidated into a single action. The complaints seek an unspecified amount in damages on behalf of persons who purchased the Company’s stock during the specified period. Similar complaints have been filed against more than 300 other companies and additional underwriters.

Lease Dispute. In July 2000, PeerLogic, Inc. signed a lease for office space in San Francisco, California. In December 2000, we acquired PeerLogic as a wholly-owned subsidiary. After review, we determined that local zoning laws likely prohibited a business such as the Company or PeerLogic from occupying the leased premises, and promptly sought a zoning determination from the San Francisco Zoning Administrator to resolve the matter. The Zoning Administrator determined that the Company’s proposed use of the leased premises was not permitted, but the landlord appealed this determination and prevailed before the San Francisco Board of Appeals. The Company requested a rehearing on the matter, which the Board of Appeals denied. In April 2002, the landlord filed suit in San Francisco Superior Court against the Company alleging, among other things, breach of the lease. In its complaint, the landlord sought unspecified compensatory damages for back rent, attorneys’ fees, treble damages under relevant statutes, and unspecified punitive damages. A number of the plaintiff’s claims of damages were struck by the court in response to the Company’s motion to strike. The plaintiff submitted an amended complaint in September 2002 and a hearing is scheduled on the Company’s motion to strike in November 2002. In July 2002, the Company filed a separate Petition for Writ of Administrative Mandamus with the San Francisco Superior Court, requesting that the Board of

Appeals’ decision be reversed and/or remanded for rehearing by the Board, with instructions from the Court. Litigation in this matter is ongoing.

The uncertainty associated with these and other unresolved or threatened lawsuits could seriously harm the Company’s business and financial condition. In particular, the lawsuits or the lingering effects of previous lawsuits and the investigation could harm its relationships with existing customers and its ability to obtain new customers. The continued defense of lawsuits 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 settlements or the lawsuits could cause the Company’s stock price to further 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, and although the Company maintains adequate and customary insurance, the size of any such payments could seriously harm the Company’s financial condition.

On June 6, 2002, the Company acquired the remaining 60% ownership interest that it did not already own in its Japanese joint venture, Critical Path Pacific, Inc., from Mitsui and Co. Ltd., NTT Communications Corporation and NEC Corporation, for $3.0 million in cash and the assumption of $2.6 million in business restructuring and capital lease obligations. The excess of the purchase price of $5.6 million over the fair value of the acquired net assets, primarily working capital and fixed assets, of $4.6 million was recorded as goodwill. In accordance with SFAS No. 142, this goodwill asset of approximately $1.0 million will not be amortized; however, the Company will test this asset for impairment on an annual basis, or more frequently if events or circumstances indicate that the asset might be impaired. The Company began including the financial results of Critical Path Pacific in its own consolidated results subsequent to the acquisition date.

During 2001 and in connection with his employment agreement, the Company made a loan and held a note receivable from David Hayden, Executive Chairman and a Director of the Company, in the amount of $1.5 million. The full recourse note accrues interest at the rate of 6.75% per annum and could be repaid by the achievement of performance-based milestones described in Mr. Hayden’s employment agreement and performance loan agreement. The loan was also subject to forgiveness upon certain change of control events. In February 2002, the Board approved an amendment of Mr. Hayden’s employment agreement that eliminated the original performance-based milestones in favor of a single performance-based milestone tied to a change of control event. In addition, the Board increased the amount available under the loan agreement by an additional $450,000, which was funded in March 2002. The loan amount was secured by a first priority security interest in all of Mr. Hayden’s shares and options in the Company, with all other terms of the loan and other agreements unchanged. In July 2002, in connection with the settlement of the terms and conditions of Mr. Hayden’s termination of employment with the Company, some of the terms of the loan were altered as described in this section below under “Termination Agreements.”

In December 2001, the Board approved a fully secured loan to William McGlashan, Jr., the Company’s Chief Executive Officer, of up to $4.0 million in connection with the purchase of a principal residence in the San Francisco Bay Area. In May 2002, the Compensation Committee of the Board and Mr. McGlashan agreed to amend the agreement in order to reduce the amount of the loan commitment to $1.5 million. As of September 30, 2002, no portion of the loan commitment has yet been funded.

In connection with the reduction of the loan commitment, in May 2002 Mr. McGlashan was granted an option to purchase 1,000,000 shares of the Company’s Common Stock, at an exercise price of $1.74 per share,

which was the fair market value on the date of grant. The option was immediately exercisable subject to the Company’s lapsing right of repurchase at a price equal to the exercise price per share over a three year period. Mr. McGlashan exercised his right to early exercise purchase the shares through a promissory note and stock pledge agreement in May 2002. As such the Company now holds a promissory note in the amount of $1,740,000 secured by shares of Common Stock. The promissory note will begin to accrue interest at the adjustable quarterly reference rate of Fidelity Investments or similar banking entity as the shares vest with respect to that portion of the purchase price that represents the purchase price of the “vested” shares.

In accordance with EITF 00-23, the early exercise of these options is not considered a substantive exercise, for accounting purposes, until the repurchase right lapses. Accordingly, the total exercise price of these options has been recognized as an asset, in Other assets, and as a liability, in Capital lease and other obligations. These balances will be reclassified to shareholders’ equity as the right of repurchase lapses.

In May 2002, David Hayden resigned his employment with the Company and from the Board of Directors. In connection with a separation agreement finalized in July 2002, Mr. Hayden received a lump sum separation payment of $350,000 plus applicable taxes, continuation of health and welfare benefits until May 31, 2003, an extension to repay the $1.95 million loan with the Company until no later than June 30, 2005, an extension of the period within which he may exercise his vested stock options until no later than June 30, 2005, acceleration of a portion of his unvested options if a change of control of the Company occurs prior to September 30, 2003 and reimbursement for $50,000 of legal fees incurred. In connection with the provision of these benefits, Mr. Hayden agreed to (i) forfeit the right under the severance provisions of his employment agreement to an additional one year extension of the $1.95 million loan until August 2006; (ii) pay all proceeds (net of taxes) from the sale of any shares held by him in the Company to reduce the principal balance of the $1.95 million loan; and (iii) forfeit his right to receive a $2.5 million loan from the Company to exercise certain of his stock options. All sales of common stock of the Company by Mr. Hayden will be made under a publicly filed trading plan. In addition, Mr. Hayden and the Company executed a mutual release of claims. As a result of Mr. Hayden’s separation, the Company recorded aggregate one-time charges of $2.6 million, included in operating expenses, inclusive of $572,000 related to the separation payment and legal fee reimbursements made to Mr. Hayden and $2.0 million in stock-based expenses related to the extension of the exercise period on Mr. Hayden’s vested stock options.

In October 2002, Pierre Van Beneden terminated his employment as president of the Company, but continues through January 2003 as a consultant on certain European license software sales. In connection with a separation agreement, Mr. Van Beneden agreed to provide consulting services to the Company on a commission only basis and shall receive the benefits to which he was entitled under his employment agreement during such consulting period. Such employment agreement benefits, which shall be payable in January 2003 upon the completion of the consulting term, included a lump sum payment of $337,500, representing nine months base salary, and accelerated vesting on a portion of his option grants. As an additional benefit under the separation agreement, Mr. Van Beneden was granted an extension from ninety days to one year of the period for exercise of his option grants. Mr. Van Beneden and the Company executed a mutual release of all claims. As a result of the execution of the separation agreement in October 2002, the Company will include the lump sum payment in its fourth quarter 2002 operating expenses.

In August 2002, the Company retained the services of The Cohen Group, an international strategic consulting company. The chairman and chief executive officer of The Cohen Group is William S. Cohen, a member of the Board of Directors of the Company. Under the agreement, The Cohen Group received a $150,000 retainer fee as a draw against a sliding scale of earned sales and referral commissions due the Cohen

Group on transactions resulting in license revenue for the Company. The agreement is for a one year term, with reimbursement for specified expenses up to a cap of 5% of the retainer and a provision for extension in the event the retainer fee is not earned during the term.

In August 2002, the Company hired R.B. Webber & Company, strategic management consultants, to prepare an executive level research and forecast presentation on the enterprise messaging market. The agreement provided for a flat fee of $85,000 over a two month period for the services of several consultants of R.B. Webber and Company, with reimbursement for expenses capped at 5% of the fee. Jeffrey Webber, a member of the Board of Directors of the Company, is a partner of R.B. Webber and Company. Mr. Webber shall also provide consulting services under the agreement.

In October 2002, the Company entered into a consulting arrangement with Pierre van Beneden in connection with a separation agreement more fully described in the section above under “Termination Agreements,” Mr. Van Beneden is entitled to commissions payable upon the completion of certain license software sales.

In May 2002, the Board of Directors approved a restructuring plan to further reduce the Company’s expense levels consistent with the current business climate. In connection with the plan, a restructuring charge of $1.5 million was recognized in the second quarter of 2002. This charge was comprised of approximately $1.2 million in severance and related costs associated with the elimination of approximately 39 positions and $300,000 in facilities lease termination costs. During the second and third quarters of 2002, approximately $762,000 was charged against this accrual, primarily cash payments of severance related costs. The balance of the accrual at September 30, 2002, of approximately $777,000 is expected to be utilized by the end of this fiscal year.

During 2001, the Company announced a strategic restructuring plan that involved reorganizing Critical Path’s product and service offerings around a group of core communications solutions, a reduction in the Company’s workforce, and the consolidation of facilities and operations. Total restructuring charges during 2001 amounted to $18.3 million, of which $8.5 million was recognized during the second quarter of 2001. As of December 31, 2001 a $2.2 million accrual associated with these restructuring actions remained as a component of accounts payable. During the first nine months of 2002, approximately $1.1 million was charged against this accrual, primarily cash paid related to facilities and operations consolidation restructuring activities, leaving a remaining restructuring accrual of $1.1 million as of September 30, 2002, which is expected to be paid over the next 9 months.

At September 30, 2002, the Company was carrying net intangible assets of $17.4 million. Of this amount, $10.8 million is associated with acquired intangible assets which are being amortized and the remaining $6.6 million is associated with goodwill which is not being amortized, in accordance with SFAS No. 142. During the second quarter of 2002, goodwill increased by approximately $1.0 million associated with the Company’s acquisition of its Japanese joint venture, Critical Path Pacific, Inc. See also Note 3 — Acquisition of Japanese Joint Venture.

Other intangible assets as of September 30, 2002 are detailed as follows (in thousands):

The aggregate amortization expense related to goodwill which is no longer being amortized totaled $1.1 million and zero for the third quarters of 2001 and 2002, respectively, and $3.6 million and zero for the first nine-months of 2001 and 2002, respectively. The estimated total amortization expense related to all intangible assets is $43.1 million for fiscal year 2002, at which time all other intangible assets will be fully amortized.

The following table presents net income (loss) attributable to common shares and net income (loss) per share attributable to common shares — basic and diluted, as if the goodwill had not been amortized during the periods presented (in thousands, except per share amounts):

The components of other comprehensive income (loss) are as follows (in thousands):

Accumulated other comprehensive income (loss) consists of net unrealized gains (losses) on available-for-sale securities, net of tax, and cumulative translation adjustments, as presented on the accompanying consolidated balance sheet.

At September 30, 2001 and 2002, approximately 31.7 million and 72.8 million potential common shares, respectively, were excluded from the determination of diluted net loss per share, as the effect of such shares is anti-dilutive.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

This report on Form 10-Q contains forward-looking statements within the meaning of the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995, as amended and in effect from time to time. The words “anticipate,” “expect,” “intend,” “plan,” “believe,” “seek,” and “estimate” and similar expressions are intended to identify forward-looking statements. These are statements that relate to future periods and include statements regarding our future strategic, operational and financial plans, anticipated or projected revenues, expenses and operational growth, markets and potential strategic partners and customers for our products and service offerings, plans related to sales strategies and global sales efforts, our plans to reach profitability, our ability to retain key customers and grow accounts in a challenging economy, the anticipated benefits of our relationships with strategic partners, growth and results of our competition, our ability to compete in the global marketplace, investments in product development, use of future earnings, the features, benefits and performance of our current and future products and services, plans to continue to reduce operating costs through continued expense reduction, and our belief as to our ability to successfully emerge from the restructuring and refocusing of our operations. These forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from those projected. 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, failure to meet sales and revenue objectives, forecasts and earnings guidance, our ability to reach profitability and history of losses, competition in the marketplace and our ability to attract and retain customers, our ability to successfully manage costs, turnover within and integration of senior management, board of directors members and other key personnel, failure to negotiate strategic technology and distribution deals on favorable terms, our dependence on a small number of key customers and the length of sales cycles, our evolving business strategy and the emerging nature of the market for our products and services, lingering doubts related to the accounting restatements and SEC investigation of our former executives and directors, volatility in the market for our stock, risks associated with delisting actions by, and an inability to maintain continued compliance with, the Nasdaq National Market and its listing requirements, potential difficulties associated with strategic relationships, investments and uncollected bills, general economic conditions in markets in which the Company does business, volatility in the market for our stock and risks associated with our international operations, foreign currency fluctuations, unplanned system interruptions and capacity constraints, and 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. The forward-looking statements speak only as of the date hereof. We expressly disclaim any 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.

All references to “Critical Path,” “we,” “our,” or the “Company” mean Critical Path, Inc. and its subsidiaries, except where it is clear from the context that such terms mean only the parent company and exclude subsidiaries.

This Quarterly Report on Form 10-Q includes numerous trademarks and registered trademarks of Critical Path. Products or service names of other companies mentioned in this Quarterly Report on Form 10-Q may be trademarks or registered trademarks of their respective owners.

Critical Path, Inc., is a global leader in digital communications software and services. We provide messaging and collaboration solutions from wireless, secure and unified messaging to basic email and personal information management, as well as identity management solutions that simplify user profile management and strengthen information security. Our standards-based Critical Path Communications Platform, built to

perform reliably at the scale of public networks, delivers the industry-noted lowest total cost of ownership for messaging solutions and lays a solid foundation for next-generation communications services.

Our primary sources of revenue come from providing a wide range of messaging and identity management products and services. Critical Path’s customers are corporate enterprises, carriers and service providers, postal authorities and government agencies. Critical Path was founded in 1997 and is headquartered in San Francisco, California with offices worldwide.

In light of the rapidly evolving nature of 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 September 30, 2002, we had 599 employees, in comparison with 562 employees at December 31, 2001 and 564 employees at September 30, 2001. We do not believe that our historical growth rates for revenues, expenses or personnel are indicative of future results.

We derive most of our revenues through the sale of our messaging and identity management communications solutions. These solutions include both licensed software products and hosted messaging services. In addition, we recognize revenues from professional services and maintenance and support services. Software license revenues are derived from perpetual and term licenses for our messaging, identity management, collaborative and enterprise application integration technologies. Hosted messaging revenues relate to fees for our hosted messaging and collaboration services. These fees are primarily based upon monthly contractual per unit rates for the services involved, and are recognized as revenue on a ratable monthly basis over the term of the contract. Professional services revenues are derived from fees primarily related to training, installation and configuration services and revenue is recognized as services are performed. Maintenance and support revenues are derived from fees related to post-contract customer support agreements associated with software product licenses. Maintenance and support revenues are recognized ratably over the term of the agreement.

Software License. We recognized $5.9 million and $27.7 million in software license revenues during the three and nine-month periods ended September 30, 2002, respectively, compared to $7.7 million and $22.2 million during the same periods in 2001. The significant decrease in third quarter 2002 software license revenues over the prior year was due primarily to the difficult worldwide business climate, which has resulted in lower and delayed information technology spending across the enterprise software market. Software license revenues for the first nine-months of 2002 were higher than the prior year period due to the uncertainty surrounding Critical Path during the first two quarters of 2001, which caused a number of current and potential customers to delay making purchase decisions. This uncertainty was created by the restatement of certain previously released financial results of Critical Path for the third quarter of 2000, significant turnover within the senior management group and the termination and resignation of much of the leadership within our sales organization. During the second half of 2001 and first half of 2002, we restructured our business and management team and worked to rebuild customer confidence in Critical Path.

During the second and third quarters of 2002, we excluded all royalty revenue earned from Sun Microsystems, Inc. related to the sale of their iPlanet meta-directory products which, based upon recent reporting, could have amounted to approximately $300,000 in each quarter. During August we entered into a dispute with Sun Microsystems, Inc. over the calculation of these royalties. We will not be recognizing royalty revenue from Sun Microsystems until we come to a mutual agreement on current and historic contractual obligations.

Hosted Messaging. We recognized $6.5 million and $19.0 million in hosted messaging revenues during the three and nine-month periods ended September 30, 2002, respectively, compared to $10.0 million and $35.6 million during the same periods in 2001. This decrease in 2002 hosted messaging revenues resulted in part due to the exiting or sale, as part of our 2001 restructuring initiatives, of certain non-core hosted messaging services during the second half of 2001. These non-core services accounted for a significant portion

of hosted messaging revenues for the first nine-months of 2001. In addition, during the second and third quarters of 2002, we did experience a net loss in customers, which further contributed to the decline in hosted messaging revenue over the prior year’s periods. We excluded approximately $300,000 in hosted messaging revenue from the second quarter of 2002 related to WorldCom’s Chapter 11 bankruptcy filing. During the third quarter of 2002, we did recognize approximately $300,000 in hosted messaging revenue from WorldCom associated with the formalization of their restructuring plan and payment for post-bankruptcy services.

We are currently completing development work on a new hosted messaging software and hardware platform which is expected to be launched in the first half of 2003. In connection with the new platform, in October 2002 we announced the formation of a global managed messaging service alliance with Hewlett-Packard Company (HP), in which Critical Path will outsource its data center operations to HP. As part of the alliance, Critical Path will continue to provide messaging applications management services and product development, with both companies marketing and selling the messaging service and providing integration services. Until these new initiatives are substantially in place, and with the elimination of certain non-core hosted messaging services in the second-half of 2001, we expect hosted messaging revenues to be lower in the fourth quarter of 2002 in comparison to the prior year’s period.

Professional Services. We recognized $3.1 million and $7.6 million in professional services revenues during the three and nine-month periods ended September 30, 2002, respectively, compared to $4.2 million and $10.5 million during the same periods in 2001. The decrease in professional services revenues in the third quarter of 2002 was due primarily to our 2001 restructuring initiatives, which eliminated certain non-core products, reducing the professional services revenues derived from these products. The decrease in revenue for the first nine-months of 2002 was due primarily to higher first quarter 2001 non-core product professional services revenues resulting from our September 2000 acquisition of PeerLogic, Inc.

Maintenance and Support. We recognized $3.7 million and $10.9 million in maintenance and support revenues during the three and nine-month periods ended September 30, 2002, respectively, compared to $4.9 million and $12.7 million for the same periods in 2001. The decrease in 2002 resulted primarily from the loss of maintenance and support revenues from the elimination of certain non-core products and services as part of our 2001 restructuring initiatives.

Critical Path’s international operations accounted for approximately 59% and 57% of net revenues for the three and nine-month periods ended September 30, 2002, and approximately 45% and 40% of net revenues for the three and nine-month periods ended September 30, 2001. This significant increase in the percentage of international revenues related primarily to a dramatic reduction in enterprise information technology spending during the first and second quarters of 2001, as it particularly impacted the sale of our license products in international markets. Additionally, the decrease in domestic hosted messaging revenue further impacted the percentage of international revenue.

Software License. Cost of net software license revenues consist primarily of product media duplication, manuals and packaging materials, personnel and facility costs, and third-party royalties. The cost of net software license revenues for the third quarter of 2002 was comparable to the prior year’s period. The cost of net software license revenues for the first nine months of 2002 were higher than the same period in the prior year, consistent with the increase in license product sales.

Hosted Messaging. Cost of net hosted messaging revenues consist 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. The cost of net hosted messaging revenues were significantly lower in the third quarter and first nine months of 2002 compared to the prior year periods primarily due to our restructuring initiatives undertaken in the second half of 2001. As a result of these initiatives, the costs associated with our hosted messaging revenues were reduced through the sale or exit of several non-core services, the termination of employees and reduction in

Professional Services. Cost of net professional services revenues consist primarily of personnel costs including custom engineering, installation and training services for both hosted and licensed solutions, and other direct and allocated indirect costs. As a result of our 2001 restructuring initiatives, personnel and certain overhead costs were reduced, resulting in lower professional services cost of net revenues for the third quarter and first nine months of 2002, in comparison to the same periods in the prior year.

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. The cost of net maintenance and support revenues was lower in the second quarter and first nine months of 2002 in comparison to the year ago period, due primarily to a decrease in staffing levels and a reduction in employee-related costs.

Operations, customer support and professional services staff decreased to 191 employees at September 30, 2002 from 197 employees at September 30, 2001.

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. Sales and marketing expenses for the third quarter of 2002 were comparable to the prior year’s period. Sales and marketing expenses for the first nine months of 2002 decreased significantly over the prior year’s periods due primarily to cost savings generated from our 2001 restructuring initiatives. Sales and marketing staffing levels, which stood at 201 employees at June 30, 2001, were reduced to 131 employees at September 30, 2001, as a result of the restructuring. The savings in personnel and personnel-related costs together with the termination of certain strategic marketing relationships related to non-core services accounted for the reduction in sales and marketing expenses for the first nine-months of 2002. Sales and marketing staffing totalled 152 employees at September 30, 2002.

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 decrease in year-to-date 2002 research and development expenses resulted primarily from a reduction in headcount and related personnel costs as part of our 2001 restructuring initiatives. Savings realized from the termination of certain outside consulting arrangements and consolidation of facilities also contributed to the decrease in research and development expenses for the third quarter of 2002 compared to the same period last year. Research and development staffing totalled 167 employees at September 30, 2002 compared to 142 employees at September 30, 2001.

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 decrease in third quarter and year-to-date 2002 general and administrative expenses in comparison to the same periods in the prior year was due primarily to cost savings realized from our 2001 restructuring initiatives. Savings were realized from a decrease in general and administrative staffing levels to 90 employees at September 30, 2002 from 94 employees at September 30, 2001, as well as savings resulting from the reduction in facilities from 77 at December 31, 2000 to 27 at September 30, 2002. In addition, as a result of the restatement of certain previously released 2000 financial results, we incurred higher fees for outside professional services in the first half of 2001, in particular higher legal and accounting fees related to the SEC investigation and extended outside audit work.

In connection with the acquisitions we completed in 1999 and 2000, 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 2000, we recorded a charge of $1.3 billion related to the impairment of certain long-lived assets, including intangible assets. In addition, in connection with our second quarter 2001 restructuring initiative, an impairment assessment of certain long-lived assets was performed. As a result of this assessment in the second quarter of 2001, we recorded an additional impairment charge of $14.2 million to reduce these intangible assets to their estimated fair values or eliminate them, as appropriate. Based upon the types of intangible assets, $4.2 million of this impairment charge was allocated to cost of net revenues and $10.0 million was allocated to operating expenses.

In connection with the adoption of FAS No. 142, Goodwill and Other Intangible Assets, in the beginning of 2002, approximately $5.6 million of goodwill will no longer be subject to amortization, but instead will be periodically tested for impairment. As a result of the second quarter 2001 impairment charge and the adoption of FAS No. 142, third quarter 2002 amortization expense decreased significantly from the third quarter of 2001. Based upon the types of identifiable intangibles acquired, third quarter 2002 amortization expense of $4.6 million was allocated to cost of net revenues and the remaining amortization expense of $6.2 million was allocated to operating expenses.

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. The significant decrease in acquisition-related retention bonus expense resulted from the completion during fiscal year 2001 of all but one of the acquisition-related retention bonus programs. The remaining program concluded in April 2002.

In April 2001, we announced a strategic restructuring plan that involved reorganizing Critical Path’s product and service offerings around a group of core communications solutions, the divestiture of many non-core products and services, a reduction in our workforce, and the consolidation of facilities and operations. As a result, we recognized restructuring charges of $8.5 million in the second quarter of 2001 and $3.8 million in the third quarter of 2001.

Stock-based expenses are comprised of charges related to certain stock options and warrants granted to employees, directors and consultants and common stock issued to certain employees, directors and advisors in 1998 and 1999. The decline in stock-based expenses in the third quarter and first nine-months of 2002 in comparison to the same periods in 2001 was primarily the result of certain of these stock-based charges related to the completion of the 1998 and 1999 grant activity amortization.

Interest and other income (expense) consists primarily of interest earned from cash and cash equivalents, net realized gains (losses) on foreign exchange transactions, and any gain or loss from changes in the fair value of the return on equity preference feature granted to the investors who participated in the Critical Path 2001 preferred stock financing transaction. The net other income of $1.9 million reported for the third quarter of 2002 was primarily generated by the recording of a $1.2 million non-cash gain associated with the revaluation of the preferred stock preference feature discussed above and interest income earned during the period. The net other (expense) recognized for the first nine months of 2002 of $803,000 was due primarily to the

Interest income amounted to $369,000 and $1.3 million for the third quarter and first nine-months of 2002, respectively, compared to interest income of $1.1 million and $5.0 million for the comparable periods in 2001, respectively. Interest income was lower in 2002 compared to the same periods in the prior year due to lower cash balances available for investing. Cash balances declined during the twelve-month period ended September 30, 2002, due primarily to the funding of our net losses and cash utilized in 2001 to retire a significant portion of our convertible debt obligations.

We also recognized a net gain in the third quarter of 2002 in the amount of $113,000 from foreign currency transactions associated with our international operations, but a net loss totalling $464,000 for the first nine months of 2002. During 2001, we recognized a $1.0 million net loss and $500,000 net gain for the comparable three and nine-month periods, respectively.

Interest expense consists primarily of the interest charges and amortization of related issuance costs associated with the Convertible Subordinated Notes we issued in March 2000, and interest on certain capital leases. Because of the retirement of a significant portion of our convertible subordinated notes and capital leases during 2001, interest expense for the third quarter and first nine months of 2002 declined to $740,000 and $2.3 million, respectively, from $3.8 million and $14.2 million for the comparable periods in 2001.

In June 2000, we established a joint venture, Critical Path Pacific, Inc., 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 held a 40% ownership interest in the joint venture. This investment was accounted for using the equity method

On June 6, 2002, we acquired the remaining 60% ownership interest that Critical Path did not already own in Critical Path Pacific, Inc. for $3.0 million in cash and the assumption of $2.6 million in business restructuring and capital lease obligations. The excess of the purchase price of $5.6 million over the fair value of the acquired net assets, primarily working capital and fixed assets, of $4.6 million was recorded as goodwill. In accordance with SFAS No. 142, this goodwill asset of approximately $1.0 million will not be amortized; however, we will test this asset for impairment on an annual basis, or more frequently if events or circumstances indicate that the asset might be impaired. We began including the financial results of Critical Path Pacific in our own consolidated results subsequent to the acquisition date. As a result, the second quarter of 2002 represented the last quarter in which we will be using the equity method to account for our Japanese entity ownership interest.

During the third quarter and first nine months of 2002, we recorded equity in net loss of joint venture of approximately zero and $1.4 million, respectively, compared to a net loss of $346,000 and $1.5 million recorded in the third quarter and first nine months of 2001.

During the third quarter of 2002, we recognized a small provision for foreign income taxes as certain of our European operations generated income taxable in certain European jurisdictions. No current provision 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. On a year-to-date basis, our tax expense reflects an $800,000 first quarter 2002 U.S. federal income tax benefit due to the repeal of the federal corporate alternative minimum tax.

As of September 30, 2002, our cash, cash equivalents and short-term investments totaled $49.2 million, comprised of $35.4 million in cash and cash equivalents and $13.8 million in short-term investments. Our working capital amounted to approximately $29.5 million. For the first nine months of 2002, we used approximately $24.4 million in cash.

We used cash of $16.4 million to fund operating activities during the first nine months of 2002 primarily due to our net loss, adjusted for non-cash charges, as operating costs, primarily employee and employee related costs, exceeded the related sales of our software products and services. In addition, accrued expenses decreased by $1.5 million due primarily to the payment of the remaining acquisition retention bonus amounts during the second quarter of 2002. These uses of cash to fund operating activities were partially offset by improved receivable collections of $4.0 million.

We used cash in investing activities during the first nine months of 2002 totaling $7.2 million. Cash was primarily used to purchase capital equipment of approximately $4.9 million, which included investments in additional network infrastructure equipment and improvements to our new San Francisco headquarters. In addition, cash was used to purchase additional short-term investments of $4.1 million, and issue a cash security deposit of $3.0 million in support of a recently negotiated licensing agreement.

During the second quarter, the Company acquired the remaining 60% ownership interest in its Japanese joint venture, Critical Path Pacific, Inc., for $3.0 million in cash and the assumption of $2.6 million in business restructuring and capital lease obligations. As a result of the acquisition, Critical Path recognized a net increase in cash, as the cash held on the books of the joint venture exceeded the cash portion of the purchase price by $4.5 million.

We used cash in financing activities during the first nine months of 2002 of $865,000. Cash was principally used to retire $3.6 million in principal on capital lease obligations. This use of cash was partially offset by proceeds the Company received from the repayment of notes receivable from former officers and shareholders totaling $1.2 million, and $1.5 million from the sale of our common stock, primarily the result of stock option exercises.

In May 2002, the Board of Directors approved a restructuring plan to further reduce our expense levels consistent with the then current business climate. In connection with the plan, a restructuring charge of $1.5 million was recognized in the second quarter of 2002. This charge was comprised of approximately $1.2 million in severance and related costs associated with the elimination of approximately 39 positions and $300,000 in facilities lease termination costs. During the second and third quarters of 2002, approximately $762,000 was charged against this accrual, primarily cash payments of severance related costs. The balance of the accrual at September 30, 2002, of approximately $777,000 is expected to be utilized by the end of this fiscal year.

Our primary sources of capital have come from both debt and equity financings that have been completed by Critical Path over the past three years. Revenues generated from the sale of our products and services may not increase to a level that exceeds our operating expenses or could fluctuate significantly as a result of changes in customer demand or acceptance of future products. We also expect to experience increased operating expenses, including moderate increases in strategic areas, such as sales and marketing, and we anticipate that operating expenses and capital expenditures will constitute a material use of our cash. Accordingly, our cash flow from operations may continue to be negatively impacted. We believe that our cash, cash equivalents and anticipated cash from operations will be sufficient to maintain current and planned operations for at least the next twelve months.

Additionally, we have no present understandings, commitments or agreements for any material acquisitions of, or investments in, other complementary businesses, products or technologies. We continually evaluate potential acquisitions of, or investments in, other businesses, products and technologies, and may in the future utilize our cash resources or may require additional equity or debt financing to accomplish any acquisitions or investments. As of the date of this Report, we are considering several alternatives to expand our presence in the Asian markets and potentially other international markets. These alternatives could increase liquidity

through the infusion of investment capital by third-party investors or decrease our liquidity as a result of Critical Path seeking to fund expansion into these markets. Such activities might also cause an increase in capital expenditures and operating expenses.

Due to our limited operating history, evolving business strategy and the nature of the messaging and directory infrastructure market, our 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 integration of acquisitions we completed in 1999 and 2000, our recent strategic and operational 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, 30% in 2001 and 31% for the third quarter of 2002. Our revenues have in some quarters and could continue to 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:


	•	the demand for licensed solutions for messaging, directory, and other products;

	•	the demand for outsourced messaging services generally and the use of messaging and directory infrastructure products and services in particular;

	•	our ability to attract and retain customers and maintain customer satisfaction;

	•	our ability to attract and retain qualified personnel with industry expertise, particularly sales personnel;

	•	the ability to upgrade, develop and maintain our systems and infrastructure and to effectively respond to the rapid technology change of the messaging and directory infrastructure market;

	•	the budgeting and payment 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 quickly handle and alleviate technical difficulties or system outages;

	•	the announcement or introduction of new or enhanced services by competitors; and

	•	general economic and market conditions and their affect on our operations and that of our customers.

In addition to the factors set forth above, operating results have been and will continue to 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 investors and other parties with whom we have business relationships. These grants of options and warrants also may be dilutive to existing shareholders.

In addition, our operating results have been affected and could continue to be impacted by the elimination of product or service offerings through termination, sale or other disposition. Future decisions to eliminate, revise or limit any other offerings of a product or service would involve other factors affecting operational results including the expenditure of capital, the realization of losses, further reductions in our workforce, facility consolidation 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, we do not believe that period-to-period comparisons of operating results are a good indication of future performance. It is likely that operating results in some quarters will be below market

Our ability to increase revenues will depend on our ability to continue to successfully recruit, train and retain experienced and effective sales and marketing personnel and to achieve results once employed with us. Competition for experienced and effctive personnel in certain markets is intense and we may not be able to hire and retain personnel with relevant experience. Moreover, our competitors frequently have larger and more established sales forces calling upon potential enterpise customers with more frequency. The complexity and implementation of our messaging and directory infrastructure products and services also 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 and training efforts would impair our ability to attract new customers and enhance our relationships with existing customers, and ultimately, grow revenues. This would also adversely impact the timing and extent of our revenues from quarter to quarter and overall or could jeopardize sales altogether. Because we have experienced turnover in our sales force and have fewer resources than many of our competitors, our sales and marketing organizations may not be able to compete successfully against the sales and marketing organizations of our competitors. In addition, certain of our competitors have longer and closer relationships with the senior management of enterprise customers who decide whose technologies and solutions to deploy. If we do not successfully operate and grow our sales and marketing activities, our business and results of operations could suffer and the price of our common stock could continue to decline.

As of September 30, 2002, we had an accumulated deficit, including other comprehensive income, of approximately $2.2 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. However, we will continue to spend resources on maintaining and strengthening our business, and this may, in the near term, have a negative effect on our operating results and our financial condition.

In past quarters, 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 messaging and directory infrastructure solutions, and to improve our sales and marketing organizations, strategic relationships and operating infrastructure. We expect that our cost of revenues, sales and marketing expenses, general and administrative expenses, 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. 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 related stock-based compensation. If revenues do not correspondingly increase, our operating results and financial condition could be harmed. If we continue to incur net losses in future periods, we may not be able to retain employees, or 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 be able to sustain or increase profitability in the future. This may also, in turn, cause the price of our common stock to demonstrate volatility and/or continue to decline.

Throughout 2001 and 2002, we announced a series of changes in our management that included the departure of many senior executives and also made changes in our board of directors. A majority of the board of directors and senior executives of the Company joined us in 2001 and 2002. We have made additional changes in recent months to our senior management team due to a variety of factors. Because of these changes and recent recruitment, our management team has not worked together as a group for a significant length of

time and may not be able to work together effectively to successfully execute on revenue goals, implement our strategies and manage our operations. If our management team is unable to accomplish our business objectives, our ability to grow our business and successfully meet operational challenges could be severely impaired. We do not have long-term employment agreements with any of our executive officers. It is possible that this high turnover at our senior management levels may also continue for a variety of reasons. The loss of the services of one or more of our key senior executive officers could harm our business and affect our ability to successfully implement our business objectives.

We depend on strategic relationships to expand distribution channels and opportunities and to undertake joint product development and marketing efforts. Our ability to increase revenues depends upon aggressively marketing our services through new and existing strategic relationships. In the third quarter, we entered into certain partnership agreements in our hosted messaging business with the Hewlett-Packard Company for the development and marketing of a complete managed messaging solution. In coming quarters we will be investing heavily in this relationship and making changes in our operations, including outsourcing our data operations, to accommodate the integration of this partnership. To the extent this integration does not proceed as anticipated or the anticipated benefits of this partnership are not borne out, our business and results may be harmed. In addition, if service levels are not adequate in connection with the outsourcing of our data centers, our customers may terminate agreements and our business will suffer. We also depend on a broad acceptance of our software and outsourced messaging services on the part of potential resellers and partners and our acceptance as a supplier of outsourced messaging solutions. We also depend on joint marketing and product development through strategic relationships to achieve further market acceptance and brand recognition. Our agreements with strategic partners typically do not restrict them from introducing competing services. These agreements typically are for terms of one to three years, and automatically renew for additional one-year periods unless either party gives prior notice of its intention to terminate the agreement. In addition, these agreements are terminable by our partners without cause, and some agreements are terminable by us, upon 30 - 120 days notice. Most of the agreements also provide for the partial refund of fees paid or other monetary penalties in the event that our services fail to meet defined minimum performance standards. Distribution partners may choose not to renew existing arrangements on commercially acceptable terms, or at all. In addition to strategic relationships, we also depend on the ability of our customers to aggressively sell and market our services to their end-users. If we lose any strategic relationships, fail to renew these agreements or relationships, fail to fully exploit our relationships, or fail to develop new strategic relationships, our business and financial results will suffer, and could have an adverse impact on our current and future revenues.

We expect that sales of our products and services to a limited number of customers will continue to account for a high percentage of our revenue for the foreseeable future. Our future success depends on our ability to retain our current customers, and to attract new customers, in our target markets. The loss of one or several major customers, whether through termination of agreements, acquisitions or bankruptcy, could harm our business. Our agreements with our customers typically have terms of one to three years often with automatic one-year renewals and can be terminated without cause upon 30 - 120 days notice. In addition, a number of our customers, particularly for our hosted services business and in the technology industry, have also suffered from falling revenue, job losses, restructuring and decreased technology spending in the recent economic downturn. Especially in the telecommunications industry, which represents a sizeable portion of our customer base, the relative financial performance of our customers will continue to impact our sales cycles and ability to attract new business. If our customers terminate their agreements for any reason before the end of the contract term, the loss of the customer could have an adverse impact on our current and future revenues. Also, if we are unable to enter into agreements with new customers and develop business with our existing customers, our business will not grow and we will not generate additional revenues.

Because we have a variety of messaging and directory infrastructure products and services, we encounter different competitors at each level of our products and services. Our primary competitors for service providers seeking insourced or outsourced product-based solutions are iPlanet and OpenWave. For secure delivery services, our competitors include Tumbleweed for product-based solutions and SlamDunk for service-based solutions. In the enterprise/eBusiness directory category, we compete primarily with iPlanet, Microsoft and Novell, and our competitors in the meta-directory market are iPlanet, Microsoft, Novell and Siemens. Our competitors for corporate customers seeking outsourced hosted messaging solutions are email service providers, such as Commtouch, Easylink, USA.NET and application service providers who offer hosted exchange services.

We believe that some of the competitive factors affecting the market for messaging and directory infrastructure solutions include:


	•	breadth of platform features and functionality of our offerings and the sophistication, innovation of competitors’;

	•	total cost of ownership and operation.

	•	scalability, reliability and performance, and ease of integration into existing systems, expansion and upgrade;

	•	flexibility to enable customers to manage certain aspects of their systems internally and leverage outsourced services in other cases when resources, costs and time to market reasons favor an outsourced offering; and

We believe competition will continue to be fierce and further increase as current competitors increase the sophistication of their offerings and as new participants enter the market. Many of our current and potential competitors have longer operating histories, larger customer bases, greater brand recognition and significantly greater financial, marketing and other resources than we do and may enter into strategic or commercial relationships with larger, more established and better-financed companies. Any delay in our development and delivery of new services or enhancement of existing services would allow our competitors additional time to improve their service or product offerings, and provide time for new competitors to develop and market messaging and directory infrastructure products and services and solicit prospective customers within our target markets. Increased competition could result in pricing pressures, reduced operating margins and loss of market share, any of which could cause our business to suffer.

Because we sell complex and sophisticated technology, our sales cycle, in particular with respect to our software solutions, can be long and unpredictable, often taking between two to twelve months. Because of the nature of our product and service offerings it can take many months of customer education and product evaluation before a purchase decision is made. In addition, many factors can influence the decision to purchase our product and service offerings including budgetary restraints and decreases in capital expenditures, quarterly fluctuations in operating results of customers and potential customers, the emerging and evolving nature of the internet-based services and wireless services markets. Furthermore, general global economic conditions, and weakness in global securities markets, continuing recessionary spending levels, and a protracted slowdown in technology spending in particular, have further lengthened and affected our sales cycle. Such factors have led to and could continue to lead to delays and postponements in purchasing decisions and in many cases cancellations of anticipated orders. Any delay or cancellation in sales of our products or services could cause our operating results to differ from those projected and cause our stock price to decline.

We believe that existing capital resources will enable us to maintain current and planned operations through at least September 30, 2003. However, additional capital may be required to continue operations and achieve profitability. In addition, we may be required to raise additional funds due to unforeseen circumstances and market conditions. If our capital requirements vary materially from those currently planned, we may require additional financing even 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. Additionally, we face a number of challenges in operating our business, including but not limited to the resources to maintain worldwide operations, continued sluggishness in technology spending, and significant contingent liabilities associated with litigation. In the event that resolution of these or other operational matters involve issuance of stock or other derivative instruments, our existing shareholders may experience significant dilution.

In recent years, we have had filed a number of lawsuits against us, including securities class action and shareholder derivative litigation filed in February and August 2001, and certain of our former officers and directors and some of our subsidiaries, as well as other lawsuits related to acquisitions, employee terminations and copyright infringement. While these lawsuits vary greatly in the materiality of potential liability associated with them and many have been satisfactorily settled, the uncertainty associated with substantial unresolved lawsuits could seriously harm our business, financial condition and reputation, whether material individually or in the aggregate. In particular, this uncertainty could harm our relationships with existing customers, our ability to obtain new customers and our ability to operate certain aspects of our business.

The continued defense of the lawsuits also could result in continued diversion of our management’s time and attention away from business operations, which could harm our business. Negative developments with respect to some of these lawsuits could cause the price of our common stock 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 each of these lawsuits by settlement or otherwise, the size of any such payments, individually or in the aggregate, could seriously harm our financial condition. Many of the complaints associated with these lawsuits 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. While we maintain customary business insurance coverage, in some cases we have not set aside financial reserves relating to potential damages associated with some of these lawsuits.

Although the Company reached and the court approved settlement agreements in connection with the securities class action pending in the U.S. District Court for the Northern District of California, a number of plaintiffs associated with the acquisition of Peer Logic, Inc. opted out of such settlement. The case against the Company with respect to these plaintiffs continues in the Southern District of New York. In addition, the Company is a defendant in a number of securities class action lawsuits filed in the U.S. District Court for the Southern District of New York, alleging that prospectuses under which securities were sold contained false and misleading statements with respect to discounts and commissions received by underwriters. Should these lawsuits linger for a long period of time, whether resolved in the Company’s favor or not, or further lawsuits be filed against us there can be no assurance that fees and expenses, and any ultimate resolution associated with such litigation, will be within the coverage limits of our insurance and/or our ability to pay such amounts. Likewise, there can be no assurance that the Company will be able to conclude or settle such litigation on terms that coincide with the coverage limits of our insurance and/or ability to pay upon any final determination. A failure to definitively resolve material litigation in which the Company is involved or in which it may become involved in the future, regardless of the merits of the respective cases, could also cast

In 2001, the SEC investigated the Company and certain of its former officers and directors related to non-specified accounting matters, financial reports, other public disclosures and trading activity in our stock. In February 2002, the SEC concluded the investigation as to the Company. Although the SEC did not impose any financial or criminal penalties against the Company, we consented, without admitting or denying liability, to a cease and desist order and an administrative order for violation of certain non-fraud provisions of the federal securities laws. In addition, since then the SEC and the Department of Justice charged five former employees of the Company with various violations of the securities laws. We believe that the investigation continues with respect to a number of other former executives and employees of the Company and expect that such investigation may result in further charges against former employees although we do not know the status of such investigation. Despite the conclusion of the investigation of the Company, lingering concerns about the actions leading up to the restatement of financials for the third quarter of 2000 have nevertheless cast doubt on the future of the Company in the eyes of customers and investors. In addition, a number of recent arrests, allegations and investigations in connection with accounting improprieties, insider trading and fraud at other public companies have created investor uncertainty and scrutiny in general as to the stability and veracity of public companies’ financial statements. Such lingering doubts stemming from the Company’s past accounting restatements and such general market uncertainty could harm our business and cause the price of our common stock to continue to fluctuate and/or decline further.

In the past, our management of operational expenses and the growth of our business have contributed to our history of losses. In addition, both the restructuring and expansion of our operations has in the past placed significant strains on managerial, operational and financial resources and affected our results. In addition, to manage any future growth and profitability we may need to improve or replace our existing operational, customer service and financial systems, procedures and controls. Any failure to properly manage these systems and procedural transitions could impair our ability to attract and service customers, and could cause us to incur higher operating costs and delays in the execution of our business plan. We will also need to hire additional personnel including highly skilled sales personnel. Our management may not be able to hire, train, retain, motivate and manage required personnel. In addition, our management may not be able to successfully identify, manage and exploit existing and potential market opportunities. If we cannot manage growth and expenses effectively, our business and operating results could suffer. In addition, the Company continues to evaluate its operations and cost structure in order to right size its operations to its business and prospects. Any failure to appropriately manage efficiencies in its operations could cause harm to our business and results.

The Nasdaq Stock Market has quantitative maintenance criteria for the continued listing of common stock on the Nasdaq National Market. The current requirements affecting us include (i) having net tangible assets of at least $4 million and (ii) maintaining a minimum closing bid price per share of $1. As of November 13, 2002 we were not in compliance with Nasdaq National Market minimum bid listing requirements and had not been in compliance since September 19, 2002. As of December 20, 2002, if our common stock price remains below $1.00 and in the event we are unable to take actions that result in per share closing bid price exceeding and remaining above $1.00 for a period of ten trading days, we may be subject to a delisting action of our common stock by The Nasdaq National Market. Also effective November 1, 2002, we need to comply with the Nasdaq National Market’s revised quantitative maintenance criteria including a new minimum requirement of $10.0 million in stockholders’ equity. The Nasdaq National Market’s Audit Committee Rules require that our audit committee be comprised of at least three independent members.

Although we believe that we currently comply with this requirement and other Nasdaq National Marketplace Rules, recent amendments to such rules may involve changes to listing requirements and the membership of our Board committees, and will require review and potential changes in our policies, procedures and committee memberships to remain in compliance. As a result, the Company is currently evaluating its compliance with rule changes to ensure future compliance with proposed, and amended rules. However, there can be no assurance that we will be able to comply with the quantitative maintenance criteria or any of the Nasdaq National Market’s listing requirements or other rules, or other markets listing requirements to the extent our stock is listed elsewhere, in the future.

If we fail to maintain continued listing on the Nasdaq National Market and must move to a market with less liquidity, our financial condition could be harmed and our stock price would likely further decline. If we are delisted, it could have a material adverse effect on the market price of, and the liquidity of the trading market for, our common stock.

The trading price of our common stock has been and may continue to experience volatility, wide fluctuations and declines. For example, during the third quarter of 2002, the closing sale prices of our common stock on the Nasdaq National Market ranged from $1.15 on August 1, 2002 to $0.56 on September 23, 2002. The closing price of our stock on September 30, 2002 was $0.63 per share. Our stock price may further decline or fluctuate in response to any number of factors and events, such as announcements related to technological innovations, intense regulatory scrutiny and new corporate and securities and other legislation, strategic and sales relationships, new product and service offerings by us or our competitors, litigation outcomes, changes in senior management, changes in financial estimates and recommendations of securities analysts, the operating and stock price performance of other companies that investors may deem comparable, news reports relating to trends in our markets and the market for our stock, media interest in accounting scandals and corporate governance questions, overall market conditions and domestic and international economic factors unrelated to our performance. In addition, the stock market in general, particularly with respect to technology stocks, has experienced extreme volatility and a significant cumulative decline in recent quarters. This volatility and decline has affected many companies, including our company, irrespective of the specific operating performance of such companies. These broad market influences and fluctuations may adversely affect the price of our stock, and our ability to remain listed on the Nasdaq National Market, regardless of our operating performance or other factors.

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 former executive officers are alleged to have occurred, provided only limited liability protection. While these policies covered the settlement amount paid in connection with the settlement of the primary securities class action, there can be no assurance that the policies will continue to cover other pending matters and related expenses from that period or future periods. If these policies do not adequately cover our expenses related to those lawsuits and the investigation, our business and financial condition could be seriously harmed. Our current director and officer liability insurance, which was put in place in March 2002, and continues through March 2003, contains similar provisions, and in the event circumstances arise requiring coverage by such policies there can be no assurance that they will be adequate for the liabilities and expenses potentially incurred. To the extent liabilities, expenses, or settlements thereof, exceed the limitations of coverage, our business and financial condition could be materially 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 Company has made payments in connection with the indemnification of officers and directors in

The loss of the services of key personnel could harm our business results. Our success also 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. If we fail to do so, we may be unable to develop new services or continue to provide a high level of customer service, which could result in the loss of customers and revenues. In addition, volatility and declines in our stock price may also affect our ability to retain key personnel, all of whom have been granted stock-based incentive compensation. In recent quarters we have also initiated reductions in our work force and job eliminations to balance the size of our employee base with anticipated revenue levels. Reductions in our workforce could make it difficult to motivate and retain remaining employees or attract needed new employees, and provide distractions affecting our ability to deliver products and solutions in a timely fashion and provide a high level of customer service and support.

We do not have long-term employment agreements with any of our 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 key personnel could harm our business and affect our ability to successfully implement our business objectives.

During 2001, we reorganized our product and service offerings around a group of core products deemed most imperative to our ability to serve the messaging and directory infrastructure market. Implementation of the plan occurred in the latter half of 2001 and, accordingly, products and services determined to be non-core to our strategy were exited. As a result, revenue from non-core products and services comprising approximately 37% of total revenues in the first quarter of 2001 declined to approximately 3% of total revenues in the fourth quarter of 2001 and to none in 2002. Our strategic plan also included initiatives aimed at reducing operating costs through headcount reduction and consolidation of approximately two-thirds of our office space and related contracts and leases, all in keeping with our increased focus on core messaging products and services. During the fourth quarter of 2001 we incurred additional charges in connection with previously announced reductions in force and were able to finalize the consolidation of additional facilities and related contracts and expenses associated with those facilities. In 2002, we have incurred a number of restructuring charges related to the right-sizing of our business given market conditions and the current operating environment. These efforts included additional facilities and equipment lease terminations, continuing expense management and headcount reductions. We expect to continue to make determinations about the strategic future of our business and operations and our ability to execute on such plans effectively and to make such determinations prudently could affect our future operations. A failure to successfully execute on such plans and to plan appropriately could negatively effect our business and financial condition.

Acquisitions involve risks related to the integration and management of acquired technology, operations and personnel. In addition, in connection with our strategic restructuring, the Company elected to divest or discontinue many of the acquired businesses. Both the integration and divestiture of acquired businesses have been and will continue to be complex, time consuming and expensive processes, which may disrupt and distract our management from its core business. With respect to integration, we must operate as a combined organization utilizing common information and communication systems, operating procedures, financial controls and human resources practices to be successful. With respect to the divestitures, the timing and transition of those businesses and their customers to other entities has required and will continue to require

resources from our legal, finance and corporate development teams as well as expenses associated with the conclusion of those transactions, winding up of entities and businesses and we may not ultimately achieve anticipated benefits and/or cost reductions from such divestitures.

In the past, due to the significant underperformance of some of our acquisitions relative to expectations, we eliminated certain acquired product or service offerings through termination, sale or other disposition. Such decisions to eliminate or limit our offering of an acquired product or service involved and could continue to include the expenditure of capital, the realization of losses, further reduction in 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.

We intend to continue to license certain technologies from third parties and incorporate such technologies into our products and services, including web server technology, virus and anti-spam solutions, storage and encryption technology. The market is evolving and we may need to license additional technologies to remain competitive. We may not be able to license these technologies on commercially reasonable terms or at all. To the extent we cannot license needed technologies or solutions, we may have to devote Company resources to the development of such technologies that could materially harm our business and operations.

In addition, we may fail to successfully integrate any licensed technology into our services. These third-party in-licenses may expose us to increased risks, including risks related to the integration of new technology, potential patent and copyright infringement issues, the diversion of resources from the development of proprietary technology, and an inability to generate revenues from new technology sufficient to offset associated acquisition and maintenance costs. In addition, an inability to obtain needed licenses could delay product and service development until equivalent technology can be identified, licensed and integrated. Any delays in services or integration problems could cause our business and operating results to suffer.

A fundamental requirement for online communications is the secure transmission of confidential information over public networks. Third parties may attempt to breach our security or that of our customers. If these attempts are successful, customers’ confidential information, including customers’ profiles, passwords, financial account information, credit card numbers or other personal information could be breached. We may be liable to our customers for any breach in security and a breach could harm our reputation. We rely on encryption technology licensed from third parties. Although we have implemented network security measures, our servers remain vulnerable to computer viruses, physical or electronic break-ins and similar disruptions, which could lead to interruptions, delays or loss of data. We may be required to expend significant capital and other resources to license encryption technology and additional technologies to protect against security breaches or to alleviate problems caused by any breach. Failure to prevent security breaches may harm our business and operating results.

Few laws currently apply directly to activity on the Internet and the messaging business, however new laws are proposed and other laws made applicable to Internet communications every year. In particular, the operations of the Company’s business faces risks associated with privacy, confidentiality of user data and communications, consumer protection, taxation, content, copyright, trade secrets, trademarks, antitrust, defamation and other legal issues. In particular, legal concerns with respect to communication of confidential data have affected our financial services and health care customers due to newly enacted federal legislation. The growth of the industry and the proliferation of Internet-based messaging devices and services may prompt further legislative attention to our industry and thus invite more regulatory control of our business. The imposition of more stringent protections and/or new regulations and application of laws to our business could

burden our company and those with which we do business. Further, the adoption of additional laws and regulations could limit the growth of our business and that of our business partners and customers. Any decreased generalized demand for our services or the loss of, or decrease, in business by a key partner due to regulation or the expense of compliance with any regulation, could either increase the costs associated with our business or affect revenue, either of which could harm our financial condition or operating results. Certain of our service offerings include operations subject to the Digital Millenium Copyright Act of 1998. The Company has expended resources and implemented processes and controls in order to remain in compliance with DMCA but there can be no assurance that our efforts will be sufficient and/or new legislation and case law will not affect the operation of certain services.

In addition, the applicability of laws and regulations directly applicable to the businesses of our customers, particularly customers in the fields of banking and health care, will continue to affect us. The security of information about our customers’ end-users continues to be an area where a variety of laws and regulations with respect to privacy and confidentiality are enacted. As our customers implement the protections and prohibitions with respect to the transmission of end user data, our customers will look to us to assist them in remaining in compliance with this evolving area of regulation. In particular the Gramm-Leach-Blilely Act contains restrictions with respect to the use and protection of banking records for end-users whose information may pass through our system and the Health Insurance Portability and Accountability Act contains provisions that require our customers to ensure the confidentiality of their customers’ health care information.

Finally, the Company faces increased regulatory scrutiny and criminal liability for its executives associated with various accounting and corporate governance rules promulgated under the Sarbanes-Oxley Act of 2002. The Company is currently reviewing all of its accounting policies and practices, legal disclosure and corporate governance policies under the new legislation, including those related to its relationships with its independent accountants, enhanced financial disclosures, internal controls, board and board committee practices, corporate responsibility and loan practices, and intends to fully comply with such laws. Nevertheless, such increased scrutiny and penalties involve risks to both the Company and its executive officers and directors in monitoring and insuring compliance. A failure to properly navigate the legal disclosure environment and implement appropriate policies and procedures if needed could harm the Company’s business and prospects.

Our software products are inherently complex. Additionally, our product and service offerings depend on complex software, both internally developed and licensed from third parties. Complex software often contains defects or errors in translation, particularly when first introduced or when new versions are released or localized for international markets. We may not discover software defects in our products or that affect new or current services or enhancements until after they are deployed. Although we have not experienced any material software defects to date, it is possible that, despite testing, defects may occur in the software. These defects could cause service interruptions, which could damage our reputation or increase service costs, cause us to lose revenue, delay market acceptance or divert development resources, any of which could cause our business to suffer.

As a provider of messaging and directory services, we face potential liability for defamation, negligence, copyright, patent or trademark infringement and other claims based on the nature and content of the materials transmitted via our services. We do not and cannot screen all of the content generated by our users, and we could be exposed to liability with respect to this content. Furthermore, some foreign governments, such as Germany, have enforced laws and regulations related to content distributed over the Internet that are more strict than those currently in place in the United States. In some instances, we may be subject to criminal liability in connection with Internet content transmission.

Although we carry general liability and umbrella liability insurance, our insurance may not cover claims of these types or may not be adequate to indemnify us for all liability that may be imposed. There is a risk that

a single claim or multiple claims, if successfully asserted against us, could exceed the total of our coverage limits. There also is a risk that a single claim or multiple claims asserted against us may not qualify for coverage under our insurance policies as a result of coverage exclusions that are contained within these policies. Should either of these risks occur, capital contributed by our shareholders might need to be used to settle claims. Any imposition of liability, particularly liability that is not covered by insurance or is in excess of insurance coverage could harm our reputation and business and operating results, or could result in the imposition of criminal penalties.

Our customers have, in the past, experienced some interruptions in our messaging service. We believe that these interruptions will continue to occur from time to time. These interruptions are due to hardware failures, unsolicited bulk email, or “spam,” attacks and operating system failures. Our business will suffer if we experience frequent or long system interruptions that result in the unavailability or reduced performance of systems or networks or reduce our ability to provide email services. We expect to experience occasional temporary capacity constraints due to sharply increased traffic, which may cause unanticipated system disruptions, slower response times, impaired quality and degradation in levels of customer service. If this were to continue to happen, our business and reputation could suffer dramatically.

We have entered into messaging agreements with some customers that require minimum performance standards, including standards regarding the availability and response time of messaging services. If we fail to meet these standards, our customers could terminate their relationships with us and we could be subject to contractual monetary penalties.

We rely on a combination of trademark, copyright and trade secret laws, contractual restrictions, such as confidentiality agreements and licenses, and patents to establish and protect our proprietary rights, which we view as critical to our success. Our ability to compete and grow our business could suffer if these rights are not adequately protected. We seek to protect our source code for our software, documentation and other written materials under trade secret and copyright laws. We license our software pursuant to agreements that impose certain restrictions on the licensee’s ability to utilize the software. Despite these precautions, unauthorized third parties may infringe or copy portions of our services or reverse engineer or obtain and use information that we regard as proprietary, which could harm our competitive position and market share. We also seek to avoid disclosure of our intellectual property by requiring employees and consultants with access to our proprietary information to execute confidentiality agreements. In addition, we have several patents pending in the United States and may seek additional patents in the future. However, the status of United States patent protection in the software industry is not well defined and will evolve as the U.S. Patent and Trademark Office grants additional patents. We do not know if our patent applications or any of our future patent applications will be issued with the scope of the claims sought, if at all, or whether any patents we have received or will receive will be challenged or invalidated.


	•	laws and contractual restrictions may not prevent misappropriation of our technologies or deter others from developing similar technologies;

	•	policing unauthorized use of our products and trademarks is difficult, expensive and time-consuming, and we may be unable to determine the extent of this unauthorized use; and

	•	end user license provisions in our contracts that protect us against unauthorized use, copying, transfer and disclosure of the licensed program may be unenforceable.

In addition, the laws of some foreign countries may not protect proprietary rights to the same extent as do the laws of the United States. Our means of protecting proprietary rights in the United States or abroad may not be adequate and competitors may independently develop similar technology. Additionally, although no claims of alleged patent infringement are currently pending, we cannot be certain that our products do not infringe issued patents that may relate to our products. In addition, because patent applications in the United States are not publicly disclosed until the patent is issued, applications may have been filed which relate to our software products.

The messaging directory infrastructure industry is characterized by rapid technological change, changes in user and customer requirements and preferences, and the emergence of new industry standards and practices that could render our existing services, proprietary technology and systems obsolete. We must continually improve the performance, features and reliability of our services, particularly in response to competitive offerings. Our success depends, in part, on our ability to enhance our existing email and messaging services and to develop new services, functionality and technology that address the increasingly sophisticated and varied needs of prospective customers. If we do not properly identify the feature preferences of prospective customers, or if we fail to deliver email features that meet the standards of these customers, our ability to market our service successfully and to increase revenues could be impaired. The development of proprietary technology and necessary service enhancements entails significant technical and business risks and requires substantial expenditures and lead-time. We may not be able to keep pace with the latest technological developments. We may also be unable to use new technologies effectively or adapt services to customer requirements or emerging industry standards.

We assume a certain level of credit risk with our customers in order to do business. Conditions affecting any of our customers could cause them to become unable or unwilling to pay us in a timely manner, or at all, for products or services we have already provided them. For example, if the current economic conditions continue to decline or if new or unanticipated government regulations are enacted which affect our customers, they may be unable to pay their bills. In the past, we have experienced significant collection delays from certain customers, and we cannot predict whether we will continue to experience similar or more severe delays in the future. In particular, some of our customers are suffering from the general weakness in the economy and among technology companies in particular. Although we have established reserves that we believe are sufficient to cover losses due to delays in or inability to pay and while we take a consistently conservative position on the collectability of revenue with respect to particular customers, there can be no assurance that such reserves will be sufficient to cover our losses. If losses due to delays or inability to pay are greater than our reserves, it could harm our business, operating results and financial condition.

We derived 57% of our revenues from international sales in the first three quarters of 2002 and 40% of our revenues from international sales in the first three quarters of 2001. We intend to continue to operate in international markets and to spend significant financial and managerial resources to do so. In particular, we have recently purchased the remaining interests of our joint venture partners for our operations in Japan. We plan to expend revenues and resources to grow our operations in the Asian market. 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 or operate 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;


	•	differing technology standards and language and translation issues;

	•	difficulties in collecting accounts receivable and longer collection periods;

	•	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.

During 2000 and 2001, California experienced a serious energy crisis that could have and may in the future disrupt our operations and increase our expenses. In the event of an acute power shortage, that is, when power reserves for the State of California fall below 1.5%, California has on several occasions implemented, and may in the future continue to implement, rolling blackouts throughout the state. If blackouts interrupt our power supply or the power supply of any of our customers, we, or our customers, may be temporarily unable to operate. Any interruption in our ability to continue operations or great increase in the cost of doing business could delay the development of or interfere with the sales of our products. Future interruptions could damage our reputation, harm our ability to retain existing customers and to obtain new customers, and could result in lost revenue, any of which could substantially harm our business and results of operations. Any interruption in the ability of our customers to continue their operations, could harm their business, and ultimately could also harm our business if they were to terminate or fail to renew contracts. We do not carry sufficient business interruption insurance to compensate us for losses that may occur as a result of blackouts, and any losses or damages we incur could harm our business. Furthermore, the deregulation of the energy industry instituted in 1996 by the California government and shortages in wholesale electricity supplies have caused power prices to increase dramatically. If wholesale prices continue to increase, our operating expenses will likely increase, as our headquarters and many employees are based in California.

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 our board of directors without prior shareholder approval, commonly referred to as “blank check” preferred stock, with rights senior to those of our common stock;

	•	prohibit shareholder action by written consent; and

	•	establish advance notice requirements for submitting nominations for election to our 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.

The following supplemental alternative measurement financial information presents Critical Path’s condensed consolidated results of operations during the three and nine-month periods ended September 30, 2001 and 2002, excluding the impact of certain special charges consisting of (i) amortization of intangible assets associated with purchase business combinations and financing transactions, (ii) accruals for employee retention bonuses associated with purchase business combinations, (iii) stock-based compensation associated with outstanding options and warrants, (iv) one-time charges related to restructuring initiatives, (v) write-down of investments, (vi) impairment of long-lived assets, (vii) extraordinary gains on retirement of convertible subordinated notes, (viii) gain (loss) on adjustment to market of the preferred stock instrument, and (ix) accretion on redeemable convertible preferred shares. 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.

Alternative Measurement Condensed Consolidated Statements of Operations Data

(1)

Earnings before interest, taxes, depreciation and amortization, equity in net loss of joint venture and one-time charges identified in the following table. EBITDA is calculated by excluding from loss from operations depreciation expense of approximately $10.6 million and $33.1 million for the three and nine-month periods ended September 30, 2001, and depreciation expense of $6.7 million and $21.9 million for the three and nine-month periods ended September 30, 2002.

The following table reconciles the alternative measurement financial data presented above to the consolidated operating results prepared and presented in accordance with generally accepted accounting principles (“GAAP”).

As of September 30, 2002, our investment portfolio consisted of available-for-sale securities, excluding those classified as cash equivalents, of $15.5 million. These securities consist of $1.7 million of strategic equity investments in corporate partners, certain of which are publicly traded and marketable and certain of which are privately held and $13.8 million of high grade, low risk government securities and corporate bonds. These equity securities are subject to price risk. Critical Path’s long-term obligations consist of our $38.4 million of face value 5.75% Convertible Subordinated Notes due April 2005, and certain fixed rate capital leases. We do not plan 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 rate 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 disclosures about market risk is set forth in “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

(a) Evaluation of Controls and Procedures. Based on their evaluation, as of a date within 90 days of the filing of this Form 10-Q, the Company’s Chief Executive Officer and Chief Financial Officer have concluded the Company’s disclosure controls and procedures (as defined in Rules 13a-14 and 15d-14 under the Securities Exchange Act of 1934) are effective.

(b) Changes in Internal Controls. There were no significant changes in the Company’s internal controls or in other factors that could significantly affect these controls subsequent to the date of their evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

We have reviewed the accompanying condensed consolidated balance sheet of Critical Path, Inc. and its subsidiaries as of September 30, 2002 and the related condensed consolidated statements of operations for the three and nine-month periods ended September 30, 2002 and the condensed consolidated statements of cash flows for the nine-month periods ended September 30, 2002 and 2001. These financial statements are the responsibility of the Company’s management.

We conducted our review in accordance with standards established by the American Institute of Certified Public Accountants. A review of interim financial information consists principally of applying analytical procedures to financial data and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with generally accepted auditing standards, the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.

Based on our review, we are not aware of any material modifications that should be made to the accompanying condensed consolidated interim financial information for it to be in conformity with accounting principles generally accepted in the United States of America.

We previously audited in accordance with auditing standards generally accepted in the United States of America, the consolidated balance sheet as of December 31, 2001, and the related consolidated statements of operations, of shareholders’ equity, and of cash flows for the year then ended (not presented herein), and in our report dated February 5, 2002 we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying condensed consolidated balance sheet as of December 31, 2001, is fairly stated in all material respects in relation to the consolidated balance sheet from which it has been derived.

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 Action in Southern District of New York. On April 30, 2002, MBCP PeerLogic LLC and other named plaintiffs filed suit in the U.S. District Court for the Southern District of New York against Critical Path and certain of its former officers. In June 2002, the plaintiff shareholders opted out of a shareholder litigation settlement that was approved by the U.S. District Court for the Northern District of California. The complaint alleged breach of contract, unjust enrichment, common law fraud and violations of federal securities laws and seeks compensatory and punitive damages in an unnamed amount but in excess of $200 million. Litigation in this matter is ongoing. The Company filed a motion to have the case transferred to the Northern District of California and is awaiting the court’s review of such motion.

Francisco Board of Appeals. The Company requested a rehearing on the matter, which the Board of Appeals denied. In April 2002, the landlord filed suit in San Francisco Superior Court against the Company alleging, among other things, breach of the lease. In its complaint, the landlord sought unspecified compensatory damages for back rent, attorneys’ fees, treble damages under relevant statutes, and unspecified punitive damages. A number of the plaintiff’s claims of damages were struck by the court in response to the Company’s motion to strike. The plaintiff submitted an amended complaint in September 2002 and a hearing is scheduled on the Company’s motion to strike in November 2002. In July 2002, the Company filed a separate Petition for Writ of Administrative Mandamus with the San Francisco Superior Court, requesting that the Board of Appeals’ decision be reversed and/or remanded for rehearing by the Board, with instructions from the Court. Litigation in this matter is ongoing.

The uncertainty associated with these and other unresolved or threatened lawsuits could seriously harm the Company’s business and financial condition. In particular, the lawsuits or the continued effects of the investigation could harm its relationships with existing customers and its ability to obtain new customers. The continued defense of lawsuits 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 settlements or the lawsuits 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, and although the Company maintains adequate and customary insurance, the size of any such payments could seriously harm the Company’s financial condition.

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.


	By:	/s/ LAUREEN DEBUONO



	Laureen DeBuono
	Executive Vice President,
	Chief Financial Officer
	(Duly Authorized Officer and Principal
	Financial and Accounting Officer)


	1. I have reviewed this quarterly report on Form 10-Q of Critical Path, Inc.

	2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report.

	3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report.

	4. The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:


	a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;

	b) evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and

	c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date.


	5. The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function):


	a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and

	b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls.


	6. The registrant’s other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.


	/s/ WILLIAM E. MCGLASHAN, JR.

	William E. McGlashan, Jr.
	Chief Executive Officer


	1. I have reviewed this quarterly report on Form 10-Q of Critical Path, Inc.

	2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report.

	3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report.

	4. The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:


	a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;

	b) evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and

	c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date.


	5. The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function):


	a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and

	b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls.


	6. The registrant’s other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

43 EX-10.1 3 f85458exv10w1.txt EXHIBIT 10.1 EXHIBIT 10.1 August 12, 2002 Mr. Bernard Harguindeguy Executive Vice President & Chief Marketing Officer Critical Path, Inc. 350 The Embarcadero San Francisco, CA 94105-1204 Dear Bernard: Thank you for your feedback on our proposal this week. Your comments have been very helpful in refining the scope and focus of the project. This letter outlines our approach for working with you and your team to . As an initial deliverable, we will produce a detailed statement of work, in accordance with Proposed Statement of Work, attached hereto as Exhibit A, including our approach to the effort, in the first week of the project. Based on our discussions with you, we understand that you want to complete a first pass evaluation of the enterprise messaging strategy in September. Accordingly, we have designed this project as a five to six week effort with an outside deadline for the entire project of September 30, 2002 ("Deadline"). We will complete our work in roughly five weeks unless otherwise agreed between the parties. Then in the ensuing weeks, we will work with you to prepare your presentation of the enterprise messaging strategy to the designated executive staff of Critical Path. In order to accomplish this on such a tight time schedule, we will need to meet with you on nearly a weekly basis to share our hypotheses, analysis, and findings. As you know, it is difficult to do a comprehensive strategy analysis on such a sweeping topic as the future of messaging in the enterprise in this short a timeframe. In fact, due to the many separate technology and business elements associated with the CP enterprise messaging strategy , a many-month study would be challenged to get to definitive answers. Even though it is impractical to attempt to get to completely defensible conclusions in a five-week effort, we propose a "best efforts" project to validate and refine Critical Path's messaging strategy for the enterprise market. We are confident that in this amount of time we can develop a well-researched perspective on the key trends and demand drivers that will be the key influencers on CP's product roadmap. This approach has one very attractive benefit associated with it. By essentially performing a strategic audit of the messaging business for the enterprise, we will be able to identify with much greater clarity the highest priority issues that deserve further examination. As we get near the completion of this initial effort, we will develop for your review a proposal for a deeper analysis of the remaining high priority issues. PROJECT OBJECTIVES The overall objective of this effort and Deliverables (as defined in Exhibit A) will be to validate and refine the existing strategy for growing the messaging business for the enterprise market. Due to the tight deadline we are working under, we recommend that we focus this effort - Specific objectives shall be as more fully described in the Statement of Work attached hereto as Exhibit A. TIMING, STAFFING AND FEES As we discussed above, we view a five-week effort as a relatively bare-boned initial assessment of such a broad topic. Such efforts shall begin on the date hereof and Deliverables (as defined in Exhibit A) shall be provided no later than September 30, 2002 in accordance with the schedule set forth herein. We believe that the only way to ensure that you and Critical Path ultimately regard this as a successful effort is for you to commit yourself and Phil Pridmore-Brown to frequent interaction with the R.B. Webber project team. We recommend that you should only undertake this effort with us if you commit to weekly reviews. Moreover, this effort -- both in terms of the process and the output -- needs to be "mentally owned" by Critical Path Marketing. We will provide analytical resources and joint-leadership, but your organization and you need to be involved in both the thought process and the conditional branching decisions that inevitably will be made on a week-to-week basis. Accordingly, we plan to complete the analytical portion of the work in roughly five weeks from the project's official kick-off. Then, in the sixth week, we will prepare a presentation of the strategy strawman for enterprise messaging for the appropriate Critical Path audience. As you can see, this approach ensures frequent and tight feedback between us. Our project team will be co-led by Messrs. Lauridsen and Meinhardt. In addition, we will staff this effort with three to four other R.B. Webber professionals. Jeff Webber will act as a consultant to the project throughout this effort. Aggregate professional fees for this phase of work will be $85,000 for the work as described in this Agreement, which shall include all professional time in order to reach the objectives and the Deliverables as described herein and in Exhibit A attached hereto. 2 The standard Critical Path Service Provider Terms and Conditions shall be incorporated by reference herein, as attached as Exhibit B hereto. Actual reasonable expenses will be invoiced at our cost for travel, report preparation, purchased research, and communications. All expenses must be approved in advance in writing by you as discussed below. Expenses shall be capped at 5 percent of professional fees, or $4,250, except with your express written consent. We don't anticipate out-of-town travel, but will seek pre-approval from you before committing to any expenses in this area. Similarly, for any purchased research over $100 we will also seek pre-approval. We do use a number of on-line databases, such as Dialog, that do charge for accessed research on a per item basis. We will be prudent in using these sources, but will be sure to seek pre-approval for any items expected to exceed $100. We bill monthly and our invoices are due net forty-five (45}days in accordance with your standard vendor billing and accounting policies. You will communicate to us any special procedures to be followed by us in order for invoices to be timely processed. To begin, we will need a signed acceptance from you for the work. For your convenience, I have attached an acceptance form to the end of this letter. * * * * Bernard, we fully understand the importance to Critical Path's future of having a "killer strategy" for the enterprise, including playing a critical and differentiating role via wireless messaging. We promise you that we will make this strategic audit highly productive and impactful for Critical Path. While we are undertaking this on a "best efforts" basis, we are confident that together we will develop a very strong fact base and a set of solid strategic directions from which the company can begin to deploy both development and marketing resources. We look forward to working with you and the Critical Path team on this hugely important effort. IN WITNESS WHEREOF, the parties have executed this Agreement as of the above date. PROPOSED BY: ACCEPTED BY: RB WEBBER, INC. CRITICAL PATH, INC. /s/ Jeffrey Webber /s/ William McGlashan - ----------------------------------- ----------------------------------- NAME: NAME: TITLE: TITLE: 3 EX-10.2 4 f85458exv10w2.txt EXHIBIT 10.2 EXHIBIT 10.2 Critical Path, Inc. 415.451.2500 (Main) 350 The Embarcadero 415.451.2300 (Fax) San Francisco, CA 94105-1204 www.cp.net August 27, 2002 THE COHEN GROUP 600 13th St. NW Suite 640 Washington, DC 20005-3096 Re: Letter Agreement for Consulting Services Dear Sirs: This letter shall set forth the terms and conditions under which Critical Path ("CP") is contracting for services with The Cohen Group ("TCG"). 1. ENGAGEMENT: TCG shall generally provide strategic and sales transactional consulting services to CP (the "Engagement") as follows, and as further mutually developed and agreed between the parties. 2. SERVICES AND FEES: CP shall pay a one-time retainer fee of one Hundred and Fifty Thousand Dollars (US $150,000) ("Retainer") as a draw against variable performance-based consulting and transactional services provided and earned against such Retainer as follows: a. Referrals: TCG shall receive an earned fee, credited against the Retainer, of 2% of any executed license revenue sales agreement resulting from simple referrals of entities by TCG to CP. Maintenance, support and professional services revenues generated shall not be considered for purposes of the earned credit. No credit will be earned for entities already in discussions with or contracted with CP and no credits shall be earned on contract renewals, unless CP requests TCG to work on such matters, in which event the credits will reflect the increase in sales to the existing client or the sales made pursuant to such renewal, as applicable, and the fee will be as set forth in Section 2(b) below. b. Direct Sales: TCG shall receive an earned fee, credited against the Retainer, of 10% of any executed license revenue sales agreement that is substantially negotiated by TCG or where direct substantial involvement with the entity is undertaken. Maintenance, support and professional services revenues generated shall not be considered for purposes of the earned credit. No credit will be earned for entities already in discussions with or contracted with CP and no credits shall be earned on contract renewals, unless CP requests TCG to work on such matters, in which event the credits will reflect the increase in sales to the existing client or the sales made pursuant to such renewal, as applicable, and the fee will be as set forth in this Section 2(b). TCG will be entitled to receive the 10% fee set forth herein during the life of each new agreement and any renewals thereof, as well as with respect to any renewals or expansions of agreements with existing CP clients where TCG qualifies for such fee, as provided in the previous sentence. c. Marketing Efforts: TCG shall receive an earned fee, credited against the Retainer, in an amount to be agreed upon by the parties on a case by case basis, for undertaking specific marketing activities at the request of CP. TCG will furnish CP with an invoice reflecting the agreed-upon fee. d. Strategic Analyses: TCG shall receive and earned fee, credited against the Retainer in an amount to be agreed upon by the parties on a case by case basis, for undertaking specific projects requested by CP including, without limitation, business growth plans, identifying prospective business partners, political and industry analyses, and other strategic consulting projects at the request of CP. TCG will furnish CP with an invoice reflecting the agreed-upon fee. e. Other Fees: TCG shall receive a mutually agreed earned fee, credited against the Retainer, upon the occurrence of other mutually agreed objectives or transactions (e.g., introductions to strategic partners and alliances, etc.) as determined by CP and TCG during the course of the Engagement. f. Other Payment Terms. The Retainer shall be paid upon the execution of this letter agreement, and shall be credited upon provision of the performance-based services as described above. Amounts earned in excess of the Retainer will be payable net forty-five (45) days after the execution of the sales agreement, renewal, or receipt by CP of TCG's invoice, as applicable. By agreement of the parties, fees may be paid in a combination of cash and warrants to purchase common stock of CP, the terms of which will be agreed at the time of issuance of such warrant, if ever. Fees will be payable on applicable contracts during the term of the Engagement and for a period of 12 months following any termination of the Engagement, provided that the obligation to pay with respect to any particular contract shall terminate upon the termination of such contract. 3. NO RESELLER: TCG's lines of business do not include acting as a reseller of goods and services and, accordingly, TCG shall not act as a reseller of CP's products and services. 4. EXPENSES: CP shall reimburse TCG for reasonably incurred out-of-pocket actual expenses related to the provision of services hereunder. Such expenses shall be capped at and shall not exceed 5% of the Retainer, or $7,500 during the Engagement, without the prior written consent of CP or they shall not be reimbursed. Expenses shall be invoiced monthly to CP, payable net forty-five (45) days after receipt of invoice. 5. TERM AND TERMINATION: This Agreement shall terminate upon the expiration of one (1) year from the effective date hereof. To the extent TCG has not earned the Retainer this Agreement shall remain in place until such time as the aggregate fee is earned and shall thereafter automatically terminate. Any nonbreaching party may terminate this Agreement (1) at any time on 30 business days' prior written notice to the other party and (2) if the other party has breached any of the provisions of the Agreement, on 5 business days' prior written notice to the breaching party unless such breach shall have been cured to the reasonable satisfaction of the nonbreaching party within such 5 days. In the event of any such termination, TCG will make reasonable efforts to bring closure to any in-process work prior to the effective date of termination of the engagement and will be paid earned professional fees to the effective date of termination. All out-of-pocket expenses reasonably incurred, in accordance with the terms and conditions of the Agreement, up to the effective date of termination shall also be reimbursed if submitted within thirty (30) days of termination. 2 6. NON-DISCLOSURE AGREEMENT: The parties shall enter into a Non-Disclosure Agreement immediately following the execution of this Agreement. 7. INDEMNIFICATION: CP will indemnify TCG for any third party claims made against TCG during the term hereof or for twelve (12) months thereafter arising in connection with the provision of consulting services by TCG under this Agreement, except to the extent that such claim arises from the gross negligence or willful wrongdoing of TCG. TCG will indemnify CP for any third party claims made against CP during the term hereof or for twelve (12) months thereafter arising in connection with the provision of consulting services by TCG under this Agreement to the extent such claim arises from the gross negligence or willful wrongdoing of TCG. The foregoing indemnification by each party shall be subject to the following: The party seeking indemnification hereunder (the "Indemnitee") (i) shall provide prompt written notice of such claim to the party from whom indemnification is sought (the "Indemnitor"); and (ii) shall allow the Indemnitor to defend any such claim using counsel of its choice. The Indemnitor shall not settle any such claim without the express written consent of the Indemnitee, such consent not to be unreasonably withheld. 8. MISCELLANEOUS: This Agreement may not be assigned by either party without the express written consent of the other party. If any provision of this Agreement is found to be illegal or invalid, the remaining provisions shall remain in full force and effect in accordance with their terms. No delay or omission by either party in exercising any right under this Agreement shall operate as a waiver of that or any other right. This Agreement constitutes the entire agreement between the parties relating to the subject matter herein and supersedes all prior agreements and understandings between the parties, whether written or oral. This Agreement may be amended or modified only by a written instrument executed by both parties. This Agreement shall be governed by California law, without regard to its conflict of law provisions. If the scope and terms of this Engagement are acceptable, please acknowledge your acceptance by signing the confirmation attached, returning the enclosed copy of this Letter to as at the above address. If there any questions, please do not hesitate to contact me. CRITICAL PATH, INC. BY: /s/ WILLIAM E. MCGLASHAN, JR. NAME: WILLIAM E. MCGLASHAN, JR. Chief Executive Officer ACKNOWLEDGED AND AGREED: THE COHEN GROUP BY: /s/ JAMES M. BODNER NAME: James M. Bodner, Senior Vice President 3 EX-10.3 5 f85458exv10w3.txt EXHIBIT 10.3 EXHIBIT 10.3 SEPARATION AGREEMENT AND RELEASE This Separation Agreement and Release ("Agreement") is made by and between CRITICAL PATH, INC. (the "Company"), and Pierre Van Beneden ("Employee") (collectively referred to herein as the "Parties") and dated as of October 16, 2002. WHEREAS, Employee was employed by the Company and such employment has terminated; WHEREAS, Employee and Company hereby agree to amend and replace in its entirety that certain Employment Agreement dated as of October 8, 2001 by and between the Parties ("Employment Agreement"); and WHEREAS, Employee and Company hereby agree to the terms and conditions of a consulting and advisory relationship going forward; NOW THEREFORE, in consideration of the mutual promises made herein, the Company and Employee hereby agree as follows: 1. Termination. Employee's full-time employment as President, including all payment of regular base salary and eligibility for bonuses, will terminate as of October 16, 2002 ("Effective Date"), and the Employment Agreement shall thereafter be null and void and have no further force and effect. As of the Effective Date, Employee's services to the Company shall continue as strategic sales consultant ("Consulting Period") through January 17, 2003 ("Termination Date") but Employee will immediately cease to accrue Paid Time Off. During the Consulting Period through the Termination Date, Employee shall provide consulting services as reasonably required by the Company and Employee's successor in order to facilitate an orderly transition of all pending work. In addition, during the Consulting Period, Employee shall also provide sales support with respect to three deals, and to the extent any of these deals close prior to the end of Q4 2002, then Employee shall receive a 5% commission on revenue recognizable in Q4 2002, and a 2.5% commission on revenue recognizable in subsequent periods. Employee's right to indemnification under the Employment Agreement shall terminate as of the Effective Date. 2. Consideration. Upon the Termination Date and in accordance with the Employment Agreement, the Company agrees to pay Employee Three Hundred Thousand Thirty-Seven and Five Hundred dollars and zero cents ($337,500), which equals nine (9) month's salary at the Employee's current base salary and will be paid less all applicable withholdings, in accordance with the Company's standard payroll practices ("Separation Amount"). 3. Vesting of Stock Options. (a) Pursuant to the terms of your Employment Agreement and as of the Effective Date, Company shall accelerate the vesting of options to purchase Three Hundred Thirty-Three Thousand, Three Hundred and Thirty-Three (333,333) shares from Option Grant No. 003378 such that a total of options to purchase 1,152,777 shares, from Option Grant No.003378 and Option Grant No.003438 combined, shall be fully vested and immediately exercisable on the Effective Date (together, all vested and accelerated options are hereinafter referred to as the "Options"). Through the Consulting Period, and provided Employee is otherwise in compliance with the terms and conditions of this Agreement, Employee shall continue to vest in the remainder of the previously granted stock options in accordance with the current vesting schedule under Option Grant No. 003378 and Option Grant No.003438. (b) As of the Termination Date, Employee shall cease vesting in all such stock options previously granted to Employee. Also as of the Termination Date, such definition of "Options" shall be deemed to include those options vested through the Consulting Period under both Option Grant No.003378 and Option Gant No.003438. Employee's right to exercise the Options shall be governed by the terms and conditions of the applicable Company Stock Option Plans and Stock Option Agreement(s) between Employee and the Company, including periods after termination for the exercise of the Options, except as expressly modified by this Agreement. Employee confirms that he or she has read and understood the terms and conditions of the Stock Option Plan and his or her Stock Option Agreement and understands his or her responsibilities contained therein, including the procedures for exercise of stock options contained therein. Employee understands that this Agreement varies the expiration of such Options from that found in the plan and the right to exercise such Options shall expire on the date twelve (12) months of the Termination Date and no further extension of such period shall be granted. Nothing in this Agreement is intended to otherwise supersede or modify the terms and conditions of the Company's Stock Option Plans or any agreements issued in connection with those plans. Company shall not be responsible for the payment of any exercise price or taxes due in connection with the exercise of such Options. 4. Benefits. The Parties acknowledge that Employee does not currently have any employer-sponsored health and welfare benefits and therefore does not have the right to convert health insurance benefits to individual coverage pursuant to COBRA upon timely payment of premiums. Nothing in this Agreement is intended to supercede or modify the terms and conditions of the Company's health benefits plans. The parties recognize that Company granted certain benefits to Employee during the term of his employment, including the lease of an automobile and the lease of an apartment in San Francisco, California, and the Parties agree that all automobile benefits will terminate as of December 31, 2002 and all apartment benefits will terminate as of January 15, 2003. Furthermore the Parties agree that the Company will reimburse Employee for reasonable travel expenses for one (1) transatlantic trip during the Consulting Period for the purposes of shutting down his apartment in San Francisco, California. 5. Payment of Salary. On the Effective Date, Company shall pay Employee for final earned but unpaid salary and commission. On or before the Termination Date, the Company will pay all earned but unpaid Paid Time Off accrued by Employee through the Effective Date. Company will reimburse Employee for all approved business related expenses accrued through the Termination Date in connection with the consulting services to be provided under this Agreement, to the extent that they are incurred in accordance with the current Company travel and expense policies and are properly submitted no later than ten (10) business days after the Termination Date. 6. Release of Claims. a. Civil Code Section 1542. In connection with all releases effected by this Agreement ("Release"), Employee expressly waives any rights or benefits under Section 1542 of the California Civil Code, or any other equivalent statute. California Civil Code Section 1542 (or similar state statutes), provides as follows: A GENERAL RELEASE DOES NOT EXTEND TO CLAIMS WHICH THE CREDITOR DOES NOT KNOW OR SUSPECT TO EXIST IN HER FAVOR AT THE TIME OF EXECUTING THE RELEASE, WHICH IF KNOWN BY HIM MUST HAVE MATERIALLY AFFECTED HER SETTLEMENT WITH THE DEBTOR. Employee fully understands that if any fact, with respect to any matter, covered by this Release is found hereafter to be other than or different from the facts now believed by them to be true, he expressly accept and assume that this Release shall be and remain effective, notwithstanding such difference in the facts. b. Release. Employee agrees that the Separation Amount represents adequate consideration for the purpose of this Release and such Separation Amount constitutes settlement in full of all outstanding obligations owed to Employee by the Company. Except for the promises or obligations made or undertaken in this Agreement and in exchange for the payments and other consideration provided hereunder, Employee, on behalf of himself, and his respective heirs, family members, executors, and assigns, hereby fully and forever releases, acquits, and discharges the Company and its respective officers, directors, employees, investors, shareholders, administrators, affiliates, divisions, subsidiaries, predecessor and successor corporations, and assigns, from, and agrees not to sue concerning, any claim, duty, obligation or cause of action relating to any matters of any kind, whether presently known or unknown, suspected or unsuspected, that he or she may possess arising from any omissions, acts or facts that have occurred up until the Termination Date including, without limitation, any and all claims relating to or arising from Employee's employment relationship with the Company and the termination of that relationship; any and all claims relating to, or arising from, Employee's right to purchase, or actual purchase of shares of stock of the Company, including, without limitation, any claims for rights of rescission, personal tax liabilities, fraud, misrepresentation, breach of fiduciary duty, breach of duty under applicable state corporate law, and securities fraud under any state or federal law; any and all claims for wrongful discharge of employment, wages or other compensation, including but not limited to bonuses and commissions; breach of contract, both express and implied; breach of a covenant of good faith and fair dealing, both express and implied; negligent or intentional infliction of emotional distress; negligent or intentional misrepresentation; negligent or intentional interference with contract or prospective economic advantage; defamation; negligence; personal injury; discrimination, disability discrimination; violation of public policy; retaliation; harassment; any tort claims, including wrongful discharge, assault; battery; harassment; invasion of privacy; false imprisonment; and conversion; any and all claims for violation of any federal, state or municipal statute, including, but not limited to, Title VII of the Civil Rights Act of 1964, the Civil Rights Act of 1991, the Age Discrimination in Employment Act of 1967, the Americans with Disabilities Act of 1990, the Fair Labor Standards Act, the California Fair Employment and Housing Act, and Labor Code section 201, et seq., and all as may be amended from time to time; any and all claims arising out of any other laws and regulations relating to employment or employment discrimination; and any and all claims for attorneys' fees and costs. This release extends to any and all administrative or criminal charges whether before the Division of Labor Standards, Equal Employment Opportunity Commission or the Department of Fair Employment and Housing or any other court or agency to which Employee currently is or shall later become a party. Should Employee ever become a party to any such proceeding, she shall immediately ask any such administrative agency or court to withdraw any such charge as to her The parties acknowledge and agree that all potential or actual disputes between them have been fully and finally settled to their complete satisfaction, leaving no disputes, controversies, claims or grievances of any kind between them. The parties therefore covenant and agree that, except as may be compelled by legal process, they will not raise or in any way pursue any claims which are being released and discharged in this Agreement in any forum of any kind, including, without limitation, the federal, state or local courts, or federal, state or local agencies or offices of any kind, be they administrative, regulatory, judicial, quasi-judicial, or otherwise. The parties further agree that, except as compelled by legal process, they will not aid, assist, abet or in any way encourage any third party to in any way pursue any claims which are being released and discharged in this Agreement. Except pursuant to formal process with appropriate prior notice to Company's counsel, the parties further agree that they will not provide documents, information or testimony to any prospective or actual claimant against one another. The parties represents and warrants that they have not, to date, discussed with any third party the possibility of that third party pursuing claims against the other party; that they have not encouraged any such pursuit of claims. If either party at any time commences or in any manner seeks relief against any of the other party through any suit or other legal proceeding, then that party shall pay in addition to any other damages caused thereby, all attorneys' fees and costs incurred by the other party in defending or otherwise responding to said suit or proceeding. Employee agrees that the release set forth in this section shall be and remain in effect in all respects as a complete general release as to the matters released. Employee understands and agrees that this Release extinguishes all claims by the Employee whether known or unknown and foreseen or unforeseen. c. Acknowledgment of Waiver of Claims under ADEA. To the extent applicable, Employee further acknowledges that he is waiving and releasing any rights he may have under the Age Discrimination in Employment Act of 1967 ("ADEA") and that this waiver and release is knowing and voluntary. Employee and the Company agree that this waiver and release does not apply to any rights or claims that may arise under ADEA after the Effective Date. Employee acknowledges that the consideration given for this waiver and release Agreement is in addition to anything of value to which Employee was already entitled. To the extent the ADEA is applicable to Employee, Employee further acknowledges that he or she has been advised by this writing, as required by the ADEA, that (a) he or she has the right to and should consult with an attorney prior to executing this Agreement (although he or she may execute this Agreement voluntarily earlier); (b) he or she has at least forty-five (45) days within which to consider this Agreement; (c) Employee has been advised that a roster of all individuals affected by the current reduction in force plan of the Company is immediately available to Employee upon request from the Human Resources department; (d) he or she has seven (7) days following the execution of this Agreement to revoke the Agreement by sending a written notice to the Company to the attention of General Counsel, Critical Path, Inc., 350 The Embarcadero, 6th Floor, San Francisco, California 94105-1204; and (e) this Agreement shall not be effective until the revocation period has expired, which shall be the eighth day after it is signed by Employee and Company. 7. Confidentiality. Employee understands and agrees that because of his former position with the Company, comments by him concerning the Company, its plans, prospects, its personnel or any other aspect of the Company's past or future performance could be understood as being based on substantial information not available to the public. Accordingly, Employee agrees not to comment on such aspects of the Company during the Consulting Period or after the Termination Date except that he may describe his accomplishments at the Company to prospective employers and others for purposes of establishing his credentials. The terms of this Agreement are highly confidential and the Parties hereto each agree to use their best efforts to maintain in confidence the existence of this Agreement, the contents and terms of this Agreement, and the consideration for this Agreement (hereinafter collectively referred to as "Settlement Information"). Each Party hereto agrees to take every reasonable precaution to prevent disclosure of any Settlement Information to third parties, and each agrees that there will be no publicity, directly or indirectly, concerning any Settlement Information, except where such disclosure is required by law and as required the by the regulations promulgated under the Securities and Exchange Act of 1934, as amended. The Parties hereto agree to take every precaution to disclose Settlement Information only to those employees, officers, directors, attorneys, accountants, governmental entities, and family members who have a reasonable need to know of such Settlement Information. 8. Proprietary Information and Inventions Agreement and/or Non-Disclosure Agreement. Employee acknowledges and is reminded of, and affirms his agreement to abide by the terms and conditions of a previously executed Proprietary Information and Inventions Agreement and/or a Non-Disclosure Agreement (together the "Confidentiality Agreement") between the Parties. Employee further agrees and understands that he may not disclose to any person or entity any confidential information in violation of the Confidentiality Agreement, whether directly or indirectly, or use or misuse such information in any way. Employee shall promptly return all the Company property and confidential and proprietary information in his possession to the Company on or before the Termination Date. A copy of this Confidentiality Agreement shall be made available to Employee upon request. 9. Insider Trading. Employee acknowledges that through the Termination Date and for a period of three months thereafter, Employee shall continue to be considered an "Affiliate" of the Company as such meaning is defined under the U.S. Securities and Exchange Act of 1934, as amended, and such Employee's trading activities and conduct will continue to be governed by the terms of the Company Insider Trading Policy. 10. Cooperation. Employee agrees to cooperate with Company in investigating, preparing or testifying on any threatened or pending claims, actions, proceedings, whether investigative, administrative, civil or criminal, involving or affecting the Company or any of its subsidiaries or predecessor companies or affiliates. Employee's reasonable, pre-approved out-of-pocket expenses associated with any such assistance shall be reimbursed in connection with these activities as agreed herein. 11. Advisory Board. As of the Effective Date, Employee shall join the Advisory Board of the Company providing support to the Chief Executive Officer of the Company. Such Advisory Board shall meet formally meet once per year and provide other support and counsel to the Chief Executive Officer and other members of the senior management on ad hoc as needed basis. Such service on the Advisory Board shall continue after the Termination Date until such time as mutually agreed by the Parties. Employee recognizes that he will receive no compensation in connection with service on the Advisory Board. 12. Non-solicitation of Customers and Employees. Employee agrees that all customers of the Company shall remain customers or clients of the Company and not Employee. Employee agrees that for the Consulting Period and for a period of one (1) year from the Termination Date, Employee shall not, on behalf of a direct competitor in the messaging market either directly or indirectly, solicit business, as to products or services competitive with those of the Company, from any of the Company's customers or prospective customers. Employee acknowledges and understands that the Company has expended substantial time and effort and resources in assembling, training and managing its present staff of personnel, which constitutes a significant asset of the Company. Accordingly, Employee agrees that for the Consulting Period and for one (1) year from the Termination Date Employee shall not directly or indirectly induce or solicit or encourage any of the Company's employees to leave their employment with the Company, provided that such restrictions shall not apply to newspaper and similar advertisements. 13. No Admission of Liability. The Parties understand and acknowledge that this Agreement constitutes a compromise and settlement of all claims. No action taken by the Parties hereto, or either of them, either previously or in connection with this Agreement shall be deemed or construed to be (a) an admission of the truth or falsity of any claims heretofore made or (b) an acknowledgment or admission by either party of any fault or liability whatsoever to the other party or to any third party. 14. Arbitration. The Parties agree that any and all future disputes or claims arising out of the terms of this Agreement, their interpretation, its breach, and any of the matters herein released, shall be subject to binding arbitration in San Francisco County, California, before the American Arbitration Association under its Employment Dispute Resolution Rules, or by a judge to be mutually agreed upon. In addition to arbitration, the Company is entitled to enforce the terms of this Agreement by seeking injunctive relief in any court of competent jurisdiction. The Parties agree that the prevailing party in any arbitration shall be entitled to injunctive relief in any court of competent jurisdiction to enforce the arbitration award. The Company shall bear the costs of the arbitration except that Employee may be required to pay costs to the same extent as in a civil action filed in the State of California, and unless the arbitrator orders otherwise. Parties agree that the prevailing party in any claim for injunctive relief shall pay each of their own attorney's fees and costs. 15. Non-Disparagement. Each party agrees to refrain from any defamation, libel or slander of the other, or tortious interference with the contracts and relationships of the other. Employee agrees that he or she will refrain from disparaging the Company's business and any and all of its past or present officers, director or other employees. 16. Authority. The Company represents and warrants that the undersigned has the authority to act on behalf of the Company and to bind the Company and all who may claim through it to the terms and conditions of this Agreement. Employee represents and warrants that he or she has the capacity to act on his or her own behalf and on behalf of all who might claim through him or her to bind them to the terms and conditions of this Agreement. Each Party warrants and represents that there are no liens, or claims of lien, or assignments in law or equity or otherwise of or against any of the claims or causes of action released herein. 17. No Representations. Neither party has relied upon any representations or statements made by the other party hereto which are not specifically set forth in this Agreement. 18. Severability. In the event that any provision hereof becomes or is declared by a court of competent jurisdiction to be illegal, unenforceable or void, this Agreement shall continue in full force and effect without said provision. Such provision shall be modified by the court so as to be rendered enforceable insofar as possible consistent with the intent of the Parties to all remaining portions of the Agreement. 19. Entire Agreement. This Agreement represents the entire agreement and understanding between the Company and Employee concerning Employee's employment with and separation from the Company, and supersedes and replaces any and all prior agreements and understandings, whether oral or written, concerning Employee's relationship with the Company and his or her compensation by the Company, except for the Confidentiality Agreement (as defined herein). Parole evidence shall be inadmissible to show agreement by and between the Parties as to any term or condition contrary to or in addition to the terms and conditions hereof. Any and all such prior agreements and understandings with respect to the subject matter herein, including agreements for compensation, including bonuses and commissions, are also hereby terminated and of no further force and effect, and Employee hereby expressly disclaims any and all rights in connection with any previous agreements, if any, whether oral or written. 20. No Oral Modification. This Agreement may only be amended in writing signed by Employee and the Chief Executive Officer or Chief Financial Officer of the Company. 21. Governing Law. This Agreement shall be governed by the laws of the State of California. Both Parties submit to jurisdiction in California and further agree that any cause of action arising under this Agreement shall be brought before an arbitrator in a court in San Francisco County, California. 22. Counterparts. This Agreement may be executed in counterparts, and each counterpart shall have the same force and effect as an original and shall constitute an effective, binding agreement on the part of each of the undersigned. 23. Voluntary Execution of Agreement. This Agreement is executed voluntarily and without any duress or undue influence on the part or behalf of the Parties hereto, with the full intent of releasing all claims. Employee acknowledges that: (a) he or she has read this Agreement; (b) has been represented in the preparation, negotiation, and execution of this Agreement by legal counsel of his or her own choice or that he or she has voluntarily declined to seek such counsel; (c) understands the terms and consequences of this Agreement and of the releases it contains; (d) is fully aware of the legal and binding effect of this Agreement. IN WITNESS WHEREOF, the Parties have executed this Agreement as of the date set forth on the first page of this Agreement. Dated: As of October 16, 2002 By /s/ William McGlashan ------------------------------------------ Name: William E. McGlashan, Jr. Title: Chief Executive Officer and Chairman of the Board of Directors Dated: As of October 16, 2002 By /s/ Pierre Van Beneden ------------------------------------------ Pierre Van Beneden EX-15.1 6 f85458exv15w1.txt EXHIBIT 15.1 EXHIBIT 15.1 November 5, 2002 Securities and Exchange Commission 450 Fifth Street, N.W. Washington, D.C. 20549 Commissioners: We are aware that our report dated November 5, 2002 on our review of interim financial information of Critical Path, Inc. (the "Company') as of and for the period ended September 30, 2002 and included in the Company's quarterly report on Form 10-Q for the quarter then ended is incorporated by reference its Registration Statements on Form S-8 (Nos. 333-63080, 333-51504, 333-44418, 333-40476, 333-36228, 333-95933, 333-95279, 333-87553) and on Form S-3 (Nos. 333-39958, 333-38006, 333-38000, 333-36382). Very truly yours, /s/ PricewaterhouseCoopers LLP EX-99.1 7 f85458exv99w1.txt EXHIBIT 99.1 EXHIBIT 99.1 STATEMENT OF CHIEF EXECUTIVE OFFICER UNDER 18 U.S.C. SECTION 1350 I, William McGlashan, Jr., the chief executive officer of Critical Path, Inc. (the "Company"), certify for the purposes of section 1350 of chapter 63 of title 18 of the United States Code that, to my knowledge, (i) the Quarterly Report of the Company on Form 10-Q for the period ending September 30, 2002 (the "Report") and filed with the U.S. Securities and Exchange Commission on the date hereof, fully complies with the requirements of section 13(a) and 15(d) of the Securities Exchange Act of 1934, as amended; and (ii) the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. /s/ William McGlashan ------------------------------------------- William McGlashan, Jr. Chief Executive Officer and Chairman of the Board of Directors November 14, 2002 EX-99.2 8 f85458exv99w2.txt EXHIBIT 99.2 EXHIBIT 99.2 STATEMENT OF CHIEF FINANCIAL OFFICER UNDER 18 U.S.C. SECTION 1350 I, Laureen DeBuono, the chief financial officer of Critical Path, Inc. (the "Company"), certify for the purposes of section 1350 of chapter 63 of title 18 of the United States Code that, to my knowledge, (i) the Quarterly Report of the Company on Form 10-Q for the period ending September 30, 2002 (the "Report"), and filed with the U.S. Securities and Exchange Commission on the date hereof, fully complies with the requirements of section 13(a) and 15(d) of the Securities Exchange Act of 1934, as amended; and (ii) the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. /s/ Laureen DeBuono ------------------------------------------- Laureen DeBuono Executive Vice President and Chief Financial Officer November 14, 2002 -----END PRIVACY-ENHANCED MESSAGE-----


þ		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

		For the quarterly period ended September 30, 2002

o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

		For the transition period from to .


PART I
	Item 1. Condensed Consolidated Financial Statements (Unaudited)
CONDENSED CONSOLIDATED BALANCE SHEETS
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
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
SUPPLEMENTAL ALTERNATIVE MEASUREMENT FINANCIAL DATA
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
	Item 3. Quantitative and Qualitative Disclosures About Market Risk
	Item 4. Controls and Procedures
REPORT OF INDEPENDENT ACCOUNTANTS
PART 2 -- OTHER INFORMATION
	Item 1. Legal Proceedings
	Item 6. Exhibits and Report on Form 8-K
SIGNATURE
CERTIFICATIONS
INDEX TO EXHIBITS
Exhibit 10.1
Exhibit 10.2
Exhibit 10.3
Exhibit 15.1
Exhibit 99.1
Exhibit 99.2


		Page

PART I
Item 1.	Condensed Consolidated Financial Statements (Unaudited)
	Condensed Consolidated Balance Sheets		2
	Condensed Consolidated Statements of Operations		3
	Condensed Consolidated Statements of Cash Flows		4
	Notes to Condensed Consolidated Financial Statements		5
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		14
	Supplemental Alternative Measurement Financial Data (Unaudited)		34
Item 3.	Quantitative and Qualitative Disclosures About Market Risk		36
Item 4.	Controls and Procedures		36
	Report of Independent Accountants		37
PART II
Item 1.	Legal Proceedings		38
Item 6.	Exhibits and Reports on Form 8-K		39
	Signature		40
	Certifications		41
	Index to Exhibits		43


				December 31,			September 30,
				2001			2002

							(Unaudited)

				(In thousands, except per
				share amounts)
ASSETS
Current assets
	Cash and cash equivalents			$	59,463		$	35,439
	Short-term investments				9,702			13,773
	Accounts receivable, net				26,692			22,061
	Other current assets				5,367			4,553

			Total current assets		101,224			75,826
Investments					7,215			1,704
Property and equipment, net					36,285			21,686
Goodwill					5,631			6,613
Other intangible assets, net					43,010			10,744
Restricted cash					2,674			5,715
Other assets					3,913			5,530

			Total assets	$	199,952		$	127,818

LIABILITIES, MANDATORILY REDEEMABLE PREFERRED STOCK AND SHAREHOLDERS’ EQUITY
Current liabilities
	Accounts payable			$	25,955		$	29,208
	Accrued expenses				6,232			4,708
	Deferred revenue				10,297			9,153
	Capital lease and other obligations, current				3,431			3,224

			Total current liabilities		45,915			46,293
Convertible subordinated notes payable					38,360			38,360
Capital lease and other obligations, long-term					1,149			1,599

			Total liabilities		85,424			86,252

Commitments and contingencies (Note 2)
Mandatorily redeemable preferred stock					5,373			17,868

Shareholders’ equity
	Common stock and paid-in-capital, $0.001 par value
		Shares authorized: 500,000
		Shares issued and outstanding: 76,581 and 79,852, respectively			2,176,370			2,169,714
	Common stock warrants				5,250			5,947
	Notes receivable from shareholders				(1,222	)		—
	Unearned compensation				(7,050	)		(646	)
	Accumulated deficit, including other comprehensive loss				(2,064,193	)		(2,151,317	)

			Total shareholders’ equity		109,155			23,698

			Total liabilities, mandatorily redeemable preferred stock and shareholders’ equity	$	199,952		$	127,818



				Three Months Ended						Nine Months Ended

				September 30,			September 30,			September 30,			September 30,
				2001			2002			2001			2002


				(Unaudited)
				(In thousands, except per share amounts)
Net revenues
	Software license			$	7,724		$	5,929		$	22,187		$	27,740
	Hosted messaging				10,000			6,461			35,580			19,007
	Professional services				4,206			3,053			10,523			7,635
	Maintenance and support				4,857			3,725			12,725			10,917

			Total net revenues		26,787			19,168			81,015			65,299

Cost of net revenues
	Software license				517			563			934			1,436
	Hosted messaging				13,982			7,448			49,360			22,835
	Professional services				2,565			2,393			8,125			7,002
	Maintenance and support				2,837			2,222			7,837			6,549
	Amortization of purchased technology				4,970			4,631			16,314			13,892
	Stock-based expense — Hosted messaging				339			113			1,165			530
	Stock-based expense — Professional services				161			50			1,182			196
	Stock-based expense — Maintenance and support				131			92			1,056			364
	Impairment of long-lived assets				—			—			4,207			—

			Total cost of net revenues		25,502			17,512			90,180			52,804

Gross profit (loss)					1,285			1,656			(9,165	)		12,495

Operating expenses
	Sales and marketing				11,018			10,945			45,424			33,262
	Research and development				7,322			5,154			25,589			15,329
	General and administrative				9,447			5,362			34,485			18,336
	Amortization of intangible assets				7,318			6,209			25,229			18,567
	Acquisition-related retention bonuses				92			—			1,055			11
	Stock-based expense — Sales and marketing				1,008			452			4,623			3,637
	Stock-based expense — Research and development				531			287			2,857			1,062
	Stock-based expense — General and administrative				4,914			212			19,981			3,620
	Restructuring expense, net				3,779			—			12,260			1,539
	Impairment of long-lived assets				—			—			9,991			—

		Total operating expenses			45,429			28,621			181,494			95,363

Loss from operations					(44,144	)		(26,965	)		(190,659	)		(82,868	)
Interest and other income (expense), net					178			1,927			4,796			(803	)
Interest expense					(3,829	)		(740	)		(14,211	)		(2,256	)
Equity in net loss of joint venture					(346	)		—			(1,519	)		(1,408	)
Gain on retirement of convertible subordinated notes, net					137,222			—			141,040			—

Income (loss) before income taxes					89,081			(25,778	)		(60,553	)		(87,335	)
Provision for income taxes					(2,180	)		(234	)		(3,673	)		(255	)

Net income (loss)					86,901			(26,012	)		(64,226	)		(87,590	)
Accretion on mandatorily redeemable convertible preferred shares					—			(3,600	)		—			(10,067	)

Net income (loss) attributable to common shares				$	86,901		$	(29,612	)	$	(64,226	)	$	(97,657	)

Net income (loss) per share attributable to common shares
	Basic			$	1.17		$	(0.38	)	$	(0.87	)	$	(1.26	)

	Diluted			$	1.15		$	(0.38	)	$	$(0.87	)	$	(1.26	)

Weighted average common shares outstanding
	Basic				74,492			78,265			73,472			77,523
	Diluted				75,589			78,265			73,472			77,523


A California Corporation		I.R.S. Employer No. 91-1788300


	January 1,				September 30,
	2002		Acquisition		2002

United States	$	2,386	$	—	$	2,386
Europe		3,245		—		3,245
Other		—		982		982

	$	5,631	$	982	$	6,613


	Gross		Accumulated			Net Book
	Amount		Amortization			Value

Existing technology	$	39,748	$	(35,134	)	$	4,614
Strategic relationships — warrants		38,660		(33,829	)		4,831
Customer base		12,493		(11,285	)		1,208
Patents		726		(635	)		91

	$	91,627	$	(80,883	)	$	10,744


	*If we fail to improve our sales and marketing results, we may be unable to grow our business, which would negatively impact our operating results.*


	*We have a history of losses, expect continuing losses and may never achieve profitability.*


	*We have experienced significant turnover of senior management and our executive management team has been together for a limited time, which could harm our business and operations.*


	*We depend on strategic relationships and the loss of any key strategic relationships could harm our business and negatively affect our revenues.*


	*A limited number of customers account for a high percentage of our revenues and if we lose a major customer or are unable to attract new customers, revenues could decline.*


	*If we are unable to successfully compete in our product market, our operating results could be harmed.*


	*Our sales cycle is lengthy, has lengthened in recent quarters, and our results could be harmed by delays or cancellations in orders.*


	*Basis of Presentation*


	*Segment and Geographic Information*


	*Reclassifications*


	*Recent accounting pronouncements*


	*We may need to raise additional capital and to initiate other operational strategies that may dilute existing shareholders.*


	*Pending litigation could harm relationships with existing or potential strategic partners and customers, and divert management’s attention, either of which could harm our business.*


	*Failure to resolve pending securities claims and other material lawsuits could significantly harm our business.*


	*Although concluded without monetary penalties to the Company, lingering effects of the recent SEC investigation could harm our business.*


	*Our failure to carefully manage expenses and growth could cause our operating results to suffer.*


	*We may not be able to maintain our listing on The Nasdaq National Market and if we fail to do so, the price and liquidity of our common stock may decline.*


	Our stock price has demonstrated volatility and overall declines during recent quarters and continued volatility in the stock market may cause further fluctuations and/or decline in our stock price.


	*Limitations of our director and officer liability insurance may harm our business.*


	*We may experience difficulty in attracting and retaining key personnel, which may negatively affect our ability to develop new services or retain and attract customers.*


	*If we are not successful in implementing strategic plans for our operations, our business could be negatively impacted.*


	*We may face continued technical, operational and strategic challenges preventing us from successfully integrating or divesting acquired businesses.*


	*We currently license many third-party technologies and may need to license further technologies and we face risks in doing so that could cause our operating results to suffer.*


	*If our system security is breached, our business and reputation could suffer.*


	*Changes in the regulatory environment for the operation of our business or those of our customers could pose risks.*


	*Unknown software defects could disrupt our services and harm our business and reputation.*


	*We may have liability for Internet content and we may not have adequate liability insurance.*


	*Unplanned system interruptions and capacity constraints could reduce our ability to provide messaging services and could harm our business reputation.*


	We rely on trademark, copyright, trade secret laws, contractual restrictions and patents to protect our proprietary rights, and if these rights are not sufficiently protected, our ability to compete and generate revenue could be harmed.


	*We may not be able to respond to the rapid technological change of the messaging and directory infrastructure industry.*


	*Our reserves may be insufficient to cover bills we are unable to collect.*